Is Shake Shack (NYSE:SHAK) A Risky Investment?

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.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. As with many other companies Shake Shack Inc. (NYSE:SHAK) makes use of debt. But is this debt a concern to shareholders?

When Is Debt A Problem?

Debt assists a business until the business has trouble paying it off, either with new capital or with free cash flow. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

See our latest analysis for Shake Shack

What Is Shake Shack's Net Debt?

As you can see below, Shake Shack had US$244.9m of debt, at March 2023, which is about the same as the year before. You can click the chart for greater detail. But it also has US$293.4m in cash to offset that, meaning it has US$48.6m net cash.

How Healthy Is Shake Shack's Balance Sheet?

The latest balance sheet data shows that Shake Shack had liabilities of US$143.1m due within a year, and liabilities of US$944.0m falling due after that. Offsetting this, it had US$293.4m in cash and US$14.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$779.4m.

While this might seem like a lot, it is not so bad since Shake Shack has a market capitalization of US$3.33b, 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're focused on the future you can check out this free report showing analyst profit forecasts.

In the last year Shake Shack wasn't profitable at an EBIT level, but managed to grow its revenue by 21%, to US$950m. With any luck the company will be able to grow its way to profitability.

So How Risky Is Shake Shack?

By their very nature companies that are losing money are more risky than those with a long history of profitability. And in the last year Shake Shack had an earnings before interest and tax (EBIT) loss, truth be told. And over the same period it saw negative free cash outflow of US$60m and booked a US$15m accounting loss. Given it only has net cash of US$48.6m, the company may need to raise more capital if it doesn't reach break-even soon. Shake Shack's revenue growth shone bright over the last year, so it may well be in a position to turn a profit in due course. Pre-profit companies are often risky, but they can also offer great rewards. For riskier companies like Shake Shack I always like to keep an eye on the long term profit and revenue trends. Fortunately, you can click to see our interactive graph of its profit, revenue, and operating cashflow.

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.