Companies Like Talon Energy (ASX:TPD) Could Be Quite Risky

We can readily understand why investors are attracted to unprofitable companies. 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 while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So, the natural question for Talon Energy (ASX:TPD) shareholders is whether they should be concerned by its rate of 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'.

View our latest analysis for Talon Energy

When Might Talon Energy Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2022, Talon Energy had AU$11m in cash, and was debt-free. Importantly, its cash burn was AU$15m over the trailing twelve months. Therefore, from June 2022 it had roughly 9 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Depicted below, you can see how its cash holdings have changed over time.

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

Whilst it's great to see that Talon Energy has already begun generating revenue from operations, last year it only produced AU$19.0, 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. Its cash burn positively exploded in the last year, up 480%. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Talon 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 Talon Energy Raise More Cash Easily?

Given its cash burn trajectory, Talon Energy shareholders should already be thinking about how easy it might be for it to raise further cash in the future. 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.

Talon Energy has a market capitalisation of AU$68m and burnt through AU$15m last year, which is 22% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.

Is Talon Energy's Cash Burn A Worry?

We must admit that we don't think Talon Energy is in a very strong position, when it comes to its cash burn. Although we can understand if some shareholders find its cash burn relative to its market cap acceptable, we can't ignore the fact that we consider its increasing cash burn to be downright troublesome. 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. On another note, we conducted an in-depth investigation of the company, and identified 6 warning signs for Talon Energy (2 shouldn't be ignored!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

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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.