Norsk Hydro (OB:NHY) Has A Pretty Healthy Balance Sheet

Legendary fund manager Li Lu (who Charlie Munger backed) once said, '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, Norsk Hydro ASA (OB:NHY) does carry debt. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. 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. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.

Check out our latest analysis for Norsk Hydro

What Is Norsk Hydro's Debt?

The image below, which you can click on for greater detail, shows that at December 2022 Norsk Hydro had debt of kr29.2b, up from kr25.3b in one year. But it also has kr31.5b in cash to offset that, meaning it has kr2.33b net cash.

A Look At Norsk Hydro's Liabilities

According to the last reported balance sheet, Norsk Hydro had liabilities of kr42.8b due within 12 months, and liabilities of kr48.0b due beyond 12 months. Offsetting this, it had kr31.5b in cash and kr24.0b in receivables that were due within 12 months. So it has liabilities totalling kr35.3b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since Norsk Hydro has a huge market capitalization of kr140.1b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But it's clear that we should definitely closely examine whether it can manage its debt without dilution. While it does have liabilities worth noting, Norsk Hydro also has more cash than debt, so we're pretty confident it can manage its debt safely.

On top of that, Norsk Hydro grew its EBIT by 49% over the last twelve months, and that growth will make it easier to handle its debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Norsk Hydro can strengthen its balance sheet over time. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a company can only pay off debt with cold hard cash, not accounting profits. Norsk Hydro may have net cash on the balance sheet, but it is still interesting to look at how well the business converts its earnings before interest and tax (EBIT) to free cash flow, because that will influence both its need for, and its capacity to manage debt. In the last three years, Norsk Hydro's free cash flow amounted to 34% of its EBIT, less than we'd expect. That's not great, when it comes to paying down debt.

Summing Up

Although Norsk Hydro's balance sheet isn't particularly strong, due to the total liabilities, it is clearly positive to see that it has net cash of kr2.33b. And it impressed us with its EBIT growth of 49% over the last year. So we don't have any problem with Norsk Hydro's use of debt. 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 Norsk Hydro has 2 warning signs (and 1 which is significant) 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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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.