We Think Zeotech (ASX:ZEO) Can Afford To Drive Business Growth

There's no doubt that money can be made by owning shares of unprofitable businesses. Indeed, Zeotech (ASX:ZEO) stock is up 963% in the last year, providing strong gains for shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

In light of its strong share price run, we think now is a good time to investigate how risky Zeotech's cash burn is. 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

Check out our latest analysis for Zeotech

How Long Is Zeotech's 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, Zeotech had cash of AU$2.3m and no debt. Importantly, its cash burn was AU$1.9m over the trailing twelve months. That means it had a cash runway of around 15 months as of December 2020. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.

How Is Zeotech's Cash Burn Changing Over Time?

Whilst it's great to see that Zeotech has already begun generating revenue from operations, last year it only produced AU$38k, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. Over the last year its cash burn actually increased by a very significant 51%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. Admittedly, we're a bit cautious of Zeotech 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 Easily Can Zeotech Raise Cash?

While Zeotech does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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.

Since it has a market capitalisation of AU$126m, Zeotech's AU$1.9m in cash burn equates to about 1.5% of its 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.

So, Should We Worry About Zeotech's Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Zeotech's cash burn relative to its market cap was relatively promising. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Zeotech's situation. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Zeotech (of which 3 make us uncomfortable!) you should know about.

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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