Here's Why Norway Royal Salmon (OB:NRS) Has A Meaningful Debt Burden

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.' 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. Importantly, Norway Royal Salmon AS (OB:NRS) does carry debt. But is this debt a concern to shareholders?

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. 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. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Norway Royal Salmon

What Is Norway Royal Salmon's Debt?

You can click the graphic below for the historical numbers, but it shows that as of March 2021 Norway Royal Salmon had kr2.16b of debt, an increase on kr160.2m, over one year. However, it also had kr388.3m in cash, and so its net debt is kr1.77b.

How Healthy Is Norway Royal Salmon's Balance Sheet?

We can see from the most recent balance sheet that Norway Royal Salmon had liabilities of kr1.15b falling due within a year, and liabilities of kr2.49b due beyond that. Offsetting this, it had kr388.3m in cash and kr360.6m in receivables that were due within 12 months. So it has liabilities totalling kr2.89b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Norway Royal Salmon has a market capitalization of kr7.80b, and so it could probably strengthen its balance sheet by raising capital if it needed to. However, it is still worthwhile taking a close look at its ability to pay off debt.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). This way, we consider both the absolute quantum of the debt, as well as the interest rates paid on it.

While Norway Royal Salmon's debt to EBITDA ratio of 5.9 suggests a heavy debt load, its interest coverage of 8.6 implies it services that debt with ease. Our best guess is that the company does indeed have significant debt obligations. Shareholders should be aware that Norway Royal Salmon's EBIT was down 40% last year. If that earnings trend continues then paying off its debt will be about as easy as herding cats on to a roller coaster. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Norway Royal Salmon's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Over the last three years, Norway Royal Salmon saw substantial negative free cash flow, in total. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

On the face of it, Norway Royal Salmon's conversion of EBIT to free cash flow left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its interest cover is a good sign, and makes us more optimistic. Overall, it seems to us that Norway Royal Salmon's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. 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. For example Norway Royal Salmon has 2 warning signs (and 1 which can't be ignored) we think you should know about.

If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.

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