There’s no doubt that money can be made by owning shares of unprofitable businesses. 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So should Lithium Australia (ASX:LIT) 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.
Does Lithium Australia Have A Long Cash Runway?
A company’s cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, Lithium Australia had AU$2.8m in cash, and was debt-free. Looking at the last year, the company burnt through AU$10m. Therefore, from June 2019 it had roughly 3 months of cash runway. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. Depicted below, you can see how its cash holdings have changed over time.
How Is Lithium Australia’s Cash Burn Changing Over Time?
In our view, Lithium Australia doesn’t yet produce significant amounts of operating revenue, since it reported just AU$177k in the last twelve months. 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. During the last twelve months, its cash burn actually ramped up 83%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. Admittedly, we’re a bit cautious of Lithium Australia due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Lithium Australia To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, Lithium Australia shareholders may wish to think ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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.
Lithium Australia’s cash burn of AU$10m is about 43% of its AU$24m market capitalisation. That’s high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
Is Lithium Australia’s Cash Burn A Worry?
As you can probably tell by now, we’re rather concerned about Lithium Australia’s cash burn. In particular, we think its cash runway suggests it isn’t in a good position to keep funding growth. And although we accept its cash burn relative to its market cap wasn’t as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Lithium Australia CEO is paid..
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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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.