We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given this risk, we thought we'd take a look at whether K2 Energy (ASX:KTE) shareholders should be worried about its cash burn. 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. Let's start with an examination of the business's cash, relative to its cash burn.
View our latest analysis for K2 Energy
How Long Is K2 Energy's 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. In June 2019, K2 Energy had AU$513k in cash, and was debt-free. Importantly, its cash burn was AU$84k over the trailing twelve months. Therefore, from June 2019 it had 6.1 years of cash runway. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. Depicted below, you can see how its cash holdings have changed over time.
How Is K2 Energy's Cash Burn Changing Over Time?
K2 Energy didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 198%. That sort of ramp in expenditure is no doubt intended to generate worthwhile long term returns. K2 Energy makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For K2 Energy To Raise More Cash For Growth?
While K2 Energy 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. Commonly, a business will sell new shares in itself to raise cash to 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).
Since it has a market capitalisation of AU$1.2m, K2 Energy's AU$84k in cash burn equates to about 7.0% 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.
Is K2 Energy's Cash Burn A Worry?
As you can probably tell by now, we're not too worried about K2 Energy's cash burn. For example, we think its cash runway suggests that the company is on a good path. While we must concede that its increasing cash burn is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that K2 Energy insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
Of course K2 Energy 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.