The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital. So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We note that Public Joint Stock Company Inter RAO UES (MCX:IRAO) does have debt on its balance sheet. But is this debt a concern to shareholders?
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. 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, 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 Inter RAO UES Carry?
The image below, which you can click on for greater detail, shows that at September 2019 Inter RAO UES had debt of ₽3.10b, up from ₽13.0k in one year. However, its balance sheet shows it holds ₽241.3b in cash, so it actually has ₽238.2b net cash.
How Strong Is Inter RAO UES's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Inter RAO UES had liabilities of ₽134.9b due within 12 months and liabilities of ₽70.0b due beyond that. Offsetting this, it had ₽241.3b in cash and ₽90.1b in receivables that were due within 12 months. So it actually has ₽126.5b more liquid assets than total liabilities.
This surplus suggests that Inter RAO UES is using debt in a way that is appears to be both safe and conservative. Due to its strong net asset position, it is not likely to face issues with its lenders. Simply put, the fact that Inter RAO UES has more cash than debt is arguably a good indication that it can manage its debt safely.
And we also note warmly that Inter RAO UES grew its EBIT by 19% last year, making its debt load easier to handle. 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 Inter RAO UES can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Inter RAO UES has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. During the last three years, Inter RAO UES generated free cash flow amounting to a very robust 81% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.
While it is always sensible to investigate a company's debt, in this case Inter RAO UES has ₽238.2b in net cash and a decent-looking balance sheet. And it impressed us with free cash flow of ₽78b, being 81% of its EBIT. When it comes to Inter RAO UES's debt, we sufficiently relaxed that our mind turns to the jacuzzi. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. Be aware that Inter RAO UES is showing 2 warning signs in our investment analysis , and 1 of those shouldn't be ignored...
When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned.
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