Here's Why We're Watching Sovereign Metals' (ASX:SVM) Cash Burn Situation

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. 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.

Given this risk, we thought we'd take a look at whether Sovereign Metals (ASX:SVM) shareholders should 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'.

See our latest analysis for Sovereign Metals

SWOT Analysis for Sovereign Metals

When Might Sovereign Metals Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at December 2022, Sovereign Metals had cash of AU$11m and no debt. Looking at the last year, the company burnt through AU$12m. So it had a cash runway of approximately 11 months from December 2022. Notably, analysts forecast that Sovereign Metals will break even (at a free cash flow level) in about 3 years. Essentially, that means the company will either reduce its cash burn, or else require more 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. Over the last year its cash burn actually increased by a very significant 64%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

How Easily Can Sovereign Metals Raise Cash?

Given its cash burn trajectory, Sovereign Metals shareholders should already be thinking about how easy it might be for it to raise further cash in the future. 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. 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.

Sovereign Metals' cash burn of AU$12m is about 5.7% of its AU$219m market capitalisation. 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.

Is Sovereign Metals' Cash Burn A Worry?

On this analysis of Sovereign Metals' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. One real positive is that analysts are forecasting that the company will reach breakeven. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 2 warning signs for Sovereign Metals that potential shareholders should take into account before putting money into a stock.

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.

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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.