We're Not Very Worried About Eastern Resources' (ASX:EFE) Cash Burn Rate

We can readily understand why investors are attracted to unprofitable companies. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given this risk, we thought we'd take a look at whether Eastern Resources (ASX:EFE) shareholders should be worried about its cash burn. 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

Check out our latest analysis for Eastern Resources

Does Eastern Resources Have A Long 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 2021, Eastern Resources had cash of AU$4.8m and no debt. Looking at the last year, the company burnt through AU$1.1m. Therefore, from December 2021 it had 4.5 years of cash runway. A runway of this length affords the company the time and space it needs to develop the business. 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?

In our view, Eastern Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$37.0 in the last twelve months. 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. Remarkably, it actually increased its cash burn by 225% in the last year. We certainly hope for shareholders' sake that the money is well spent, because that kind of expenditure increase always makes us nervous. 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.

How Hard Would It Be For Eastern Resources To Raise More Cash For Growth?

Given its cash burn trajectory, Eastern Resources shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. 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 has a market capitalisation of AU$30m and burnt through AU$1.1m last year, which is 3.5% of the company's 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 Eastern Resources' Cash Burn A Worry?

As you can probably tell by now, we're not too worried about Eastern Resources' cash burn. For example, we think its cash runway suggests that the company is on a good path. Although we do find its increasing cash burn to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. 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. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Eastern Resources (1 is significant!) that you should be aware of before investing here.

Of course Eastern 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.

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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.