Does Rosseti Volga (MCX:MRKV) Have A Healthy Balance Sheet?

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We note that Public Joint Stock Company Rosseti Volga (MCX:MRKV) does have debt on its balance sheet. 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. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Rosseti Volga

How Much Debt Does Rosseti Volga Carry?

The image below, which you can click on for greater detail, shows that at September 2020 Rosseti Volga had debt of ₽6.68b, up from ₽3.38b in one year. However, because it has a cash reserve of ₽724.2m, its net debt is less, at about ₽5.96b.

How Healthy Is Rosseti Volga's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Rosseti Volga had liabilities of ₽7.82b due within 12 months and liabilities of ₽13.6b due beyond that. Offsetting this, it had ₽724.2m in cash and ₽6.02b in receivables that were due within 12 months. So it has liabilities totalling ₽14.6b more than its cash and near-term receivables, combined.

Given this deficit is actually higher than the company's market capitalization of ₽13.1b, we think shareholders really should watch Rosseti Volga's debt levels, like a parent watching their child ride a bike for the first time. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Rosseti Volga has net debt of just 1.0 times EBITDA, indicating that it is certainly not a reckless borrower. And it boasts interest cover of 8.0 times, which is more than adequate. The modesty of its debt load may become crucial for Rosseti Volga if management cannot prevent a repeat of the 75% 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 it is future earnings, more than anything, that will determine Rosseti Volga'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Rosseti Volga created free cash flow amounting to 20% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Our View

Mulling over Rosseti Volga's attempt at (not) growing its EBIT, we're certainly not enthusiastic. But on the bright side, its net debt to EBITDA is a good sign, and makes us more optimistic. It's also worth noting that Rosseti Volga is in the Electric Utilities industry, which is often considered to be quite defensive. Overall, we think it's fair to say that Rosseti Volga has enough debt that there are some real risks around the balance sheet. If everything goes well that may pay off but the downside of this debt is a greater risk of permanent losses. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Rosseti Volga is showing 2 warning signs in our investment analysis , you should know about...

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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