How to assess the company's debts

Как оценивать долги компании

In most people's lives, debt is most often associated with financial difficulties and has negative connotations.. For companies, debts are natural and sometimes necessary for the functioning of the business and further development.

Why do companies borrow money? The presence of a debt burden is typical for companies at the stage of growth, and in a mature state. Borrowed funds are most often attracted for the purchase of raw materials and materials - replenishment of working capital or the implementation of investment projects and the purchase of other businesses (M&A deals).

Mature companies can finance it all with those profits., which they receive. But it may be more profitable for them to borrow money now and give it back with interest., than limit yourself to your own funds. This happens in the event, when the profitability of a business or project is higher, than the leveraged rate. Growing companies without debt can sometimes find it very difficult to reach this scale, when investments start to pay off.

Companies pay for such a "booster" with financial stability - by borrowing funds, they increase their risks. It turns out, that up to a certain level, the growth of the debt burden is good, but at some point the risks become tangible and it becomes dangerous to borrow money further. To understand this mechanism, it is important to assess and analyze the debt burden..

Where to begin

First, let's analyze, what is total debt.

Total debt - a set of loans and borrowings, attracted by the company. You can calculate it according to the balance sheet data.. In the most common sense, it corresponds to the sum of short-term and long-term loans and credits.

In the balance sheet of Severstal it looks like this:

At the end of the III quarter 2021 r. total debt of Severstal was $1815 million.

However, the more representative indicator is net debt.

Net debt Is the total debt minus short-term most liquid funds, which usually include money and cash equivalents.

Net debt from Severstal's balance sheet at the end of Q3 2021 r. was $1534 million. Many companies publish the value of net debt in press releases to financial statements.

Worth saying, that individual companies may have different methods of calculating total and net debt due to industry, accounting or other features. However, most often, to understand the general picture of the given calculation, it is enough.

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Also sometimes there is a situation, when net debt is negative. It means, that the amount of cash exceeds the volume of loans and borrowings. For instance, Raspadskaya's net debt since the second half of the year 2017 r. up to the first half of the year 2021 r. was negative. Then the company used the accumulated funds and attracted loans to purchase Yuzhkuzbassugol, thereby more than doubling coal production.

The value of total or net debt alone does little, but the indicator is needed to calculate the odds, which will help to analyze the financial condition.

Analysis coefficients

The most common and frequently encountered indicator is net debt / EBITDA ratio (Net Debt/EBITDA). The numerator is net debt at the end of the period, the denominator is EBITDA for the last 12 months (LTM). Ratio shows, how many years will the company need, to pay off all net debt at the expense of EBITDA.

For instance, EBITDA of Severstal for the last 12 months was $3029 million. Net debt / EBITDA ratio - 0.52х. That is, Severstal needs to work for six months., to pay off the net debt in full.

A comfortable level is considered a value up to 3x. For fast-growing companies, an indicator of up to 4x is acceptable. A ratio above this value means, that you need to study the company more closely: possibly, she has problems.

Consider next leverage ratio (Debt To Equity Ratio), which is calculated as the ratio of total debt to equity. He shows, in what proportion the company's activities are financed from own funds, and in which - from borrowed. The lower the indicator, the higher is the share of own financing and the more stable the company is.

Severstal has a coefficient of 0.42x. A good level is considered to be a coefficient of up to 2x, but large, for sustainable companies the indicator may be higher.

Interest coverage ratio (Interest Coverage Ratio; ICR) represents the ratio of EBIT to interest payable for the period over the last 12 months. EBIT is similar to EBITDA, but takes into account depreciation and impairment of assets. The multiplier reflects the company's ability to pay off interest on loans at the expense of funds from operating activities. That is, the coefficient must be at least higher than 1x, in this case, the funds will only be enough to pay off interest, but not the body of duty. Comfort levels start at about 3 and up.

Severstal has an interest coverage ratio of 33.2x. That is, the company can easily service debts through operating activities.

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These indicators are sufficient to obtain an initial assessment of the company's debt status.. At the same time, you need to understand, that in certain industries, in companies at different stages of development and in some cases the assessment needs to be adjusted, and for a deeper understanding of the situation, it is worth understanding the specifics of the company's functioning. Below we will consider several features of industries and companies., debt-related.

Features of industries and individual companies

In terms of debt burden, RUSAL's case is interesting. Until recently, the company was considered one of the most heavily credited on the Russian public market - at the end 2020 r. net debt / EBITDA ratio reached 6.4x, interest coverage ratio was 3.1x, and the leverage ratio was 1.2x.

Considering the odds, we can conclude, that the company's debt burden is relatively high. Net debt / EBITDA above the industry average. ICR near lower comfort levels.

It is worth considering, that RUSAL controls 26,25% Norilsk Nickel shares, the market value of which is now about 927 billion rubles and in 1,6 times the total debt of the company at the end of the 1st half of the year 2021 r. That is, in case of financial problems, RUSAL could sell a stake in Norilsk Nickel, and the proceeds would be more than enough to pay off debts.

Another case is that MTS has a leverage ratio at the end of the first half of the year 2021 r. is 52.9x at normal levels up to 2x. The thing is, that the company has relatively little capital, since almost all retained earnings are channeled to dividends. At the same time, there are no obvious reasons for concern - MTS business is mature, stable and weakly dependent on economic cycles. Net debt / EBITDA ratio is 1.6x, а ICR — 8,2х.

Aeroflot's case is interesting, that when calculating the net debt / EBITDA ratio at the end of the 1st half of the year 2021 r. 0.2x is obtained in the standard way - more than a comfortable value. However, to understand the big picture, it is worth adding to the net debt calculation of the aircraft lease liability., engines, the property. In this case, it comes out already 24.4x, which is much higher than normal values.

Debt load of the company increased due to restrictions on air traffic and falling EBITDA. High Net Debt / EBITDA reflects, that the company has problems, however, this does not mean, that the company will soon go bankrupt. Need to understand, that Aeroflot is strategically important for the state, which means, can count on support during difficult times. For instance, relatively recently, the group underwent additional capitalization due to an additional issue of shares.

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Retail has a similar situation with the impact of lease on debt burden.. for example, Net debt / EBITDA ratio of Magnit under IAS 17 (where store rent is not included in the net debt calculation) is 1.9x at the end of the third quarter 2021 g., and according to new IFRS standards 16 (including rent) the same indicator increases to 3.5x. Moreover, such levels can be called comfortable for the industry., as the business is mature and stable and relatively weakly dependent on the state of the economy.

Continuing to consider industry specifics, it is worth paying attention to agricultural enterprises, in particular, Rusagro and Cherkizovo. Net debt / EBITDA at Cherkizovo at the end of the 1st half of the year 2021 r. was at 2.6x, Rusagro - 1.6x. However, the actual pressure of debt on the financial condition of companies is less due to subsidies from the state..

FROM 2017 r. accredited banks provide soft loans to agricultural producers at a reduced rate. Effective Debt Cost Cherkizovo (interest expenses for the last 12 months, divided by total debt) at the end of the first half of the year was 4,2%, and the share of subsidized loans - 53%.

In this way, at a reduced rate, companies can afford to attract large amounts of debt financing, while remaining financially stable.

A feature of the debt burden of developers is the use of escrow accounts. Due to regulatory changes, the money of buyers of real estate under construction ends up in the bank, the developer gets access to money only when the house is rented out.

This creates a situation, when there is money, but they are frozen. Excluding escrow accounts, PIK's net debt at the end of the 1st half of the year 2021 r. was 284,6 RUB billion, and taking into account funds on escrow accounts - 121,8 RUB billion, or in 2,3 times less.

Here you need to focus on that calculation, which is needed for a specific purpose. To assess the debt burden at the moment, more representative indicator excluding escrow accounts, since the company now does not have access to these funds. However, in the longer term, as construction is completed, the developer will receive these funds, which means, will be able to reduce debt burden.

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