Just because a business does not make any money, does not mean that the stock will go down. By way of example, Challenger Exploration (ASX:CEL) has seen its share price rise 120% over the last year, delighting many shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
In light of its strong share price run, we think now is a good time to investigate how risky Challenger Exploration's cash burn is. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is Challenger Exploration'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 2020, Challenger Exploration had cash of AU$15m and no debt. Importantly, its cash burn was AU$4.4m over the trailing twelve months. So it had a cash runway of about 3.4 years from December 2020. 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 Challenger Exploration's Cash Burn Changing Over Time?
While Challenger Exploration did record statutory revenue of AU$30k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. With the cash burn rate up 18% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Challenger Exploration 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.
Can Challenger Exploration Raise More Cash Easily?
While Challenger Exploration does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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. 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.
Challenger Exploration has a market capitalisation of AU$202m and burnt through AU$4.4m last year, which is 2.2% of the company's market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
How Risky Is Challenger Exploration's Cash Burn Situation?
As you can probably tell by now, we're not too worried about Challenger Exploration's cash burn. For example, we think its cash runway suggests that the company is on a good path. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Challenger Exploration (of which 2 shouldn't be ignored!) you should know about.
Of course Challenger Exploration 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.
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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. 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.
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