We can readily understand why investors are attracted to unprofitable companies. 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. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should Highfield Resources (ASX:HFR) shareholders 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.
When Might Highfield Resources Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Highfield Resources last reported its balance sheet in June 2021, it had zero debt and cash worth AU$13m. Importantly, its cash burn was AU$15m over the trailing twelve months. So it had a cash runway of approximately 10 months from June 2021. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. You can see how its cash balance has changed over time in the image below.
How Is Highfield Resources' Cash Burn Changing Over Time?
Highfield Resources didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Given the length of the cash runway, we'd interpret the 25% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we're a bit cautious of Highfield 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 Highfield Resources Raise More Cash Easily?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Highfield Resources to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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).
Highfield Resources' cash burn of AU$15m is about 7.6% of its AU$202m market capitalisation. 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.
Is Highfield Resources' Cash Burn A Worry?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Highfield 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. Taking a deeper dive, we've spotted 4 warning signs for Highfield Resources you should be aware of, and 3 of them are a bit unpleasant.
Of course Highfield 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.
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.
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