Is Sovereign Metals (ASX:SVM) In A Good Position To Invest In Growth?

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. Indeed, Sovereign Metals (ASX:SVM) stock is up 239% in the last year, providing strong gains for shareholders. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

In light of its strong share price run, we think now is a good time to investigate how risky Sovereign Metals' cash burn is. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business' cash, relative to its cash burn.

Check out our latest analysis for Sovereign Metals

Does Sovereign Metals Have A Long Cash Runway?

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 June 2020, Sovereign Metals had AU$2.4m in cash, and was debt-free. Looking at the last year, the company burnt through AU$4.1m. Therefore, from June 2020 it had roughly 7 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. 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. It's possible that the 17% reduction in cash burn over the last year is evidence of management tightening their belts as cash reserves deplete. Admittedly, we're a bit cautious of Sovereign Metals due to its lack of significant operating revenues. 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?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sovereign Metals to raise more cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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).

Sovereign Metals has a market capitalisation of AU$158m and burnt through AU$4.1m last year, which is 2.6% 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 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 cash runway has us a bit worried. 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, we conducted an in-depth investigation of the company, and identified 3 warning signs for Sovereign Metals (1 is concerning!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, 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. 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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