There’s no doubt that money can be made by owning shares of unprofitable businesses. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you’d have done very well indeed. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should Great Western Exploration (ASX:GTE) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we’ll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Great Western Exploration Run Out Of Money?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. When Great Western Exploration last reported its balance sheet in June 2019, it had zero debt and cash worth AU$1.2m. Importantly, its cash burn was AU$2.1m over the trailing twelve months. Therefore, from June 2019 it had roughly 7 months of cash runway. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. You can see how its cash balance has changed over time in the image below.
How Is Great Western Exploration’s Cash Burn Changing Over Time?
While Great Western Exploration did record statutory revenue of AU$21k over the last year, it didn’t have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Given the length of the cash runway, we’d interpret the 32% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we’re a bit cautious of Great Western Exploration due to its lack of significant operating revenues. So we’d generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Great Western Exploration Raise Cash?
While Great Western Exploration is showing a solid reduction in its cash burn, it’s still worth considering how easily it could raise more cash, even just to fuel faster growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash to drive growth. We can compare a company’s cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year’s operations.
Great Western Exploration has a market capitalisation of AU$3.8m and burnt through AU$2.1m last year, which is 55% of the company’s market value. From this perspective, it seems that the company spent a huge amount relative to its market value, and we’d be very wary of a painful capital raising.
How Risky Is Great Western Exploration’s Cash Burn Situation?
On this analysis of Great Western Exploration’s cash burn, we think its cash burn reduction was reassuring, while its cash burn relative to its market cap has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we’d be watching like a hawk for any deterioration. We think it’s very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Great Western Exploration’s CEO gets paid each year.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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