Stock Analysis

We're Hopeful That Red Hill Iron (ASX:RHI) Will Use Its Cash Wisely

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ASX:RHI
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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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So, the natural question for Red Hill Iron (ASX:RHI) shareholders is whether they should be concerned by its rate of 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.

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When Might Red Hill Iron Run Out Of Money?

A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. In December 2020, Red Hill Iron had AU$408k in cash, and was debt-free. Importantly, its cash burn was AU$450k over the trailing twelve months. That means it had a cash runway of around 11 months as of December 2020. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. You can see how its cash balance has changed over time in the image below.

debt-equity-history-analysis
ASX:RHI Debt to Equity History June 3rd 2021

How Is Red Hill Iron's Cash Burn Changing Over Time?

In our view, Red Hill Iron doesn't yet produce significant amounts of operating revenue, since it reported just AU$5.0k 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. 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. Red Hill Iron makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Easily Can Red Hill Iron Raise Cash?

While Red Hill Iron is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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 Hill Iron has a market capitalisation of AU$66m and burnt through AU$450k last year, which is 0.7% 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 2 are significant!) you should know about.

Of course Red Hill Iron 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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