Is Mordovia Energy Retail Company (MCX:MRSB) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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. We can see that Mordovia Energy Retail Company Public Joint-Stock Company (MCX:MRSB) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

View our latest analysis for Mordovia Energy Retail Company

What Is Mordovia Energy Retail Company's Net Debt?

As you can see below, Mordovia Energy Retail Company had ₽631.1m of debt, at September 2020, which is about the same as the year before. You can click the chart for greater detail. However, it also had ₽64.1m in cash, and so its net debt is ₽566.9m.

How Strong Is Mordovia Energy Retail Company's Balance Sheet?

We can see from the most recent balance sheet that Mordovia Energy Retail Company had liabilities of ₽1.23b falling due within a year, and liabilities of ₽2.59m due beyond that. Offsetting this, it had ₽64.1m in cash and ₽883.9m in receivables that were due within 12 months. So it has liabilities totalling ₽286.0m more than its cash and near-term receivables, combined.

This deficit isn't so bad because Mordovia Energy Retail Company is worth ₽508.4m, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. 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.

While we wouldn't worry about Mordovia Energy Retail Company's net debt to EBITDA ratio of 3.9, we think its super-low interest cover of 2.3 times is a sign of high leverage. So shareholders should probably be aware that interest expenses appear to have really impacted the business lately. Looking on the bright side, Mordovia Energy Retail Company boosted its EBIT by a silky 52% in the last year. Like a mother's loving embrace of a newborn that sort of growth builds resilience, putting the company in a stronger position to manage its debt. The balance sheet is clearly the area to focus on when you are analysing debt. But you can't view debt in total isolation; since Mordovia Energy Retail Company will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent two years, Mordovia Energy Retail Company recorded free cash flow of 33% of its EBIT, which is weaker than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On our analysis Mordovia Energy Retail Company's EBIT growth rate should signal that it won't have too much trouble with its debt. But the other factors we noted above weren't so encouraging. In particular, interest cover gives us cold feet. It's also worth noting that Mordovia Energy Retail Company 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 Mordovia Energy Retail Company's debt levels. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. These risks can be hard to spot. Every company has them, and we've spotted 2 warning signs for Mordovia Energy Retail Company 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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