Just because a business does not make any money, does not mean that the stock will go down. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
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). Let's start with an examination of the business' cash, relative to its cash burn.
Does Encounter Resources Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Encounter Resources last reported its balance sheet in June 2021, it had zero debt and cash worth AU$5.7m. Looking at the last year, the company burnt through AU$5.1m. So it had a cash runway of approximately 13 months from June 2021. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. 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?
While Encounter Resources did record statutory revenue of AU$144k over the last year, it didn't 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. During the last twelve months, its cash burn actually ramped up 66%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Encounter Resources makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
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. 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.
Encounter Resources' cash burn of AU$5.1m is about 12% of its AU$41m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
So, Should We Worry About Encounter Resources' Cash Burn?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Encounter Resources' cash burn relative to its market cap was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. Separately, we looked at different risks affecting the company and spotted 3 warning signs for Encounter Resources (of which 1 doesn't sit too well with us!) you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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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.