Is Territorial Generating Company No. 1 (MCX:TGKA) Using Too Much Debt?

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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 can see that Public Joint Stock Company Territorial Generating Company No. 1 (MCX:TGKA) does use debt in its business. But the more important question is: how much risk is that debt creating?

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. 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?

The image below, which you can click on for greater detail, shows that at September 2021 Territorial Generating Company No. 1 had debt of ₽9.57b, up from ₽7.34b in one year. However, because it has a cash reserve of ₽2.82b, its net debt is less, at about ₽6.76b.

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 ₽19.1b due within 12 months, and liabilities of ₽18.2b due beyond 12 months. Offsetting these obligations, it had cash of ₽2.82b as well as receivables valued at ₽14.7b due within 12 months. So it has liabilities totalling ₽19.7b more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of ₽24.7b, so it does suggest shareholders should keep an eye on Territorial Generating Company No. 1's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Territorial Generating Company No. 1's net debt is only 0.29 times its EBITDA. And its EBIT easily covers its interest expense, being 21.6 times the size. So you could argue it is no more threatened by its debt than an elephant is by a mouse. And we also note warmly that Territorial Generating Company No. 1 grew its EBIT by 12% last year, making its debt load easier to handle. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Territorial Generating Company No. 1's ability to maintain a healthy balance sheet going forward. 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 always check how much of that EBIT is translated into free cash flow. Looking at the most recent three years, Territorial Generating Company No. 1 recorded free cash flow of 36% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

Territorial Generating Company No. 1's interest cover was a real positive on this analysis, as was its net debt to EBITDA. On the other hand, its level of total liabilities makes us a little less comfortable about its debt. We would also note that Electric Utilities industry companies like Territorial Generating Company No. 1 commonly do use debt without problems. When we consider all the elements mentioned above, it seems to us that Territorial Generating Company No. 1 is managing its debt quite well. Having said that, the load is sufficiently heavy that we would recommend any shareholders keep a close eye on it. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 3 warning signs for Territorial Generating Company No. 1 (of which 1 is potentially serious!) 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. 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.