There's no doubt that money can be made by owning shares of unprofitable businesses. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given this risk, we thought we'd take a look at whether Emmerson Resources (ASX:ERM) shareholders should be worried about its cash burn. 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Emmerson 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. In December 2020, Emmerson Resources had AU$5.5m in cash, and was debt-free. Looking at the last year, the company burnt through AU$2.0m. Therefore, from December 2020 it had 2.7 years of cash runway. That's decent, giving the company a couple years to develop its business. You can see how its cash balance has changed over time in the image below.
How Is Emmerson Resources' Cash Burn Changing Over Time?
In the last year, Emmerson Resources did book revenue of AU$105k, but its revenue from operations was less, at just AU$33k. Given how low that operating leverage is, we think it's too early to put much weight on the revenue growth, so we'll focus on how the cash burn is changing, instead. Even though it doesn't get us excited, the 37% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Emmerson Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Emmerson Resources Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Emmerson Resources to raise more cash in the future. 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.
Emmerson Resources has a market capitalisation of AU$37m and burnt through AU$2.0m last year, which is 5.4% 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.
How Risky Is Emmerson Resources' Cash Burn Situation?
As you can probably tell by now, we're not too worried about Emmerson Resources' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. And even though its cash burn reduction wasn't quite as impressive, it was still a positive. 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. Taking a deeper dive, we've spotted 3 warning signs for Emmerson Resources you should be aware of, and 1 of them is concerning.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, 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. 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.
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