Second Generating Company of the Electric Power Wholesale Market (MCX:OGKB) Seems To Use Debt Quite Sensibly

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.' 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 "Second Generating Company of the Electric Power Wholesale Market" (MCX:OGKB) does have debt on its balance sheet. But should shareholders be worried about its use of debt?

When Is Debt A Problem?

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 frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

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

How Much Debt Does Second Generating Company of the Electric Power Wholesale Market Carry?

As you can see below, at the end of June 2021, Second Generating Company of the Electric Power Wholesale Market had ₽38.0b of debt, up from ₽35.2b a year ago. Click the image for more detail. Net debt is about the same, since the it doesn't have much cash.

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

According to the last reported balance sheet, Second Generating Company of the Electric Power Wholesale Market had liabilities of ₽20.2b due within 12 months, and liabilities of ₽59.9b due beyond 12 months. On the other hand, it had cash of ₽86.0m and ₽30.6b worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽49.4b.

Second Generating Company of the Electric Power Wholesale Market has a market capitalization of ₽83.5b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

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). 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 has a low net debt to EBITDA ratio of only 1.1. And its EBIT easily covers its interest expense, being 14.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. Also good is that Second Generating Company of the Electric Power Wholesale Market grew its EBIT at 15% over the last year, further increasing its ability to manage debt. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Second Generating Company of the Electric Power Wholesale Market's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Second Generating Company of the Electric Power Wholesale Market produced sturdy free cash flow equating to 73% of its EBIT, about what we'd expect. This free cash flow puts the company in a good position to pay down debt, when appropriate.

Our View

The good news is that Second Generating Company of the Electric Power Wholesale Market's demonstrated ability to cover its interest expense with its EBIT delights us like a fluffy puppy does a toddler. But, on a more sombre note, we are a little concerned by its level of total liabilities. Taking all this data into account, it seems to us that Second Generating Company of the Electric Power Wholesale Market takes a pretty sensible approach to debt. While that brings some risk, it can also enhance returns for shareholders. 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. To that end, you should learn about the 2 warning signs we've spotted with Second Generating Company of the Electric Power Wholesale Market (including 1 which makes us a bit uncomfortable) .

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.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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