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.' 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. As with many other companies Public Joint Stock Company Gazprom Gazoraspredelenie Rostov-na-Donu (MCX:RTGZ) makes use of debt. But the real question is whether this debt is making the company risky.
What Risk Does Debt Bring?
Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. If things get really bad, the lenders can take control of the business. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
How Much Debt Does Gazprom Gazoraspredelenie Rostov-na-Donu Carry?
The image below, which you can click on for greater detail, shows that at December 2020 Gazprom Gazoraspredelenie Rostov-na-Donu had debt of ₽1.92b, up from ₽1.28b in one year. On the flip side, it has ₽419.6m in cash leading to net debt of about ₽1.50b.
A Look At Gazprom Gazoraspredelenie Rostov-na-Donu's Liabilities
We can see from the most recent balance sheet that Gazprom Gazoraspredelenie Rostov-na-Donu had liabilities of ₽4.19b falling due within a year, and liabilities of ₽3.34b due beyond that. Offsetting this, it had ₽419.6m in cash and ₽2.01b in receivables that were due within 12 months. So it has liabilities totalling ₽5.10b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's ₽4.62b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.
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).
Gazprom Gazoraspredelenie Rostov-na-Donu has a low net debt to EBITDA ratio of only 0.84. And its EBIT covers its interest expense a whopping 16.3 times over. So you could argue it is no more threatened by its debt than an elephant is by a mouse. It is just as well that Gazprom Gazoraspredelenie Rostov-na-Donu's load is not too heavy, because its EBIT was down 22% over the last year. When a company sees its earnings tank, it can sometimes find its relationships with its lenders turn sour. 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 Gazprom Gazoraspredelenie Rostov-na-Donu will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.
Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Gazprom Gazoraspredelenie Rostov-na-Donu created free cash flow amounting to 19% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.
We'd go so far as to say Gazprom Gazoraspredelenie Rostov-na-Donu's EBIT growth rate was disappointing. But on the bright side, its interest cover is a good sign, and makes us more optimistic. It's also worth noting that Gazprom Gazoraspredelenie Rostov-na-Donu is in the Gas Utilities industry, which is often considered to be quite defensive. Overall, we think it's fair to say that Gazprom Gazoraspredelenie Rostov-na-Donu has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. There's no doubt that we learn most about debt from the balance sheet. But ultimately, every company can contain risks that exist outside of the balance sheet. Case in point: We've spotted 3 warning signs for Gazprom Gazoraspredelenie Rostov-na-Donu you should be aware of, and 1 of them is potentially serious.
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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