We Think Red Sky Energy (ASX:ROG) Can Afford To Drive Business Growth

We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

Given this risk, we thought we'd take a look at whether Red Sky Energy (ASX:ROG) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Red Sky Energy

How Long Is Red Sky 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. As at December 2021, Red Sky Energy had cash of AU$7.0m and no debt. In the last year, its cash burn was AU$2.2m. So it had a cash runway of about 3.2 years from December 2021. A runway of this length affords the company the time and space it needs to develop the business. Depicted below, you can see how its cash holdings have changed over time.

How Is Red Sky Energy's Cash Burn Changing Over Time?

Whilst it's great to see that Red Sky Energy has already begun generating revenue from operations, last year it only produced AU$98k, so we don't think it is generating significant revenue, at this point. 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 445% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Red Sky 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.

Can Red Sky Energy Raise More Cash Easily?

Given its cash burn trajectory, Red Sky Energy shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and drive growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Red Sky Energy has a market capitalisation of AU$32m and burnt through AU$2.2m last year, which is 6.8% 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.

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

It may already be apparent to you that we're relatively comfortable with the way Red Sky Energy is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Although we do find its increasing cash burn to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Taking a deeper dive, we've spotted 4 warning signs for Red Sky Energy you should be aware of, and 1 of them doesn't sit too well with us.

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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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.