We Think Sovereign Metals (ASX:SVM) Needs To Drive Business Growth Carefully

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Sovereign Metals (ASX:SVM) shareholders have done very well over the last year, with the share price soaring by 135%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

Given its strong share price performance, we think it's worthwhile for Sovereign Metals shareholders to consider whether its cash burn is concerning. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). 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 company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Sovereign Metals last reported its balance sheet in December 2020, it had zero debt and cash worth AU$2.3m. In the last year, its cash burn was AU$3.4m. So it had a cash runway of approximately 8 months from December 2020. 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.

How Is Sovereign Metals' Cash Burn Changing Over Time?

While Sovereign Metals did record statutory revenue of AU$38k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. As it happens, the company's cash burn reduced by 26% over the last year, which suggests that management are mindful of the possibility of running out of cash. Admittedly, we're a bit cautious of Sovereign Metals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Sovereign Metals Raise More Cash Easily?

While Sovereign Metals 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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 has a market capitalisation of AU$258m and burnt through AU$3.4m last year, which is 1.3% of the company's market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.

So, Should We Worry About Sovereign Metals' Cash Burn?

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 5 warning signs for Sovereign Metals (3 are a bit unpleasant!) 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 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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