Some say volatility, rather than debt, is the best way to think about risk as an investor, but Warren Buffett famously said that 'Volatility is far from synonymous with risk.' 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 Norwegian Cruise Line Holdings Ltd. (NYSE:NCLH) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. If things get really bad, the lenders can take control of the business. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

What Is Norwegian Cruise Line Holdings's Net Debt?

The image below, which you can click on for greater detail, shows that at March 2024 Norwegian Cruise Line Holdings had debt of US$13.7b, up from US$13.1b in one year. However, because it has a cash reserve of US$559.8m, its net debt is less, at about US$13.2b.

How Strong Is Norwegian Cruise Line Holdings' Balance Sheet?

The latest balance sheet data shows that Norwegian Cruise Line Holdings had liabilities of US$6.60b due within a year, and liabilities of US$12.9b falling due after that. Offsetting these obligations, it had cash of US$559.8m as well as receivables valued at US$282.3m due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$18.6b.

The deficiency here weighs heavily on the US$7.68b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Norwegian Cruise Line Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Weak interest cover of 1.5 times and a disturbingly high net debt to EBITDA ratio of 6.4 hit our confidence in Norwegian Cruise Line Holdings like a one-two punch to the gut. This means we'd consider it to have a heavy debt load. However, the silver lining was that Norwegian Cruise Line Holdings achieved a positive EBIT of US$1.1b in the last twelve months, an improvement on the prior year's loss. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Norwegian Cruise Line Holdings'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 it is important to check how much of its earnings before interest and tax (EBIT) converts to actual free cash flow. During the last year, Norwegian Cruise Line Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Norwegian Cruise Line Holdings's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. Having said that, its ability to grow its EBIT isn't such a worry. Taking into account all the aforementioned factors, it looks like Norwegian Cruise Line Holdings has too much debt. That sort of riskiness is ok for some, but it certainly doesn't float our boat. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Norwegian Cruise Line Holdings is showing 1 warning sign in our investment analysis , you should know about...

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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com