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.’ 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. We can see that Casper Sleep Inc. (NYSE:CSPR) does use debt in its business. But should shareholders be worried about its use of debt?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. 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. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.
What Is Casper Sleep’s Debt?
The image below, which you can click on for greater detail, shows that Casper Sleep had debt of US$63.0m at the end of March 2021, a reduction from US$65.9m over a year. However, it also had US$61.6m in cash, and so its net debt is US$1.34m.
How Strong Is Casper Sleep’s Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Casper Sleep had liabilities of US$118.5m due within 12 months and liabilities of US$86.8m due beyond that. Offsetting this, it had US$61.6m in cash and US$28.2m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$115.4m.
While this might seem like a lot, it is not so bad since Casper Sleep has a market capitalization of US$390.8m, 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. But either way, Casper Sleep has virtually no net debt, so it’s fair to say it does not have a heavy debt load! There’s no doubt that we learn most about debt from the balance sheet. But ultimately the future profitability of the business will decide if Casper Sleep can strengthen its balance sheet over time.
Over 12 months, Casper Sleep reported revenue of US$512m, which is a gain of 11%, although it did not report any earnings before interest and tax. That rate of growth is a bit slow for our taste, but it takes all types to make a world.
Over the last twelve months Casper Sleep produced an earnings before interest and tax (EBIT) loss. Indeed, it lost a very considerable US$61m at the EBIT level. Considering that alongside the liabilities mentioned above does not give us much confidence that company should be using so much debt. Quite frankly we think the balance sheet is far from match-fit, although it could be improved with time. Another cause for caution is that is bled US$51m in negative free cash flow over the last twelve months. So suffice it to say we consider the stock very risky. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet.