Stock Analysis

We're Hopeful That Sovereign Cloud Holdings (ASX:SOV) Will Use Its Cash Wisely

ASX:SOV
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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for Sovereign Cloud Holdings (ASX:SOV) shareholders is whether they should be concerned by its rate of cash burn. 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). 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 Cloud Holdings

Does Sovereign Cloud Holdings Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2021, Sovereign Cloud Holdings had AU$14m in cash, and was debt-free. In the last year, its cash burn was AU$8.8m. So it had a cash runway of approximately 18 months from June 2021. 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.

debt-equity-history-analysis
ASX:SOV Debt to Equity History November 25th 2021

How Is Sovereign Cloud Holdings' Cash Burn Changing Over Time?

In our view, Sovereign Cloud Holdings doesn't yet produce significant amounts of operating revenue, since it reported just AU$2.5m in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With the cash burn rate up 26% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. 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?

While Sovereign Cloud Holdings 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. 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. 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$106m, Sovereign Cloud Holdings' AU$8.8m in cash burn equates to about 8.3% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.

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

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Sovereign Cloud Holdings' 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 Sovereign Cloud Holdings' situation. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Sovereign Cloud Holdings (1 shouldn't be ignored!) that you should be aware of before investing here.

Of course Sovereign Cloud Holdings 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.

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

Find out whether Sovereign Cloud Holdings is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.

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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.

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