Here's Why Carnavale Resources (ASX:CAV) Must Play Its Cards Just Right

There's no doubt that money can be made by owning shares of unprofitable businesses. 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 Carnavale Resources (ASX:CAV) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Carnavale Resources

When Might Carnavale Resources Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Carnavale Resources last reported its balance sheet in June 2019, it had zero debt and cash worth AU$191k. In the last year, its cash burn was AU$2.0m. That means it had a cash runway of under two months as of June 2019. It's extremely surprising to us that the company has allowed its cash runway to get that short! We should note, however, that if we extrapolate recent trends in its cash burn, then its cash runway would get a lot longer. You can see how its cash balance has changed over time in the image below.

How Is Carnavale Resources's Cash Burn Changing Over Time?

Whilst it's great to see that Carnavale Resources has already begun generating revenue from operations, last year it only produced AU$10k, so we don't think it is generating significant revenue, at this point. 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 233% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Carnavale Resources 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 Hard Would It Be For Carnavale Resources To Raise More Cash For Growth?

Since its cash burn is moving in the wrong direction, Carnavale Resources shareholders may wish to think ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash to 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.

Since it has a market capitalisation of AU$3.0m, Carnavale Resources's AU$2.0m in cash burn equates to about 68% of its market value. That's very high expenditure relative to the company's size, suggesting it is an extremely high risk stock.

How Risky Is Carnavale Resources's Cash Burn Situation?

As you can probably tell by now, we're rather concerned about Carnavale Resources's cash burn. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. While not as bad as its cash runway, its cash burn relative to its market cap is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. Its cash burn situation feels about as comfortable as sitting next to the lavatory on a long haul flight. It's likely to need more cash in the near term; and that could well hurt returns. Notably, our data indicates that Carnavale Resources insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.

Of course Carnavale Resources 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.

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.

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. Thank you for reading.