Can Horizon Petroleum (CVE:HPL) Afford To Invest In Growth?

There’s no doubt that money can be made by owning shares of unprofitable businesses. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. 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, the natural question for Horizon Petroleum (CVE:HPL) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company’s annual negative free cash flow, henceforth referring to it as the ‘cash burn’. The first step is to compare its cash burn with its cash reserves, to give us its ‘cash runway’.

See our latest analysis for Horizon Petroleum

When Might Horizon Petroleum Run Out Of Money?

You can calculate a company’s cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. As at May 2019, Horizon Petroleum had cash of CA$278k and no debt. In the last year, its cash burn was CA$1.1m. So it had a cash runway of approximately 3 months from May 2019. That’s a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

TSXV:HPL Historical Debt, October 11th 2019
TSXV:HPL Historical Debt, October 11th 2019

How Is Horizon Petroleum’s Cash Burn Changing Over Time?

Because Horizon Petroleum isn’t currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Given the length of the cash runway, we’d interpret the 46% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we’re a bit cautious of Horizon Petroleum due to its lack of significant operating revenues. So we’d generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Horizon Petroleum Raise More Cash Easily?

While Horizon Petroleum 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to drive growth. By looking at a company’s cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year’s cash burn.

Horizon Petroleum’s cash burn of CA$1.1m is about 45% of its CA$2.4m market capitalisation. That’s high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).

So, Should We Worry About Horizon Petroleum’s Cash Burn?

As you can probably tell by now, we’re rather concerned about Horizon Petroleum’s cash burn. In particular, we think its cash runway suggests it isn’t in a good position to keep funding growth. But the silver lining was its cash burn reduction, which was encouraging. After considering the data discussed in this article, we don’t have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. While it’s important to consider hard data like the metrics discussed above, many investors would also be interested to note that Horizon Petroleum insiders have been trading shares in the company. Click here to find out if they have been buying or selling.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

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If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.