Here’s Why We’re Not Too Worried About China Demeter Financial Investments’s (HKG:8120) Cash Burn Situation

Just because a business does not make any money, does not mean that the stock will go down. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given this risk, we thought we’d take a look at whether China Demeter Financial Investments (HKG:8120) 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. We’ll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for China Demeter Financial Investments

When Might China Demeter Financial Investments 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 June 2019, China Demeter Financial Investments had cash of HK$92m and no debt. Importantly, its cash burn was HK$18m over the trailing twelve months. That means it had a cash runway of about 5.0 years as of June 2019. A runway of this length affords the company the time and space it needs to develop the business. Depicted below, you can see how its cash holdings have changed over time.

SEHK:8120 Historical Debt, February 12th 2020
SEHK:8120 Historical Debt, February 12th 2020

Is China Demeter Financial Investments’s Revenue Growing?

Given that China Demeter Financial Investments actually had positive free cash flow last year, before burning cash this year, we’ll focus on its operating revenue to get a measure of the business trajectory. Happily for shareholders, the revenue is up a stonking 131% over the last year. Of course, we’ve only taken a quick look at the stock’s growth metrics, here. This graph of historic revenue growth shows how China Demeter Financial Investments is building its business over time.

How Easily Can China Demeter Financial Investments Raise Cash?

While China Demeter Financial Investments’s revenue growth truly does shine bright, it’s important not to ignore the possibility that it might need more cash, at some point, even if only to optimise its growth plans. 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 comparing a company’s annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Since it has a market capitalisation of HK$41m, China Demeter Financial Investments’s HK$18m in cash burn equates to about 45% of its market value. 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 China Demeter Financial Investments’s Cash Burn?

As you can probably tell by now, we’re not too worried about China Demeter Financial Investments’s cash burn. In particular, we think its revenue growth stands out as evidence that the company is well on top of its spending. Although we do find its cash burn relative to its market cap to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don’t think they should be worried. For us, it’s always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the China Demeter Financial Investments CEO receives in total remuneration.

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 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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