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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for Encounter Resources (ASX:ENR) shareholders is whether they should be concerned by its rate of 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 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 June 2023 balance sheet in September 2023, it had zero debt and cash worth AU$12m. Looking at the last year, the company burnt through AU$4.3m. So it had a cash runway of about 2.8 years from June 2023. That's decent, giving the company a couple years to develop its business. Importantly, if we extrapolate recent cash burn trends, the cash runway would be a lot longer. The image below shows how its cash balance has been changing over the last few years.

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. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. 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. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can Encounter Resources Raise More Cash Easily?

While Encounter 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Encounter Resources has a market capitalisation of AU$109m and burnt through AU$4.3m last year, which is 3.9% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

How Risky Is Encounter Resources' Cash Burn Situation?

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. On another note, Encounter Resources has 3 warning signs (and 1 which doesn't sit too well with us) we think 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.