There’s no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 Chewy (NYSE:CHWY) 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.
When Might Chewy 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. In February 2020, Chewy had US$212m in cash, and was debt-free. Importantly, its cash burn was US$2.1m over the trailing twelve months. That means it had a cash runway of very many years as of February 2020. Notably, however, analysts think that Chewy will break even (at a free cash flow level) before then. In that case, it may never reach the end of its cash runway. The image below shows how its cash balance has been changing over the last few years.
How Well Is Chewy Growing?
Chewy managed to reduce its cash burn by 96% over the last twelve months, which is extremely promising, when it comes to considering its need for cash. And revenue is up 37% in that same period; also a good sign. Considering these factors, we’re fairly impressed by its growth trajectory. 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 Easily Can Chewy Raise Cash?
While Chewy seems to be in a decent position, we reckon it is still worth thinking about how easily it could raise more cash, if that proved desirable. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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 US$18b, Chewy’s US$2.1m in cash burn equates to about 0.01% of its market value. So it could almost certainly just borrow a little to fund another year’s growth, or else easily raise the cash by issuing a few shares.
How Risky Is Chewy’s Cash Burn Situation?
It may already be apparent to you that we’re relatively comfortable with the way Chewy is burning through its cash. In particular, we think its cash burn reduction stands out as evidence that the company is well on top of its spending. And even its revenue growth was very encouraging. There’s no doubt that shareholders can take a lot of heart from the fact that analysts are forecasting it will reach breakeven before too long. Taking all the factors in this report into account, we’re not at all worried about its cash burn, as the business appears well capitalized to spend as needs be. Taking an in-depth view of risks, we’ve identified 2 warning signs for Chewy that you should be aware of before investing.
Of course Chewy 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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