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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Prospect Resources

Does Prospect Resources Have A Long Cash Runway?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at June 2023, Prospect Resources had cash of AU$26m and no debt. Looking at the last year, the company burnt through AU$7.2m. That means it had a cash runway of about 3.7 years as of June 2023. There's no doubt that this is a reassuringly long runway. Depicted below, you can see how its cash holdings have changed over time.

How Is Prospect Resources' Cash Burn Changing Over Time?

Because Prospect Resources isn't currently generating revenue, we consider it an early-stage 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. Even though it doesn't get us excited, the 31% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Prospect 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 Prospect Resources Raise More Cash Easily?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Prospect 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. 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$35m and burnt through AU$7.2m last year, which is 21% of the company's market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.

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

As you can probably tell by now, we're not too worried about Prospect Resources' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its cash burn relative to its market cap wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. 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. On another note, Prospect Resources has 3 warning signs (and 2 which shouldn't be ignored) we think you should know about.

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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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.