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. By way of example, Stroud Resources (CVE:SDR) has seen its share price rise 168% over the last year, delighting many shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given its strong share price performance, we think it’s worthwhile for Stroud Resources shareholders to consider whether its cash burn is concerning. 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. First, we’ll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Stroud Resources Run Out Of Money?
A company’s cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2020, Stroud Resources had cash of CA$788k and no debt. In the last year, its cash burn was CA$981k. So it had a cash runway of approximately 10 months from June 2020. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. However, if we extrapolate the company’s recent cash burn trend, then it would have a longer cash run way. The image below shows how its cash balance has been changing over the last few years.
How Is Stroud Resources’ Cash Burn Changing Over Time?
In our view, Stroud Resources doesn’t yet produce significant amounts of operating revenue, since it reported just CA$23k in the last twelve months. Therefore, for the purposes of this analysis we’ll focus on how the cash burn is tracking. Remarkably, it actually increased its cash burn by 1,567% in the last year. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Admittedly, we’re a bit cautious of Stroud Resources due to its lack of significant operating revenues. So we’d generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Stroud Resources To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, Stroud Resources shareholders may wish to think ahead to when the company may need to raise more cash. 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.
Stroud Resources’ cash burn of CA$981k is about 3.2% of its CA$31m 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.
How Risky Is Stroud Resources’ Cash Burn Situation?
On this analysis of Stroud Resources’ cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn 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. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Stroud Resources (of which 2 don’t sit too well with us!) you should know about.
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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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