Is Shake Shack (NYSE:SHAK) Using Debt In A Risky Way?

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. As with many other companies Shake Shack Inc. (NYSE:SHAK) makes use of debt. But the more important question is: how much risk is that debt creating?

When Is Debt Dangerous?

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. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Shake Shack

What Is Shake Shack's Net Debt?

As you can see below, Shake Shack had US$244.3m of debt, at September 2022, which is about the same as the year before. You can click the chart for greater detail. However, its balance sheet shows it holds US$337.0m in cash, so it actually has US$92.7m net cash.

How Strong Is Shake Shack's Balance Sheet?

According to the last reported balance sheet, Shake Shack had liabilities of US$144.5m due within 12 months, and liabilities of US$929.0m due beyond 12 months. Offsetting these obligations, it had cash of US$337.0m as well as receivables valued at US$11.8m due within 12 months. So it has liabilities totalling US$724.7m more than its cash and near-term receivables, combined.

Shake Shack has a market capitalization of US$2.36b, so it could very likely raise cash to ameliorate its balance sheet, if the need arose. However, it is still worthwhile taking a close look at its ability to pay off debt. While it does have liabilities worth noting, Shake Shack also has more cash than debt, so we're pretty confident it can manage its debt safely. When analysing debt levels, the balance sheet is the obvious place to start. But it is future earnings, more than anything, that will determine Shake Shack's ability to maintain a healthy balance sheet going forward. 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 25%, to US$865m. Shareholders probably have their fingers crossed that it can grow its way to profits.

So How Risky Is Shake Shack?

We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Shake Shack had an earnings before interest and tax (EBIT) loss, over the last year. Indeed, in that time it burnt through US$58m of cash and made a loss of US$23m. Given it only has net cash of US$92.7m, the company may need to raise more capital if it doesn't reach break-even 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. 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.

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.