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

We can readily understand why investors are attracted to unprofitable companies. For example, Encounter Resources (ASX:ENR) shareholders have done very well over the last year, with the share price soaring by 126%. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So notwithstanding the buoyant share price, we think it's well worth asking whether Encounter Resources' cash burn is too risky. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Encounter Resources

When Might Encounter Resources Run Out Of Money?

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. When Encounter Resources last reported its balance sheet in June 2023, it had zero debt and cash worth AU$12m. Importantly, its cash burn was AU$4.3m over the trailing twelve months. So it had a cash runway of about 2.8 years from June 2023. Arguably, that's a prudent and sensible length of runway to have. Importantly, if we extrapolate recent cash burn trends, the cash runway would be a lot longer. You can see how its cash balance has changed over time in the image below.

How Is Encounter Resources' Cash Burn Changing Over Time?

Although Encounter Resources reported revenue of AU$135 last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. Over the last year its cash burn actually increased by 13%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Encounter 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.

Can Encounter Resources Raise More Cash Easily?

Given its cash burn trajectory, Encounter Resources shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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 and 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.

Encounter Resources has a market capitalisation of AU$138m and burnt through AU$4.3m last year, which is 3.1% 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.

So, Should We Worry About Encounter Resources' Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Encounter Resources is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Encounter Resources (of which 1 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.