These 4 Measures Indicate That Interregional Distribution Grid Company of the North-West (MCX:MRKZ) Is Using Debt In A Risky Way

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. Importantly, Public Joint-Stock Company Interregional Distribution Grid Company of the North-West (MCX:MRKZ) does carry debt. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Interregional Distribution Grid Company of the North-West

What Is Interregional Distribution Grid Company of the North-West's Net Debt?

The chart below, which you can click on for greater detail, shows that Interregional Distribution Grid Company of the North-West had ₽15.4b in debt in June 2020; about the same as the year before. However, it also had ₽636.0m in cash, and so its net debt is ₽14.7b.

How Strong Is Interregional Distribution Grid Company of the North-West's Balance Sheet?

The latest balance sheet data shows that Interregional Distribution Grid Company of the North-West had liabilities of ₽14.2b due within a year, and liabilities of ₽15.8b falling due after that. On the other hand, it had cash of ₽636.0m and ₽5.39b worth of receivables due within a year. So it has liabilities totalling ₽23.9b more than its cash and near-term receivables, combined.

This deficit casts a shadow over the ₽4.93b company, like a colossus towering over mere mortals. So we'd watch its balance sheet closely, without a doubt. After all, Interregional Distribution Grid Company of the North-West would likely require a major re-capitalisation if it had to pay its creditors today.

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.

While Interregional Distribution Grid Company of the North-West has a quite reasonable net debt to EBITDA multiple of 2.4, its interest cover seems weak, at 1.7. The main reason for this is that it has such high 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 the North-West's EBIT was down 34% 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 the North-West'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 it's worth checking how much of that EBIT is backed by free cash flow. Considering the last two years, Interregional Distribution Grid Company of the North-West actually recorded a cash outflow, overall. Debt is far more risky for companies with unreliable free cash flow, so shareholders should be hoping that the past expenditure will produce free cash flow in the future.

Our View

On the face of it, Interregional Distribution Grid Company of the North-West's EBIT growth rate left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. 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 the North-West commonly do use debt without problems. Considering all the factors previously mentioned, we think that Interregional Distribution Grid Company of the North-West really is carrying too much debt. To us, that makes the stock rather risky, like walking through a dog park with your eyes closed. But some investors may feel differently. 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. To that end, you should learn about the 4 warning signs we've spotted with Interregional Distribution Grid Company of the North-West (including 1 which is is a bit concerning) .

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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