Companies Like Prospect Resources (ASX:PSC) Are In A Position To Invest In Growth

Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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. 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 Prospect Resources (ASX:PSC) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Prospect Resources

Does Prospect Resources Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at December 2022, Prospect Resources had cash of AU$30m and no debt. Importantly, its cash burn was AU$11m over the trailing twelve months. Therefore, from December 2022 it had 2.8 years of cash runway. Arguably, that's a prudent and sensible length of runway to have. The image below shows how its cash balance has been changing over the last few years.

How Is Prospect Resources' Cash Burn Changing Over Time?

Whilst it's great to see that Prospect Resources has already begun generating revenue from operations, last year it only produced AU$5.1m, 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. During the last twelve months, its cash burn actually ramped up 61%. 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. Of course, we've only taken a quick look at the stock's growth metrics, here. You can take a look at how Prospect Resources is growing revenue over time by checking this visualization of past revenue growth.

How Easily Can Prospect Resources Raise Cash?

Given its cash burn trajectory, Prospect Resources shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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. 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.

Prospect Resources has a market capitalisation of AU$44m and burnt through AU$11m last year, which is 25% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.

So, Should We Worry About Prospect Resources' Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Prospect Resources' cash runway was relatively promising. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Prospect Resources' situation. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Prospect Resources (of which 1 makes us a bit uncomfortable!) you should know about.

Of course Prospect 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.

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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.