Stock Analysis

We're Keeping An Eye On Sovereign Metals' (ASX:SVM) Cash Burn Rate

ASX:SVM
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Just because a business does not make any money, does not mean that the stock will go down. By way of example, Sovereign Metals (ASX:SVM) has seen its share price rise 368% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Sovereign Metals

Does Sovereign Metals Have A Long 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. As at December 2020, Sovereign Metals had cash of AU$2.3m and no debt. Looking at the last year, the company burnt through AU$3.4m. That means it had a cash runway of around 8 months as of December 2020. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years.

debt-equity-history-analysis
ASX:SVM Debt to Equity History May 13th 2021

How Is Sovereign Metals' Cash Burn Changing Over Time?

Although Sovereign Metals reported revenue of AU$38k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. 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.

How Easily Can Sovereign Metals Raise Cash?

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. Many companies end up issuing new shares to fund future 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$244m and burnt through AU$3.4m last year, which is 1.4% 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?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Sovereign Metals' cash burn relative to its market cap was relatively promising. 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, Sovereign Metals has 5 warning signs (and 3 which are a bit concerning) we think you should know about.

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. 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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