We can readily understand why investors are attracted to unprofitable companies. 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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
Given this risk, we thought we’d take a look at whether European Cobalt (ASX:EUC) 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 European Cobalt 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. When European Cobalt last reported its balance sheet in December 2019, it had zero debt and cash worth AU$10m. Looking at the last year, the company burnt through AU$3.8m. Therefore, from December 2019 it had 2.7 years of cash runway. That’s decent, giving the company a couple years to develop its business. You can see how its cash balance has changed over time in the image below.
How Is European Cobalt’s Cash Burn Changing Over Time?
In our view, European Cobalt doesn’t yet produce significant amounts of operating revenue, since it reported just AU$231k in the last twelve months. Therefore, for the purposes of this analysis we’ll focus on how the cash burn is tracking. Even though it doesn’t get us excited, the 37% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Admittedly, we’re a bit cautious of European Cobalt due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For European Cobalt To Raise More Cash For Growth?
While European Cobalt is showing a solid reduction in its cash burn, it’s still worth considering how easily it could raise more cash, even just to fuel faster growth. 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 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).
European Cobalt has a market capitalisation of AU$13m and burnt through AU$3.8m last year, which is 29% of the company’s market value. That’s not insignificant, and if the company had to sell enough shares to fund another year’s growth at the current share price, you’d likely witness fairly costly dilution.
How Risky Is European Cobalt’s Cash Burn Situation?
On this analysis of European Cobalt’s cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don’t think they should be worried. On another note, European Cobalt has 5 warning signs (and 2 which are potentially serious) we think you should know about.
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)
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