We Think Carnarvon Energy (ASX:CVN) Can Afford To Drive Business Growth

Just because a business does not make any money, does not mean that the stock will go down. 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

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. Let's start with an examination of the business' cash, relative to its cash burn.

See our latest analysis for Carnarvon Energy

How Long Is Carnarvon Energy's Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In December 2022, Carnarvon Energy had AU$98m in cash, and was debt-free. Importantly, its cash burn was AU$41m over the trailing twelve months. That means it had a cash runway of about 2.4 years as of December 2022. That's decent, giving the company a couple years to develop its business. The image below shows how its cash balance has been changing over the last few years.

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

Carnarvon Energy didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. During the last twelve months, its cash burn actually ramped up 65%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. 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.

How Hard Would It Be For Carnarvon Energy To Raise More Cash For Growth?

While Carnarvon Energy 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. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and drive 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.

Carnarvon Energy has a market capitalisation of AU$234m and burnt through AU$41m last year, which is 18% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

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

On this analysis of Carnarvon Energy's cash burn, we think its cash runway was reassuring, while its increasing cash burn has us a bit worried. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Carnarvon Energy's situation. Separately, we looked at different risks affecting the company and spotted 3 warning signs for Carnarvon Energy (of which 2 can't be ignored!) you should know about.

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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.