Here's Why We're Not Too Worried About Eastern Resources' (ASX:EFE) Cash Burn Situation

We can readily understand why investors are attracted to unprofitable companies. For example, Eastern Resources (ASX:EFE) shareholders have done very well over the last year, with the share price soaring by 627%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given its strong share price performance, we think it's worthwhile for Eastern Resources shareholders to consider whether its cash burn is concerning. 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. Let's start with an examination of the business' cash, relative to its cash burn.

See our latest analysis for Eastern Resources

Does Eastern Resources 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 2021, Eastern Resources had AU$1.5m in cash, and was debt-free. Looking at the last year, the company burnt through AU$792k. Therefore, from June 2021 it had roughly 23 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. The image below shows how its cash balance has been changing over the last few years.

How Is Eastern Resources' Cash Burn Changing Over Time?

Whilst it's great to see that Eastern Resources has already begun generating revenue from operations, last year it only produced AU$37.0, 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 119%. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Admittedly, we're a bit cautious of Eastern Resources due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can Eastern Resources Raise More Cash Easily?

While Eastern Resources 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. Commonly, a business will sell new shares in itself to raise cash and drive 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.

Eastern Resources' cash burn of AU$792k is about 1.0% of its AU$76m market capitalisation. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

Is Eastern Resources' Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Eastern Resources' cash burn relative to its market cap was relatively promising. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Eastern Resources (of which 2 can't be ignored!) you should know about.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

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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.