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. 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. Importantly, Luckin Coffee Inc. (NASDAQ:LK) does carry debt. But is this debt a concern to shareholders?
Why Does Debt Bring Risk?
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. 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. 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.
How Much Debt Does Luckin Coffee Carry?
The image below, which you can click on for greater detail, shows that Luckin Coffee had debt of CN¥237.0m at the end of September 2019, a reduction from CN¥416.4m over a year. But it also has CN¥5.54b in cash to offset that, meaning it has CN¥5.31b net cash.
How Strong Is Luckin Coffee's Balance Sheet?
We can see from the most recent balance sheet that Luckin Coffee had liabilities of CN¥1.50b falling due within a year, and liabilities of CN¥93.0m due beyond that. Offsetting this, it had CN¥5.54b in cash and CN¥22.5m in receivables that were due within 12 months. So it actually has CN¥3.97b more liquid assets than total liabilities.
This short term liquidity is a sign that Luckin Coffee could probably pay off its debt with ease, as its balance sheet is far from stretched. Succinctly put, Luckin Coffee 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 it is future earnings, more than anything, that will determine Luckin Coffee's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.
In the last year Luckin Coffee wasn't profitable at an EBIT level, but managed to grow its revenue by440%, to CN¥3.4b. When it comes to revenue growth, that's like nailing the game winning 3-pointer!
So How Risky Is Luckin Coffee?
We have no doubt that loss making companies are, in general, riskier than profitable ones. And we do note that Luckin Coffee had negative earnings before interest and tax (EBIT), over the last year. And over the same period it saw negative free cash outflow of CN¥2.4b and booked a CN¥3.8b accounting loss. However, it has net cash of CN¥5.31b, so it has a bit of time before it will need more capital. Importantly, Luckin Coffee's revenue growth is hot to trot. High growth pre-profit companies may well be risky, but they can also offer great rewards. When we look at a riskier company, we like to check how their profits (or losses) are trending over time. Today, we're providing readers this interactive graph showing how Luckin Coffee's profit, revenue, and operating cashflow have changed over the last few years.
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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