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 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 Pharmaxis (ASX:PXS) shareholders should be worried about its cash burn. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. We’ll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
When Might Pharmaxis Run Out Of Money?
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 September 2019, Pharmaxis had cash of AU$23m and such minimal debt that we can ignore it for the purposes of this analysis. In the last year, its cash burn was AU$21m. That means it had a cash runway of around 13 months as of September 2019. Importantly, though, the one analyst we see covering the stock thinks that Pharmaxis will reach cashflow breakeven before then. In that case, it may never reach the end of its cash runway. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Pharmaxis Growing?
Pharmaxis boosted investment sharply in the last year, with cash burn ramping by 66%. While operating revenue was up over the same period, the 9.1% gain gives us scant comfort. In light of the data above, we’re fairly sanguine about the business growth trajectory. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Easily Can Pharmaxis Raise Cash?
Since Pharmaxis has been boosting its cash burn, the market will likely be considering how it can raise more cash if need be. 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.
Pharmaxis has a market capitalisation of AU$51m and burnt through AU$21m last year, which is 40% of the company’s 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).
Is Pharmaxis’s Cash Burn A Worry?
On this analysis of Pharmaxis’s cash burn, we think its revenue growth was reassuring, while its cash burn relative to its market cap has us a bit worried. It’s clearly very positive to see that at least one analyst is forecasting the company will break even fairly soon. 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 Pharmaxis’s situation. 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 Pharmaxis’s CEO gets paid each year.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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