There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So, the natural question for S2 Resources (ASX:S2R) 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. Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is S2 Resources' Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2021, S2 Resources had cash of AU$14m and no debt. Importantly, its cash burn was AU$5.9m over the trailing twelve months. That means it had a cash runway of about 2.3 years as of June 2021. Arguably, that's a prudent and sensible length of runway to have. You can see how its cash balance has changed over time in the image below.
How Is S2 Resources' Cash Burn Changing Over Time?
Although S2 Resources reported revenue of AU$56k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. Over the last year its cash burn actually increased by 3.7%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Easily Can S2 Resources Raise Cash?
Since its cash burn is increasing (albeit only slightly), S2 Resources shareholders should still be mindful of the possibility it will require more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
S2 Resources has a market capitalisation of AU$61m and burnt through AU$5.9m last year, which is 9.8% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is S2 Resources' Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought S2 Resources' cash runway was relatively promising. 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, S2 Resources has 4 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.
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.
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