Is Dampskibsselskabet Norden (CPH:DNORD) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Dampskibsselskabet Norden A/S (CPH:DNORD) makes use of debt. But should shareholders be worried about its use of debt?

What Risk Does Debt Bring?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. 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. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

Check out our latest analysis for Dampskibsselskabet Norden

What Is Dampskibsselskabet Norden's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Dampskibsselskabet Norden had US$205.2m of debt in September 2024, down from US$275.5m, one year before. On the flip side, it has US$193.7m in cash leading to net debt of about US$11.5m.

How Strong Is Dampskibsselskabet Norden's Balance Sheet?

According to the last reported balance sheet, Dampskibsselskabet Norden had liabilities of US$794.4m due within 12 months, and liabilities of US$301.5m due beyond 12 months. On the other hand, it had cash of US$193.7m and US$393.7m worth of receivables due within a year. So it has liabilities totalling US$508.5m more than its cash and near-term receivables, combined.

This deficit is considerable relative to its market capitalization of US$847.1m, so it does suggest shareholders should keep an eye on Dampskibsselskabet Norden's use of debt. Should its lenders demand that it shore up the balance sheet, shareholders would likely face severe dilution. Carrying virtually no net debt, Dampskibsselskabet Norden has a very light debt load indeed.

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). 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).

Dampskibsselskabet Norden's net debt to EBITDA ratio is very low, at 0.063, suggesting the debt is only trivial. Although with EBIT only covering interest expenses 6.6 times over, the company is truly paying for borrowing. It is just as well that Dampskibsselskabet Norden's load is not too heavy, because its EBIT was down 71% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But it is Dampskibsselskabet Norden's earnings that will influence how the balance sheet holds up in the future. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, Dampskibsselskabet Norden generated free cash flow amounting to a very robust 100% of its EBIT, more than we'd expect. That positions it well to pay down debt if desirable to do so.

Our View

Based on what we've seen Dampskibsselskabet Norden is not finding it easy, given its EBIT growth rate, but the other factors we considered give us cause to be optimistic. In particular, we are dazzled with its conversion of EBIT to free cash flow. When we consider all the factors mentioned above, we do feel a bit cautious about Dampskibsselskabet Norden's use of debt. While we appreciate debt can enhance returns on equity, we'd suggest that shareholders keep close watch on its debt levels, lest they increase. 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. To that end, you should learn about the 3 warning signs we've spotted with Dampskibsselskabet Norden (including 1 which is a bit unpleasant) .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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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.