These 4 Measures Indicate That Norwegian Cruise Line Holdings (NYSE:NCLH) Is Using Debt In A Risky Way

David Iben put it well when he said, 'Volatility is not a risk we care about. What we care about is avoiding the permanent loss of capital.' 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 note that Norwegian Cruise Line Holdings Ltd. (NYSE:NCLH) does have debt on its balance sheet. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

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. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. 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, debt can be an important tool in businesses, particularly capital heavy businesses. 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 Norwegian Cruise Line Holdings

How Much Debt Does Norwegian Cruise Line Holdings Carry?

The chart below, which you can click on for greater detail, shows that Norwegian Cruise Line Holdings had US$13.9b in debt in September 2023; about the same as the year before. However, it does have US$681.6m in cash offsetting this, leading to net debt of about US$13.2b.

How Strong Is Norwegian Cruise Line Holdings' Balance Sheet?

We can see from the most recent balance sheet that Norwegian Cruise Line Holdings had liabilities of US$5.40b falling due within a year, and liabilities of US$13.4b due beyond that. Offsetting this, it had US$681.6m in cash and US$239.4m in receivables that were due within 12 months. So its liabilities total US$17.9b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the US$7.57b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. At the end of the day, Norwegian Cruise Line Holdings would probably need a major re-capitalization if its creditors were to demand repayment.

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). 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).

Weak interest cover of 0.75 times and a disturbingly high net debt to EBITDA ratio of 9.5 hit our confidence in Norwegian Cruise Line Holdings like a one-two punch to the gut. The debt burden here is substantial. However, the silver lining was that Norwegian Cruise Line Holdings achieved a positive EBIT of US$525m in the last twelve months, an improvement on the prior year's loss. 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 Norwegian Cruise Line Holdings 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.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So it's worth checking how much of the earnings before interest and tax (EBIT) is backed by free cash flow. During the last year, Norwegian Cruise Line Holdings burned a lot of cash. While that may be a result of expenditure for growth, it does make the debt far more risky.

Our View

To be frank both Norwegian Cruise Line Holdings's conversion of EBIT to free cash flow and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But at least its EBIT growth rate is not so bad. We think the chances that Norwegian Cruise Line Holdings has too much debt a very significant. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. Given the risks around Norwegian Cruise Line Holdings's use of debt, the sensible thing to do is to check if insiders have been unloading the stock.

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.