We're Not Worried About African Energy Resources' (ASX:AFR) Cash Burn

Just because a business does not make any money, does not mean that the stock will go down. Indeed, African Energy Resources (ASX:AFR) stock is up 105% in the last year, providing strong gains for shareholders. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given its strong share price performance, we think it's worthwhile for African Energy Resources shareholders to consider whether its cash burn is concerning. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for African Energy Resources

When Might African Energy Resources 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. In December 2020, African Energy Resources had US$3.7m in cash, and was debt-free. Importantly, its cash burn was US$560k over the trailing twelve months. That means it had a cash runway of about 6.5 years as of December 2020. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.

How Is African Energy Resources' Cash Burn Changing Over Time?

Because African Energy Resources isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Over the last year its cash burn actually increased by 13%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. African Energy Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Easily Can African Energy Resources Raise Cash?

While African Energy Resources does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

African Energy Resources has a market capitalisation of US$21m and burnt through US$560k last year, which is 2.7% of the company's market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

Is African Energy Resources' Cash Burn A Worry?

It may already be apparent to you that we're relatively comfortable with the way African Energy Resources is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. Taking a deeper dive, we've spotted 5 warning signs for African Energy Resources you should be aware of, and 2 of them don't sit too well with us.

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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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