Is Territorial Generating Company No. 1 (MCX:TGKA) A Risky Investment?

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. Importantly, Public Joint Stock Company Territorial Generating Company No. 1 (MCX:TGKA) does carry debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. 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, debt can be an important tool in businesses, particularly capital heavy businesses. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Territorial Generating Company No. 1

What Is Territorial Generating Company No. 1's Debt?

You can click the graphic below for the historical numbers, but it shows that Territorial Generating Company No. 1 had ₽7.34b of debt in September 2020, down from ₽9.24b, one year before. However, it does have ₽1.71b in cash offsetting this, leading to net debt of about ₽5.64b.

How Strong Is Territorial Generating Company No. 1's Balance Sheet?

According to the last reported balance sheet, Territorial Generating Company No. 1 had liabilities of ₽15.8b due within 12 months, and liabilities of ₽21.8b due beyond 12 months. Offsetting this, it had ₽1.71b in cash and ₽12.3b in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₽23.6b.

This deficit isn't so bad because Territorial Generating Company No. 1 is worth ₽43.6b, and thus could probably raise enough capital to shore up 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 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

Territorial Generating Company No. 1's net debt is only 0.26 times its EBITDA. 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. The modesty of its debt load may become crucial for Territorial Generating Company No. 1 if management cannot prevent a repeat of the 35% cut to EBIT 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 ultimately the future profitability of the business will decide if Territorial Generating Company No. 1 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 the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Looking at the most recent three years, Territorial Generating Company No. 1 recorded free cash flow of 31% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

While Territorial Generating Company No. 1's EBIT growth rate has us nervous. To wit both its interest cover and net debt to EBITDA were encouraging signs. We should also note that Electric Utilities industry companies like Territorial Generating Company No. 1 commonly do use debt without problems. Looking at all the angles mentioned above, it does seem to us that Territorial Generating Company No. 1 is a somewhat risky investment as a result of its debt. That's not necessarily a bad thing, since leverage can boost returns on equity, but it is something to be aware of. 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. We've identified 4 warning signs with Territorial Generating Company No. 1 (at least 1 which is a bit unpleasant) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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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