Here's Why We're Watching European Cobalt's (ASX:EUC) Cash Burn Situation

Just because a business does not make any money, does not mean that the stock will go down. 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 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 European Cobalt (ASX:EUC) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for European Cobalt

Does European Cobalt Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When European Cobalt last reported its balance sheet in June 2019, it had zero debt and cash worth AU$11m. In the last year, its cash burn was AU$6.8m. So it had a cash runway of approximately 20 months from June 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.

How Is European Cobalt's Cash Burn Changing Over Time?

In our view, European Cobalt doesn't yet produce significant amounts of operating revenue, since it reported just AU$345k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by a very significant 85%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. Admittedly, we're a bit cautious of European Cobalt 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 European Cobalt Raise More Cash Easily?

Given its cash burn trajectory, European Cobalt shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. 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.

European Cobalt's cash burn of AU$6.8m is about 50% of its AU$14m market capitalisation. 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.

Is European Cobalt's Cash Burn A Worry?

On this analysis of European Cobalt's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. 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 European Cobalt's CEO gets paid each year.

Of course European Cobalt 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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