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. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for Global Petroleum (ASX:GBP) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company’s annual negative free cash flow, henceforth referring to it as the ‘cash burn’. First, we’ll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Global Petroleum’s Cash Runway?
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. When Global Petroleum last reported its balance sheet in June 2019, it had zero debt and cash worth US$2.8m. Looking at the last year, the company burnt through US$2.1m. Therefore, from June 2019 it had roughly 16 months of cash runway. While that cash runway isn’t too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. You can see how its cash balance has changed over time in the image below.
How Is Global Petroleum’s Cash Burn Changing Over Time?
Global Petroleum didn’t record any revenue over the last year, indicating that it’s an early stage company still developing its 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. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 25% over the last year suggests some degree of prudence. Global Petroleum 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.
Can Global Petroleum Raise More Cash Easily?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Global Petroleum to raise more cash in the future. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to 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).
Global Petroleum has a market capitalisation of US$2.5m and burnt through US$2.1m last year, which is 85% of the company’s market value. Given just how high that expenditure is, relative to the company’s market value, we think there’s an elevated risk of funding distress, and we would be very nervous about holding the stock.
So, Should We Worry About Global Petroleum’s Cash Burn?
Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Global Petroleum’s cash burn reduction was relatively promising. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we’d be watching like a hawk for any deterioration. We think it’s very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Global Petroleum’s CEO gets paid each year.
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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