We can readily understand why investors are attracted to unprofitable companies. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So should Kina Petroleum (ASX:KPE) shareholders be worried about its cash burn? 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’s cash, relative to its cash burn.
How Long Is Kina Petroleum’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 June 2019, Kina Petroleum had US$2.9m in cash, and was debt-free. In the last year, its cash burn was US$4.8m. So it had a cash runway of approximately 7 months from June 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. Depicted below, you can see how its cash holdings have changed over time.
How Is Kina Petroleum’s Cash Burn Changing Over Time?
In our view, Kina Petroleum doesn’t yet produce significant amounts of operating revenue, since it reported just US$4.4k in the last twelve months. Therefore, for the purposes of this analysis we’ll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by a very significant 72%. While this spending increase is no doubt intended to drive growth, if the trend continues the company’s cash runway will shrink very quickly. Kina 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.
How Easily Can Kina Petroleum Raise Cash?
Given its cash burn trajectory, Kina Petroleum shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to 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.
Kina Petroleum has a market capitalisation of US$11m and burnt through US$4.8m last year, which is 44% of the company’s market value. That’s high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
How Risky Is Kina Petroleum’s Cash Burn Situation?
Kina Petroleum is not in a great position when it comes to its cash burn situation. Although we can understand if some shareholders find its increasing cash burn acceptable, we can’t ignore the fact that we consider its cash runway to be downright troublesome. After considering the data discussed in this article, we don’t have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. For us, it’s always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Kina Petroleum CEO receives in total remuneration.
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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