We're Keeping An Eye On Sovereign Cloud Holdings' (ASX:SOV) Cash Burn Rate

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So should Sovereign Cloud Holdings (ASX:SOV) shareholders 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

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When Might Sovereign Cloud Holdings Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2022, Sovereign Cloud Holdings had cash of AU$29m and such minimal debt that we can ignore it for the purposes of this analysis. Looking at the last year, the company burnt through AU$16m. Therefore, from June 2022 it had roughly 22 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. You can see how its cash balance has changed over time in the image below.

How Well Is Sovereign Cloud Holdings Growing?

Sovereign Cloud Holdings actually ramped up its cash burn by a whopping 77% in the last year, which shows it is boosting investment in the business. While that certainly gives us pause for thought, we take a lot of comfort in the strong annual revenue growth of 66%. Considering the factors above, the company doesn’t fare badly when it comes to assessing how it is changing over time. In reality, this article only makes a short study of the company's growth data. This graph of historic revenue growth shows how Sovereign Cloud Holdings is building its business over time.

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

While Sovereign Cloud Holdings seems to be in a fairly good position, it's still worth considering how easily it could raise more cash, even just to fuel 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. Commonly, a business will sell new shares in itself to raise cash and 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$31m, Sovereign Cloud Holdings' AU$16m in cash burn equates to about 50% of its market value. From this perspective, it seems that the company spent a huge amount relative to its market value, and we'd be very wary of a painful capital raising.

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

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Sovereign Cloud Holdings' revenue growth 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. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Sovereign Cloud Holdings (of which 3 are potentially serious!) you should know about.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

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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.