David Iben said it well when he said: “Volatility is not a risk that interests us. What matters to us is to avoid the permanent loss of capital. When we think of a company’s risk, we always like to look at its use of debt, because over-indebtedness can lead to ruin. We can see that Public Limited Company “Second Generating Company of the Wholesale Electric Power Market” (MCX:OGKB) uses debt in its business. But should shareholders worry about its use of debt?
What risk does debt carry?
Debt is a tool to help businesses grow, but if a business is unable to repay its lenders, it exists at their mercy. An integral part of capitalism is the process of “creative destruction” where bankrupt companies are mercilessly liquidated by their bankers. However, a more common (but still painful) scenario is that it has to raise new equity at a low price, thereby permanently diluting shareholders. Of course, debt can be an important tool in businesses, especially capital-intensive businesses. When we think about a company’s use of debt, we first look at cash and debt together.
Check out our latest analysis for the second-largest generation company in the wholesale electric power market
What is the net debt of the second generation company in the wholesale electricity market?
The graph below, which you can click on for more details, shows that the second generation company in the wholesale electric power market had a debt of ₽38.0 billion in September 2021; about the same as the previous year. And he doesn’t have a lot of cash, so his net debt is about the same.
How strong is the balance sheet of the second generation company in the wholesale electricity market?
We can see from the most recent balance sheet that the second generation company in the wholesale power market had liabilities of ₽13.0 billion maturing within a year, and liabilities of 59. ₽7 billion beyond. In return, it had 57.0 million euros in cash and 26.4 billion euros in receivables due within 12 months. It therefore has liabilities totaling 46.3 billion euros more than its cash and short-term receivables, combined.
This deficit is considerable compared to its market capitalization of 63.4 billion euros, so he suggests that shareholders keep an eye on the use of debt by the second generation company in the wholesale electricity market. If its lenders asked it to shore up its balance sheet, shareholders would likely face significant dilution.
We use two main ratios to inform us about debt to earnings levels. The first is net debt divided by earnings before interest, taxes, depreciation and amortization (EBITDA), while the second is how often its earnings before interest and taxes (EBIT) covers its interest expense (or its interests, for short). The advantage of this approach is that we consider both the absolute amount of debt (with net debt to EBITDA) and the actual interest expense associated with that debt (with its interest coverage ratio ).
The net debt of the second generation company in the wholesale electricity market is only 1.00 times its EBITDA. And its EBIT easily covers its interest costs, which is 19.9 times the size. So we’re pretty relaxed about his super-conservative use of debt. On top of that, we are pleased to report that the second-largest generation company in the wholesale electricity market increased its EBIT by 47%, reducing the specter of future debt repayments. The balance sheet is clearly the area to focus on when analyzing debt. But ultimately, the company’s future profitability will decide whether the second-largest generation company in the wholesale electricity market can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free analyst earnings forecast report interesting.
But our last consideration is also important, because a company cannot pay debt with paper profits; he needs cash. We must therefore clearly examine whether this EBIT generates a corresponding free cash flow. Over the past three years, the second-largest generation company in the wholesale electric power market has produced strong free cash flow equivalent to 69% of its EBIT, which is what we expected. This cold hard cash allows him to reduce his debt whenever he wants.
Our point of view
The interest coverage of the second generation company in the wholesale electricity market suggests that it can manage its debt as easily as Cristiano Ronaldo could score a goal against an under-14 goalkeeper. But truth be told, we think his total passive level undermines that impression a bit. When we consider the range of factors above, it seems that the second generation company in the wholesale electric power market is quite sensitive with its use of debt. This means they take on a bit more risk, hoping to increase shareholder returns. When analyzing debt levels, the balance sheet is the obvious starting point. But at the end of the day, every business can contain risks that exist outside of the balance sheet. For example, we have identified 3 warning signs for the second generation company of the electric power wholesale market (1 is a little worrying) you should be aware.
In the end, sometimes it’s easier to focus on companies that don’t even need to take on debt. Readers can access a list of growth stocks with no net debt 100% free, at present.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.