Here's Why We're Not Too Worried About Sovereign Metals' (ASX:SVM) Cash Burn Situation

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So should Sovereign Metals (ASX:SVM) shareholders be worried about its 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

View our latest analysis for Sovereign Metals

How Long Is Sovereign Metals' Cash Runway?

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 Sovereign Metals last reported its balance sheet in June 2021, it had zero debt and cash worth AU$8.0m. In the last year, its cash burn was AU$4.2m. So it had a cash runway of approximately 23 months from June 2021. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. The image below shows how its cash balance has been changing over the last few years.

How Is Sovereign Metals' Cash Burn Changing Over Time?

Because Sovereign Metals isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Cash burn was pretty flat over the last year, which suggests that management are holding spending steady while the business advances its strategy. Sovereign Metals 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 Sovereign Metals To Raise More Cash For Growth?

While its cash burn is only increasing slightly, Sovereign Metals shareholders should still consider the potential need for further cash, down the track. Companies can raise capital through either debt or equity. 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.

Sovereign Metals has a market capitalisation of AU$203m and burnt through AU$4.2m last year, which is 2.1% 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.

How Risky Is Sovereign Metals' Cash Burn Situation?

As you can probably tell by now, we're not too worried about Sovereign Metals' cash burn. In particular, we think its cash burn relative to its market cap stands out as evidence that the company is well on top of its spending. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Sovereign Metals (2 don't sit too well with us!) that you should be aware of before investing here.

Of course Sovereign Metals 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.

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

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.