Companies Like Red Metal (ASX:RDM) Could Be Quite Risky

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. By way of example, Red Metal (ASX:RDM) has seen its share price rise 125% over the last year, delighting many shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given its strong share price performance, we think it's worthwhile for Red Metal shareholders to consider whether its cash burn is concerning. 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.

See our latest analysis for Red Metal

When Might Red Metal Run Out Of Money?

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. When Red Metal last reported its December 2023 balance sheet in March 2024, it had zero debt and cash worth AU$5.4m. Importantly, its cash burn was AU$10m over the trailing twelve months. Therefore, from December 2023 it had roughly 7 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. However, if we extrapolate the company's recent cash burn trend, then it would have a longer cash run way. Depicted below, you can see how its cash holdings have changed over time.

How Well Is Red Metal Growing?

Notably, Red Metal actually ramped up its cash burn very hard and fast in the last year, by 101%, signifying heavy investment in the business. On top of that, the fact that operating revenue was basically flat over the same period compounds the concern. Taken together, we think these growth metrics are a little worrying. In reality, this article only makes a short study of the company's growth data. This graph of historic earnings and revenue shows how Red Metal is building its business over time.

How Easily Can Red Metal Raise Cash?

Given the trajectory of Red Metal's cash burn, many investors will already be thinking about how it might raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Red Metal's cash burn of AU$10m is about 21% of its AU$49m market capitalisation. 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 Red Metal's Cash Burn?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Red Metal's revenue growth was relatively promising. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. Taking a deeper dive, we've spotted 5 warning signs for Red Metal you should be aware of, and 1 of them is potentially serious.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

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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.

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