Is Norstar Holdings (TLV:NSTR) A Risky Investment?

Warren Buffett famously said, '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. We can see that Norstar Holdings Inc. (TLV:NSTR) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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. Of course, the upside of debt is that it often represents cheap capital, especially when it replaces dilution in a company with the ability to reinvest at high rates of return. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

View our latest analysis for Norstar Holdings

How Much Debt Does Norstar Holdings Carry?

The chart below, which you can click on for greater detail, shows that Norstar Holdings had ₪25.3b in debt in September 2020; about the same as the year before. However, it also had ₪851.0m in cash, and so its net debt is ₪24.4b.

How Strong Is Norstar Holdings's Balance Sheet?

We can see from the most recent balance sheet that Norstar Holdings had liabilities of ₪3.52b falling due within a year, and liabilities of ₪25.1b due beyond that. On the other hand, it had cash of ₪851.0m and ₪516.0m worth of receivables due within a year. So its liabilities outweigh the sum of its cash and (near-term) receivables by ₪27.3b.

The deficiency here weighs heavily on the ₪600.0m 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'd watch its balance sheet closely, without a doubt. At the end of the day, Norstar 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). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

As it happens Norstar Holdings has a fairly concerning net debt to EBITDA ratio of 14.9 but very strong interest coverage of 1k. This means that unless the company has access to very cheap debt, that interest expense will likely grow in the future. If Norstar Holdings can keep growing EBIT at last year's rate of 14% over the last year, then it will find its debt load easier to manage. The balance sheet is clearly the area to focus on when you are analysing debt. But it is Norstar Holdings's earnings that will influence how the balance sheet holds up in the future. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. So we clearly need to look at whether that EBIT is leading to corresponding free cash flow. In the last three years, Norstar Holdings's free cash flow amounted to 27% of its EBIT, less than we'd expect. That weak cash conversion makes it more difficult to handle indebtedness.

Our View

On the face of it, Norstar Holdings's net debt to EBITDA left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. But at least it's pretty decent at covering its interest expense with its EBIT; that's encouraging. Overall, we think it's fair to say that Norstar Holdings has enough debt that there are some real risks around the balance sheet. If all goes well, that should boost returns, but on the flip side, the risk of permanent capital loss is elevated by the debt. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For instance, we've identified 2 warning signs for Norstar Holdings that you should be aware of.

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. 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.
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