Will South Harz Potash (ASX:SHP) Spend Its Cash Wisely?

By
Simply Wall St
Published
June 21, 2021
ASX:SHP
Source: Shutterstock

Just because a business does not make any money, does not mean that the stock will go down. Indeed, South Harz Potash (ASX:SHP) stock is up 108% in the last year, providing strong gains for shareholders. 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 notwithstanding the buoyant share price, we think it's well worth asking whether South Harz Potash's cash burn is too risky. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for South Harz Potash

When Might South Harz Potash 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, South Harz Potash had AU$842k in cash, and was debt-free. Importantly, its cash burn was AU$1.3m over the trailing twelve months. Therefore, from December 2020 it had roughly 8 months of cash runway. 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. Depicted below, you can see how its cash holdings have changed over time.

debt-equity-history-analysis
ASX:SHP Debt to Equity History June 21st 2021

How Is South Harz Potash's Cash Burn Changing Over Time?

Because South Harz Potash isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Given the length of the cash runway, we'd interpret the 40% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. South Harz Potash 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 Hard Would It Be For South Harz Potash To Raise More Cash For Growth?

While South Harz Potash 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. Companies can raise capital through either debt or equity. 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).

South Harz Potash has a market capitalisation of AU$34m and burnt through AU$1.3m last year, which is 3.9% of the company's market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.

How Risky Is South Harz Potash's Cash Burn Situation?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought South Harz Potash's cash burn relative to its market cap was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. On another note, South Harz Potash has 6 warning signs (and 4 which are a bit unpleasant) 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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