Here's Why We're A Bit Worried About Australian Mines's (ASX:AUZ) 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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So should Australian Mines (ASX:AUZ) shareholders be worried about its cash burn? 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 Australian Mines

Does Australian Mines Have A Long Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In June 2019, Australian Mines had AU$3.4m in cash, and was debt-free. In the last year, its cash burn was AU$15m. That means it had a cash runway of around 3 months as of June 2019. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. The image below shows how its cash balance has been changing over the last few years.

How Is Australian Mines's Cash Burn Changing Over Time?

Australian Mines didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. It's possible that the 17% reduction in cash burn over the last year is evidence of management tightening their belts as cash reserves deplete. Australian Mines 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.

How Hard Would It Be For Australian Mines To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Australian Mines to raise more cash in the future. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Australian Mines has a market capitalisation of AU$60m and burnt through AU$15m last year, which is 24% 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 Australian Mines's Cash Burn A Worry?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Australian Mines's cash burn reduction was relatively promising. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Australian Mines CEO receives in total remuneration.

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

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.