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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, Shake Shack Inc. (NYSE:SHAK) does carry debt. But should shareholders be worried about its use of debt?
Why Does Debt Bring Risk?
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. 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, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.
What Is Shake Shack's Net Debt?
As you can see below, Shake Shack had US$243.8m of debt, at March 2022, which is about the same as the year before. You can click the chart for greater detail. However, it does have US$358.9m in cash offsetting this, leading to net cash of US$115.1m.
How Strong Is Shake Shack's Balance Sheet?
We can see from the most recent balance sheet that Shake Shack had liabilities of US$126.0m falling due within a year, and liabilities of US$898.5m due beyond that. Offsetting this, it had US$358.9m in cash and US$11.8m in receivables that were due within 12 months. So its liabilities total US$653.8m more than the combination of its cash and short-term receivables.
While this might seem like a lot, it is not so bad since Shake Shack has a market capitalization of US$2.30b, 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. Despite its noteworthy liabilities, Shake Shack boasts net cash, so it's fair to say it does not have a heavy debt load! When analysing debt levels, the balance sheet is the obvious place to start. But ultimately the future profitability of the business will decide if Shake Shack 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.
In the last year Shake Shack wasn't profitable at an EBIT level, but managed to grow its revenue by 47%, to US$788m. With any luck the company will be able to grow its way to profitability.
So How Risky Is Shake Shack?
Statistically speaking companies that lose money are riskier than those that make money. And the fact is that over the last twelve months Shake Shack lost money at the earnings before interest and tax (EBIT) line. Indeed, in that time it burnt through US$50m of cash and made a loss of US$20m. With only US$115.1m on the balance sheet, it would appear that its going to need to raise capital again soon. With very solid revenue growth in the last year, Shake Shack may be on a path to profitability. Pre-profit companies are often risky, but they can also offer great rewards. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. These risks can be hard to spot. Every company has them, and we've spotted 1 warning sign for Shake Shack you should know about.
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. 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.