David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital. 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. We can see that Public Joint Stock Oil Company Bashneft (MCX:BANE) does use debt in its business. But should shareholders be worried about its use of debt?
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. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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 step when considering a company's debt levels is to consider its cash and debt together.
How Much Debt Does Oil Company Bashneft Carry?
The chart below, which you can click on for greater detail, shows that Oil Company Bashneft had ₽120.1b in debt in June 2019; about the same as the year before. However, it does have ₽33.8b in cash offsetting this, leading to net debt of about ₽86.3b.
A Look At Oil Company Bashneft's Liabilities
According to the last reported balance sheet, Oil Company Bashneft had liabilities of ₽128.8b due within 12 months, and liabilities of ₽184.5b due beyond 12 months. Offsetting this, it had ₽33.8b in cash and ₽156.8b in receivables that were due within 12 months. So it has liabilities totalling ₽122.7b more than its cash and near-term receivables, combined.
This deficit isn't so bad because Oil Company Bashneft is worth ₽328.4b, and thus could probably raise enough capital to shore up its balance sheet, if the need arose. But it's clear that we should definitely closely examine whether it can manage its debt without 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). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.
Oil Company Bashneft's net debt is only 0.48 times its EBITDA. And its EBIT covers its interest expense a whopping 22.6 times over. 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 Oil Company Bashneft grew its EBIT by 12% last year, making its debt load easier to handle. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine Oil Company Bashneft'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, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So we always check how much of that EBIT is translated into free cash flow. In the last three years, Oil Company Bashneft's free cash flow amounted to 27% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.
Both Oil Company Bashneft's ability to to cover its interest expense with its EBIT and its net debt to EBITDA gave us comfort that it can handle its debt. Having said that, its conversion of EBIT to free cash flow somewhat sensitizes us to potential future risks to the balance sheet. When we consider all the elements mentioned above, it seems to us that Oil Company Bashneft 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. Another positive for shareholders is that it pays dividends. So if you like receiving those dividend payments, check Oil Company Bashneft's dividend history, without delay!
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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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. Thank you for reading.