Here's Why We're Watching Talon Energy's (ASX:TPD) Cash Burn Situation

Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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 history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given this risk, we thought we'd take a look at whether Talon Energy (ASX:TPD) 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

Check out our latest analysis for Talon Energy

When Might Talon Energy Run Out Of Money?

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 2021, Talon Energy had AU$6.7m in cash, and was debt-free. Looking at the last year, the company burnt through AU$7.0m. That means it had a cash runway of around 12 months as of December 2021. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. You can see how its cash balance has changed over time in the image below.

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

In our view, Talon Energy doesn't yet produce significant amounts of operating revenue, since it reported just AU$8.2k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Remarkably, it actually increased its cash burn by 282% in the last year. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Admittedly, we're a bit cautious of Talon Energy due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Easily Can Talon Energy Raise Cash?

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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.

Since it has a market capitalisation of AU$70m, Talon Energy's AU$7.0m in cash burn equates to about 9.9% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.

Is Talon Energy's Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Talon Energy's cash burn relative to its market cap was relatively promising. Summing up, we think the Talon Energy's cash burn is a risk, based on the factors we mentioned in this article. On another note, we conducted an in-depth investigation of the company, and identified 6 warning signs for Talon Energy (2 make us uncomfortable!) that you should be aware of before investing here.

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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.