Interregional Distribution Grid Company of Urals (MCX:MRKU) Seems To Be Using A Lot Of Debt

The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. As with many other companies Interregional Distribution Grid Company of Urals, Joint Stock Company (MCX:MRKU) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Interregional Distribution Grid Company of Urals

What Is Interregional Distribution Grid Company of Urals's Debt?

You can click the graphic below for the historical numbers, but it shows that as of September 2020 Interregional Distribution Grid Company of Urals had ₽20.3b of debt, an increase on ₽16.4b, over one year. However, it also had ₽2.70b in cash, and so its net debt is ₽17.5b.

A Look At Interregional Distribution Grid Company of Urals' Liabilities

The latest balance sheet data shows that Interregional Distribution Grid Company of Urals had liabilities of ₽15.8b due within a year, and liabilities of ₽28.8b falling due after that. On the other hand, it had cash of ₽2.70b and ₽7.75b worth of receivables due within a year. So its liabilities total ₽34.2b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the ₽13.6b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Interregional Distribution Grid Company of Urals would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Even though Interregional Distribution Grid Company of Urals's debt is only 2.0, its interest cover is really very low at 2.1. In large part that's it has so much depreciation and amortisation. While companies often boast that these charges are non-cash, most such businesses will therefore require ongoing investment (that is not expensed.) Either way there's no doubt the stock is using meaningful leverage. Shareholders should be aware that Interregional Distribution Grid Company of Urals's EBIT was down 61% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Interregional Distribution Grid Company of Urals's ability to maintain a healthy balance sheet going forward. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. During the last three years, Interregional Distribution Grid Company of Urals burned a lot of cash. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.

Our View

To be frank both Interregional Distribution Grid Company of Urals's EBIT growth rate and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its net debt to EBITDA is not so bad. We should also note that Electric Utilities industry companies like Interregional Distribution Grid Company of Urals commonly do use debt without problems. We think the chances that Interregional Distribution Grid Company of Urals has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. We've identified 3 warning signs with Interregional Distribution Grid Company of Urals (at least 2 which are significant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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