Stock Analysis

Companies Like Sovereign Cloud Holdings (ASX:SOV) Are In A Position To Invest In Growth

ASX:SOV
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We can readily understand why investors are attracted to unprofitable companies. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for Sovereign Cloud Holdings (ASX:SOV) shareholders is whether they should be concerned by its rate of 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

View our latest analysis for Sovereign Cloud Holdings

Does Sovereign Cloud Holdings Have A Long Cash Runway?

A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. When Sovereign Cloud Holdings last reported its balance sheet in December 2021, it had zero debt and cash worth AU$41m. Importantly, its cash burn was AU$7.3m over the trailing twelve months. That means it had a cash runway of about 5.6 years as of December 2021. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. Depicted below, you can see how its cash holdings have changed over time.

debt-equity-history-analysis
ASX:SOV Debt to Equity History July 28th 2022

How Well Is Sovereign Cloud Holdings Growing?

It was fairly positive to see that Sovereign Cloud Holdings reduced its cash burn by 22% during the last year. And arguably the operating revenue growth of 73% was even more impressive. It seems to be growing nicely. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

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

We are certainly impressed with the progress Sovereign Cloud Holdings has made over the last year, but it is also worth considering how costly it would be if it wanted to raise more cash to fund faster growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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 Cloud Holdings' cash burn of AU$7.3m is about 19% of its AU$37m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

So, Should We Worry About Sovereign Cloud Holdings' Cash Burn?

As you can probably tell by now, we're not too worried about Sovereign Cloud Holdings' cash burn. For example, we think its revenue growth suggests that the company is on a good path. On this analysis its cash burn relative to its market cap was its weakest feature, but we are not concerned about it. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Sovereign Cloud Holdings (2 shouldn't be ignored!) 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 companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

Valuation is complex, but we're helping make it simple.

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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.