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. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given this risk, we thought we’d take a look at whether Egdon Resources (LON:EDR) 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.
When Might Egdon Resources Run Out Of Money?
A company’s cash runway is calculated by dividing its cash hoard by its cash burn. In July 2019, Egdon Resources had UK£1.6m in cash, and was debt-free. Looking at the last year, the company burnt through UK£3.1m. So it had a cash runway of approximately 6 months from July 2019. That’s quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.
How Well Is Egdon Resources Growing?
Egdon Resources reduced its cash burn by 9.4% during the last year, which points to some degree of discipline. Having said that, the revenue growth of 81% was considerably more inspiring. We think it is growing rather well, upon reflection. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Egdon Resources To Raise More Cash For Growth?
Given Egdon Resources’s revenue is receding, there’s a considerable chance it will eventually need to raise more money to spend on driving growth. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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 UK£16m, Egdon Resources’s UK£3.1m in cash burn equates to about 20% of its market value. Given that situation, it’s fair to say the company wouldn’t have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
Is Egdon Resources’s Cash Burn A Worry?
On this analysis of Egdon Resources’s cash burn, we think its revenue growth was reassuring, while its cash runway 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. 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 Egdon Resources CEO receives in total remuneration.
Of course Egdon Resources 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 email@example.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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