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, Energy Metals (ASX:EME) has seen its share price rise 225% over the last year, delighting many shareholders. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So notwithstanding the buoyant share price, we think it's well worth asking whether Energy Metals' cash burn is too risky. 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). Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is Energy Metals' Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In December 2020, Energy Metals had AU$16m in cash, and was debt-free. In the last year, its cash burn was AU$908k. So it had a very long cash runway of many years from 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. The image below shows how its cash balance has been changing over the last few years.
How Is Energy Metals' Cash Burn Changing Over Time?
Although Energy Metals reported revenue of AU$7.3k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. With the cash burn rate up 9.7% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Energy Metals makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can Energy Metals Raise More Cash Easily?
Since its cash burn is increasing (albeit only slightly), Energy Metals shareholders should still be mindful of the possibility it will require more cash in the future. 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. 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).
Energy Metals has a market capitalisation of AU$41m and burnt through AU$908k last year, which is 2.2% 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 Energy Metals' Cash Burn A Worry?
It may already be apparent to you that we're relatively comfortable with the way Energy Metals is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Taking a deeper dive, we've spotted 3 warning signs for Energy Metals you should be aware of, and 1 of them is concerning.
Of course Energy Metals may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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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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