Here's Why We're Watching Melbana Energy's (ASX:MAY) Cash Burn Situation

Just because a business does not make any money, does not mean that the stock will go down. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So, the natural question for Melbana Energy (ASX:MAY) 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'. Let's start with an examination of the business' cash, relative to its cash burn.

Check out our latest analysis for Melbana Energy

When Might Melbana Energy Run Out Of Money?

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 2021, Melbana Energy had AU$11m in cash, and was debt-free. Importantly, its cash burn was AU$9.5m over the trailing twelve months. So it had a cash runway of approximately 14 months from June 2021. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. We should note, however, that if we extrapolate recent trends in its cash burn, then its cash runway would get a lot longer. The image below shows how its cash balance has been changing over the last few years.

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

In our view, Melbana Energy doesn't yet produce significant amounts of operating revenue, since it reported just AU$1.1m 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. Remarkably, it actually increased its cash burn by 300% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Melbana Energy 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 Melbana Energy Raise More Cash Easily?

Given its cash burn trajectory, Melbana Energy shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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. 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.

Melbana Energy's cash burn of AU$9.5m is about 16% of its AU$59m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

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

On this analysis of Melbana Energy's cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. On another note, Melbana Energy has 4 warning signs (and 1 which can't be ignored) we think you should know about.

Of course Melbana Energy 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.