Here's Why We're Not Too Worried About Carnarvon Energy's (ASX:CVN) Cash Burn Situation

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. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given this risk, we thought we'd take a look at whether Carnarvon Energy (ASX:CVN) 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Carnarvon Energy

When Might Carnarvon Energy 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 June 2022, Carnarvon Energy had AU$113m in cash, and was debt-free. In the last year, its cash burn was AU$44m. That means it had a cash runway of about 2.6 years as of June 2022. Arguably, that's a prudent and sensible length of runway to have. Depicted below, you can see how its cash holdings have changed over time.

How Is Carnarvon Energy's Cash Burn Changing Over Time?

Because Carnarvon Energy 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. Remarkably, it actually increased its cash burn by 204% 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. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

Can Carnarvon Energy Raise More Cash Easily?

Given its cash burn trajectory, Carnarvon Energy shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and 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).

Carnarvon Energy has a market capitalisation of AU$252m and burnt through AU$44m last year, which is 17% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

So, Should We Worry About Carnarvon Energy's Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Carnarvon Energy's cash runway was relatively promising. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. On another note, Carnarvon Energy has 3 warning signs (and 2 which are potentially serious) we think 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. 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.