Here's Why We're A Bit Worried About Algernon Pharmaceuticals's (CNSX:AGN) Cash Burn Situation

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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given this risk, we thought we'd take a look at whether Algernon Pharmaceuticals (CNSX:AGN) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Algernon Pharmaceuticals

Does Algernon Pharmaceuticals Have A Long Cash Runway?

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. As at May 2019, Algernon Pharmaceuticals had cash of CA$497k and no debt. In the last year, its cash burn was CA$1.7m. So it had a cash runway of approximately 4 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. You can see how its cash balance has changed over time in the image below.

How Is Algernon Pharmaceuticals's Cash Burn Changing Over Time?

Algernon Pharmaceuticals didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. In fact, it ramped its spending strongly over the last year, increasing cash burn by 111%. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Admittedly, we're a bit cautious of Algernon Pharmaceuticals 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 Algernon Pharmaceuticals Raise Cash?

Given its cash burn trajectory, Algernon Pharmaceuticals shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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.

Algernon Pharmaceuticals's cash burn of CA$1.7m is about 50% of its CA$3.3m market capitalisation. From this perspective, it seems that the company spent a hugh amount relative to its market value, and we'd be very wary of a painful capital raising.

Is Algernon Pharmaceuticals's Cash Burn A Worry?

As you can probably tell by now, we're rather concerned about Algernon Pharmaceuticals's cash burn. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. And although we accept its cash burn relative to its market cap wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. 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 Algernon Pharmaceuticals CEO is paid..

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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.