Is Second Generating Company of the Electric Power Wholesale Market (MCX:OGKB) A Risky Investment?

By
Simply Wall St
Published
January 19, 2022
MISX:OGKB
Source: Shutterstock

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 can see that Public Joint-Stock Company "Second Generating Company of the Electric Power Wholesale Market" (MCX:OGKB) does use debt in its business. But should shareholders be worried about its use of debt?

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 common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Of course, debt can be an important tool in businesses, particularly capital heavy businesses. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Second Generating Company of the Electric Power Wholesale Market

What Is Second Generating Company of the Electric Power Wholesale Market's Net Debt?

The chart below, which you can click on for greater detail, shows that Second Generating Company of the Electric Power Wholesale Market had ₽38.0b in debt in September 2021; about the same as the year before. And it doesn't have much cash, so its net debt is about the same.

debt-equity-history-analysis
MISX:OGKB Debt to Equity History January 19th 2022

How Strong Is Second Generating Company of the Electric Power Wholesale Market's Balance Sheet?

We can see from the most recent balance sheet that Second Generating Company of the Electric Power Wholesale Market had liabilities of ₽13.0b falling due within a year, and liabilities of ₽59.7b due beyond that. Offsetting this, it had ₽57.0m in cash and ₽26.4b in receivables that were due within 12 months. So it has liabilities totalling ₽46.3b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₽63.4b, so it does suggest shareholders should keep an eye on Second Generating Company of the Electric Power Wholesale Market's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

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). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Second Generating Company of the Electric Power Wholesale Market's net debt is only 1.00 times its EBITDA. And its EBIT easily covers its interest expense, being 19.9 times the size. So we're pretty relaxed about its super-conservative use of debt. In addition to that, we're happy to report that Second Generating Company of the Electric Power Wholesale Market has boosted its EBIT by 47%, thus reducing the spectre of future debt repayments. 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 Second Generating Company of the Electric Power Wholesale Market 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. During the last three years, Second Generating Company of the Electric Power Wholesale Market produced sturdy free cash flow equating to 69% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Second Generating Company of the Electric Power Wholesale Market's interest cover suggests it can handle its debt as easily as Cristiano Ronaldo could score a goal against an under 14's goalkeeper. But truth be told we feel its level of total liabilities does undermine this impression a bit. When we consider the range of factors above, it looks like Second Generating Company of the Electric Power Wholesale Market is pretty sensible with its use of debt. That means they are taking on a bit more risk, in the hope of boosting shareholder returns. 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. For instance, we've identified 3 warning signs for Second Generating Company of the Electric Power Wholesale Market (1 is a bit concerning) you should be aware of.

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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