We Think Second Generating Company of the Electric Power Wholesale Market (MCX:OGKB) Can Stay On Top Of Its Debt

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. 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?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. 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

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

The image below, which you can click on for greater detail, shows that at March 2021 Second Generating Company of the Electric Power Wholesale Market had debt of ₽43.1b, up from ₽35.1b in one year. And it doesn't have much cash, so its net debt is about the same.

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

Zooming in on the latest balance sheet data, we can see that Second Generating Company of the Electric Power Wholesale Market had liabilities of ₽19.6b due within 12 months and liabilities of ₽59.8b due beyond that. On the other hand, it had cash of ₽384.0m and ₽32.1b worth of receivables due within a year. So its liabilities total ₽46.9b more than the combination of its cash and short-term receivables.

While this might seem like a lot, it is not so bad since Second Generating Company of the Electric Power Wholesale Market has a market capitalization of ₽86.7b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

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 1.3 times its EBITDA. And its EBIT easily covers its interest expense, being 11.5 times the size. So we're pretty relaxed about its super-conservative use of debt. On the other hand, Second Generating Company of the Electric Power Wholesale Market saw its EBIT drop by 5.1% in the last twelve months. If earnings continue to decline at that rate the company may have increasing difficulty managing its debt load. There's no doubt that we learn most about debt from the balance sheet. 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.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. 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 72% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

Both Second Generating Company of the Electric Power Wholesale Market's ability to to cover its interest expense with its EBIT and its conversion of EBIT to free cash flow gave us comfort that it can handle its debt. Having said that, its EBIT growth rate somewhat sensitizes us to potential future risks to the balance sheet. Considering this range of data points, we think Second Generating Company of the Electric Power Wholesale Market is in a good position to manage its debt levels. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. 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 example Second Generating Company of the Electric Power Wholesale Market has 2 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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This article by Simply Wall St is general in nature. 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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