Is Northland Power (TSE:NPI) A Risky Investment?

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.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. Importantly, Northland Power Inc. (TSE:NPI) does carry debt. But the more important question is: how much risk is that debt creating?

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When Is Debt Dangerous?

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. 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 thing to do when considering how much debt a business uses is to look at its cash and debt together.

What Is Northland Power's Net Debt?

As you can see below, Northland Power had CA$7.26b of debt, at December 2024, which is about the same as the year before. You can click the chart for greater detail. However, it also had CA$657.7m in cash, and so its net debt is CA$6.60b.

A Look At Northland Power's Liabilities

According to the last reported balance sheet, Northland Power had liabilities of CA$1.33b due within 12 months, and liabilities of CA$7.72b due beyond 12 months. Offsetting these obligations, it had cash of CA$657.7m as well as receivables valued at CA$536.0m due within 12 months. So its liabilities total CA$7.85b more than the combination of its cash and short-term receivables.

The deficiency here weighs heavily on the CA$4.87b 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. After all, Northland Power would likely require a major re-capitalisation if it had to pay its creditors today.

View our latest analysis for Northland Power

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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Northland Power's debt is 4.3 times its EBITDA, and its EBIT cover its interest expense 2.8 times over. Taken together this implies that, while we wouldn't want to see debt levels rise, we think it can handle its current leverage. On a slightly more positive note, Northland Power grew its EBIT at 16% over the last year, further increasing its ability to manage debt. 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 Northland Power can strengthen its balance sheet over time. 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 company can only pay off debt with cold hard cash, not accounting profits. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Northland Power recorded free cash flow worth a fulsome 83% of its EBIT, which is stronger than we'd usually expect. That puts it in a very strong position to pay down debt.

Our View

We'd go so far as to say Northland Power's level of total liabilities was disappointing. But at least it's pretty decent at converting EBIT to free cash flow; that's encouraging. Once we consider all the factors above, together, it seems to us that Northland Power's debt is making it a bit risky. That's not necessarily a bad thing, but we'd generally feel more comfortable with less leverage. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. For example, we've discovered 2 warning signs for Northland Power (1 doesn't sit too well with us!) that you should be aware of before investing here.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

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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.