We're Not Worried About Melbana Energy's (ASX:MAY) Cash Burn

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Melbana Energy (ASX:MAY) shareholders have done very well over the last year, with the share price soaring by 133%. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given its strong share price performance, we think it's worthwhile for Melbana Energy 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Melbana Energy

How Long Is Melbana Energy'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. In December 2020, Melbana Energy had AU$6.9m in cash, and was debt-free. Looking at the last year, the company burnt through AU$1.9m. That means it had a cash runway of about 3.6 years as of December 2020. A runway of this length affords the company the time and space it needs to develop the business. 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?

Because Melbana Energy isn't currently generating revenue, we consider it an early-stage 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 36% over the last year suggests some degree of prudence. Melbana Energy 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.

How Easily Can Melbana Energy Raise Cash?

While Melbana Energy is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. 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.

Melbana Energy has a market capitalisation of AU$49m and burnt through AU$1.9m last year, which is 4.0% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

How Risky Is Melbana Energy's Cash Burn Situation?

As you can probably tell by now, we're not too worried about Melbana Energy's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Its cash burn reduction wasn't quite as good, but was still rather encouraging! Taking all the factors in this report into account, we're not at all worried about its cash burn, as the business appears well capitalized to spend as needs be. Its important for readers to be cognizant of the risks that can affect the company's operations, and we've picked out 1 warning sign for Melbana Energy that investors should know when investing in the stock.

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.

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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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