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 Hill Iron (ASX:RHI) has seen its share price rise 114% over the last year, delighting many shareholders. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So notwithstanding the buoyant share price, we think it's well worth asking whether Red Hill Iron's cash burn is too risky. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Red Hill Iron 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 Hill Iron last reported its balance sheet in December 2020, it had zero debt and cash worth AU$408k. In the last year, its cash burn was AU$450k. Therefore, from December 2020 it had roughly 11 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. The image below shows how its cash balance has been changing over the last few years.
How Is Red Hill Iron's Cash Burn Changing Over Time?
Whilst it's great to see that Red Hill Iron has already begun generating revenue from operations, last year it only produced AU$5.0k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Given the length of the cash runway, we'd interpret the 20% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we're a bit cautious of Red Hill Iron due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Red Hill Iron To Raise More Cash For Growth?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Red Hill Iron 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. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.
Red Hill Iron has a market capitalisation of AU$27m and burnt through AU$450k last year, which is 1.7% of the company's market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
Is Red Hill Iron's Cash Burn A Worry?
On this analysis of Red Hill Iron's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Red Hill Iron (of which 3 are concerning!) 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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