Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 Energy Metals (ASX:EME) 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. We’ll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
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Does Energy Metals Have A Long Cash Runway?
A company’s cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2019, Energy Metals had AU$18m in cash, and was debt-free. Looking at the last year, the company burnt through AU$1.1m. So it had a very long cash runway of many years from June 2019. Even though this is but one measure of the company’s cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.
How Is Energy Metals’s Cash Burn Changing Over Time?
In our view, Energy Metals doesn’t yet produce significant amounts of operating revenue, since it reported just AU$820 in the last twelve months. As a result, we think it’s a bit early to focus on the revenue growth, so we’ll limit ourselves to looking at how the cash burn is changing over time. With cash burn dropping by 9.5% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Admittedly, we’re a bit cautious of Energy Metals 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 Energy Metals Raise Cash?
While Energy Metals 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. Companies can raise capital through either debt or equity. 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.
Since it has a market capitalisation of AU$19m, Energy Metals’s AU$1.1m in cash burn equates to about 5.7% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year’s growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is Energy Metals’s Cash Burn Situation?
As you can probably tell by now, we’re not too worried about Energy Metals’s cash burn. For example, we think its cash runway suggests that the company is on a good path. Its weak point is its cash burn reduction, but even that wasn’t too bad! After taking into account the various metrics mentioned in this report, we’re pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Energy Metals CEO is paid..
Of course Energy Metals may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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.
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