Warren Buffett famously said, 'Volatility is far from synonymous with risk.' 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 can see that Public Joint-Stock Company "Rosseti Moscow Region" (MCX:MSRS) does use debt in its business. 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. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Rosseti Moscow Region Carry?
The chart below, which you can click on for greater detail, shows that Rosseti Moscow Region had ₽86.6b in debt in September 2020; about the same as the year before. However, because it has a cash reserve of ₽7.90b, its net debt is less, at about ₽78.7b.
A Look At Rosseti Moscow Region's Liabilities
We can see from the most recent balance sheet that Rosseti Moscow Region had liabilities of ₽50.9b falling due within a year, and liabilities of ₽125.3b due beyond that. Offsetting this, it had ₽7.90b in cash and ₽12.7b in receivables that were due within 12 months. So it has liabilities totalling ₽155.5b more than its cash and near-term receivables, combined.
The deficiency here weighs heavily on the ₽67.7b 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'd watch its balance sheet closely, without a doubt. After all, Rosseti Moscow Region would likely require a major re-capitalisation if it had to pay its creditors today.
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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.
Rosseti Moscow Region has net debt worth 2.0 times EBITDA, which isn't too much, but its interest cover looks a bit on the low side, with EBIT at only 4.2 times the interest expense. In large part that's due to the company's significant depreciation and amortisation charges, which arguably mean its EBITDA is a very generous measure of earnings, and its debt may be more of a burden than it first appears. Notably Rosseti Moscow Region's EBIT was pretty flat over the last year. Ideally it can diminish its debt load by kick-starting earnings growth. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Rosseti Moscow Region can strengthen its balance sheet over time. 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. Looking at the most recent three years, Rosseti Moscow Region recorded free cash flow of 25% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.
Mulling over Rosseti Moscow Region's attempt at staying on top of its total liabilities, we're certainly not enthusiastic. But at least its net debt to EBITDA is not so bad. It's also worth noting that Rosseti Moscow Region is in the Electric Utilities industry, which is often considered to be quite defensive. We're quite clear that we consider Rosseti Moscow Region to be really rather risky, as a result of its balance sheet health. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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 be aware of the 1 warning sign we've spotted with Rosseti Moscow Region .
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.
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