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Legendary fund manager Li Lu (who Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital. When we think about how risky a business is, we always like to look at its use of debt because debt overload can lead to bankruptcy. Like many other companies Shake Shack Inc. (NYSE: SHAK) uses debt. But the real question is whether this debt makes the business risky.
When Is Debt a Problem?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. If things really go wrong, lenders can take over the business. However, a more common (but still painful) scenario is that he has to raise new equity at low cost, thereby constantly diluting shareholders. Of course, many companies use debt to finance their growth without negative consequences. When we think of a business’s use of debt, we first look at cash flow and debt together.
See our latest review for Shake Shack
What is Shake Shack’s debt?
You can click on the graph below for historical numbers, but it shows that as of March 2021, Shake Shack had $ 242.9 million in debt, an increase from $ 50 million, year over year. But it also has $ 415.9 million in cash to make up for that, which means it has $ 173.0 million in net cash.
Is Shake Shack’s track record healthy?
We can see from the most recent balance sheet that Shake Shack had liabilities of US $ 118.7 million due within one year and liabilities of US $ 848.9 million beyond. In compensation for these obligations, he had cash of US $ 415.9 million as well as receivables valued at US $ 8.84 million due within 12 months. As a result, its liabilities exceed the sum of its cash and (short-term) receivables by $ 542.9 million.
Given that Shake Shack’s publicly traded shares are worth a total of US $ 4.37 billion, it seems unlikely that this level of liabilities is a major threat. Having said that, it is clear that we must continue to monitor his record lest it get worse. While he has some liabilities to note, Shake Shack also has more cash than debt, so we’re pretty confident he can handle his debt safely. The balance sheet is clearly the area you need to focus on when analyzing debt. But it’s future profits, more than anything, that will determine Shake Shack’s ability to maintain a healthy balance sheet in the future. So if you are focused on the future you can check this out free report showing analysts‘ earnings forecasts.
Over 12 months, Shake Shack recorded a loss in EBIT and saw sales fall to US $ 535 million, a decrease of 11%. This is not what we hope to see.
So how risky is Shake Shack?
We are convinced that loss-making companies are, in general, riskier than profitable ones. And we note that Shake Shack has recorded a loss of earnings before interest and taxes (EBIT) over the past year. Indeed, during that time, he burned $ 33 million in cash and recorded a loss of $ 40 million. With only $ 173.0 million on the balance sheet, it looks like it will soon have to raise capital again. In summary, we’re a little skeptical about this one, as it looks pretty risky in the absence of free cash flow. There is no doubt that we learn the most about debt from the balance sheet. However, not all investment risks lie on the balance sheet – far from it. For example, we discovered 1 warning sign for Shake Shack which you should know before investing here.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
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