There’s no doubt that money can be made by owning shares of unprofitable businesses. By way of example, Petrel Resources (LON:PET) has seen its share price rise 157% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So notwithstanding the buoyant share price, we think it’s well worth asking whether Petrel Resources’s cash burn is too risky 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. The first step is to compare its cash burn with its cash reserves, to give us its ‘cash runway’.
Does Petrel Resources Have A Long Cash Runway?
A company’s cash runway is calculated by dividing its cash hoard by its cash burn. When Petrel Resources last reported its balance sheet in June 2019, it had zero debt and cash worth €178k. In the last year, its cash burn was €353k. So it had a cash runway of approximately 6 months from June 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 Is Petrel Resources’s Cash Burn Changing Over Time?
Because Petrel Resources isn’t currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. As it happens, the company’s cash burn reduced by 11% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Petrel Resources makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Petrel Resources Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Petrel Resources to raise more cash in the future. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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.
Petrel Resources has a market capitalisation of UK£7.2m and burnt through €353k last year, which is 4.2% of the company’s market value. That’s a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
Is Petrel Resources’s Cash Burn A Worry?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Petrel Resources’s cash burn relative to its market cap was relatively promising. 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. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Petrel Resources CEO is paid..
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)
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.
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. Thank you for reading.