We Think Carnarvon Petroleum (ASX:CVN) Needs To Drive Business Growth Carefully

Even when a business is losing money, it’s possible for shareholders to make money if they buy a good business at the right price. 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 while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So should Carnarvon Petroleum (ASX:CVN) shareholders 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). Let’s start with an examination of the business’s cash, relative to its cash burn.

View our latest analysis for Carnarvon Petroleum

Does Carnarvon Petroleum 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 June 2019, Carnarvon Petroleum had cash of AU$74m and no debt. Looking at the last year, the company burnt through AU$43m. So it had a cash runway of approximately 21 months from June 2019. While that cash runway isn’t too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. The image below shows how its cash balance has been changing over the last few years.

ASX:CVN Historical Debt, November 25th 2019
ASX:CVN Historical Debt, November 25th 2019

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

Carnarvon Petroleum didn’t record any revenue over the last year, indicating that it’s an early stage company still developing its business. So while we can’t look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Its cash burn positively exploded in the last year, up 318%. Given that sharp increase in spending, the company’s cash runway will shrink rapidly as it depletes its cash reserves. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

How Hard Would It Be For Carnarvon Petroleum To Raise More Cash For Growth?

Given its cash burn trajectory, Carnarvon Petroleum shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future growth. We can compare a company’s cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year’s operations.

Carnarvon Petroleum’s cash burn of AU$43m is about 8.0% of its AU$531m market capitalisation. 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.

Is Carnarvon Petroleum’s Cash Burn A Worry?

On this analysis of Carnarvon Petroleum’s cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. While we’re the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Carnarvon Petroleum’s situation. When you don’t have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Carnarvon Petroleum insiders have been trading shares, according to our data. Click here to check whether insiders 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)

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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.