Howard Marks put it nicely when he said that, rather than worrying about share price volatility, ‘The possibility of permanent loss is the risk I worry about… and every practical investor I know worries about. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. Importantly, Public Joint-Stock Company Interregional Distribution Grid Company of Volga (MCX:MRKV) does carry debt. But the more important question is: how much risk is that debt creating?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Part and parcel of capitalism is the process of ‘creative destruction’ where failed businesses are mercilessly liquidated by their bankers. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Interregional Distribution Grid Company of Volga’s Net Debt?
As you can see below, Interregional Distribution Grid Company of Volga had ₽3.38b of debt, at September 2019, which is about the same the year before. You can click the chart for greater detail. However, because it has a cash reserve of ₽1.40b, its net debt is less, at about ₽1.98b.
How Healthy Is Interregional Distribution Grid Company of Volga’s Balance Sheet?
The latest balance sheet data shows that Interregional Distribution Grid Company of Volga had liabilities of ₽6.46b due within a year, and liabilities of ₽9.29b falling due after that. Offsetting these obligations, it had cash of ₽1.40b as well as receivables valued at ₽6.36b due within 12 months. So it has liabilities totalling ₽8.00b more than its cash and near-term receivables, combined.
While this might seem like a lot, it is not so bad since Interregional Distribution Grid Company of Volga has a market capitalization of ₽17.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it’s clear that we should definitely closely examine whether it can manage its debt without dilution.
We measure a company’s debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Interregional Distribution Grid Company of Volga has a low debt to EBITDA ratio of only 0.22. And remarkably, despite having net debt, it actually received more in interest over the last twelve months than it had to pay. So it’s fair to say it can handle debt like a hotshot teppanyaki chef handles cooking. The modesty of its debt load may become crucial for Interregional Distribution Grid Company of Volga if management cannot prevent a repeat of the 49% cut to EBIT over the last year. When it comes to paying off debt, falling earnings are no more useful than sugary sodas are for your health. There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Interregional Distribution Grid Company of Volga can strengthen its balance sheet over time. So if you’re focused on the future you can check out this free report showing analyst profit forecasts.
But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Interregional Distribution Grid Company of Volga produced sturdy free cash flow equating to 58% of its EBIT, about what we’d expect. This cold hard cash means it can reduce its debt when it wants to.
Interregional Distribution Grid Company of Volga’s EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. There’s no doubt that its ability to to cover its interest expense with its EBIT is pretty flash. It’s also worth noting that Interregional Distribution Grid Company of Volga is in the Electric Utilities industry, which is often considered to be quite defensive. Looking at all this data makes us feel a little cautious about Interregional Distribution Grid Company of Volga’s debt levels. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Take risks, for example – Interregional Distribution Grid Company of Volga has 1 warning sign we think you should be aware of.
Of course, if you’re the type of investor who prefers buying stocks without the burden of debt, then don’t hesitate to discover our exclusive list of net cash growth stocks, today.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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