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

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 report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Sovereign Metals

When Might Sovereign Metals Run Out Of Money?

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. In December 2021, Sovereign Metals had AU$3.9m in cash, and was debt-free. Looking at the last year, the company burnt through AU$7.6m. That means it had a cash runway of around 6 months as of December 2021. Importantly, analysts think that Sovereign Metals will reach cashflow breakeven in 4 years. Essentially, that means the company will either reduce its cash burn, or else require more cash. You can see how its cash balance has changed over time in the image below.

How Is Sovereign Metals' Cash Burn Changing Over Time?

Because Sovereign Metals 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 125%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Hard Would It Be For Sovereign Metals To Raise More Cash For Growth?

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. Many companies end up issuing new shares to fund future 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.

Since it has a market capitalisation of AU$172m, Sovereign Metals' AU$7.6m in cash burn equates to about 4.4% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

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 increasing cash burn has us a bit worried. One real positive is that analysts are forecasting that the company will reach breakeven. Summing up, we think the Sovereign Metals' cash burn is a risk, based on the factors we mentioned in this article. On another note, Sovereign Metals has 5 warning signs (and 2 which are a bit concerning) 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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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.