Companies Like Eclipse Metals (ASX:EPM) Are In A Position To Invest In Growth

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Eclipse Metals (ASX:EPM) shareholders have done very well over the last year, with the share price soaring by 320%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given its strong share price performance, we think it's worthwhile for Eclipse Metals shareholders to consider whether its cash burn is concerning. 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Eclipse Metals

How Long Is Eclipse Metals' Cash Runway?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2020, Eclipse Metals had AU$962k in cash, and was debt-free. In the last year, its cash burn was AU$366k. So it had a cash runway of about 2.6 years from June 2020. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.

How Is Eclipse Metals' Cash Burn Changing Over Time?

In our view, Eclipse Metals doesn't yet produce significant amounts of operating revenue, since it reported just AU$68k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. Over the last year its cash burn actually increased by 11%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Eclipse Metals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Eclipse Metals Raise More Cash Easily?

While Eclipse Metals 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. Many companies end up issuing new shares to fund future 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.

Eclipse Metals has a market capitalisation of AU$28m and burnt through AU$366k last year, which is 1.3% 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.

So, Should We Worry About Eclipse Metals' Cash Burn?

As you can probably tell by now, we're not too worried about Eclipse Metals' cash burn. For example, we think its cash burn relative to its market cap 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. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Eclipse Metals (1 is potentially serious!) that you should be aware of before investing here.

Of course Eclipse 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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