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

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 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.

Our analysis indicates that ERM is potentially overvalued!

Does Emmerson Resources Have A Long Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In June 2022, Emmerson Resources had AU$9.0m in cash, and was debt-free. In the last year, its cash burn was AU$4.0m. So it had a cash runway of about 2.2 years from June 2022. Arguably, that's a prudent and sensible length of runway to have. Depicted below, you can see how its cash holdings have changed over time.

How Is Emmerson Resources' Cash Burn Changing Over Time?

Whilst it's great to see that Emmerson Resources has already begun generating revenue from operations, last year it only produced AU$85k, so we don't think it is generating significant revenue, at this point. 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. As it happens, the company's cash burn reduced by 3.3% over the last year, which suggests that management are maintaining a fairly steady rate of business development, albeit with a slight decrease in spending. 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.

Can Emmerson Resources Raise More Cash Easily?

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. 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).

Emmerson Resources' cash burn of AU$4.0m is about 10% of its AU$39m market capitalisation. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

How Risky Is Emmerson Resources' Cash Burn Situation?

Emmerson Resources appears to be in pretty good health when it comes to its cash burn situation. Not only was its cash burn relative to its market cap quite good, but its cash runway was a real positive. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Taking a deeper dive, we've spotted 3 warning signs for Emmerson Resources you should be aware of, and 1 of them can't be ignored.

Of course Emmerson 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.