Here's Why We're Not Too Worried About Constellation Technologies' (ASX:AGX) Cash Burn Situation

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 while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

Given this risk, we thought we'd take a look at whether Constellation Technologies (ASX:AGX) 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Constellation Technologies

When Might Constellation Technologies Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2020, Constellation Technologies had AU$4.4m in cash, and was debt-free. In the last year, its cash burn was AU$1.9m. That means it had a cash runway of about 2.3 years as of June 2020. That's decent, giving the company a couple years to develop its business. The image below shows how its cash balance has been changing over the last few years.

How Is Constellation Technologies' Cash Burn Changing Over Time?

Whilst it's great to see that Constellation Technologies has already begun generating revenue from operations, last year it only produced AU$691k, 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. During the last twelve months, its cash burn actually ramped up 54%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Admittedly, we're a bit cautious of Constellation Technologies due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For Constellation Technologies To Raise More Cash For Growth?

Given its cash burn trajectory, Constellation Technologies shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. 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 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$46m, Constellation Technologies' AU$1.9m in cash burn equates to about 4.2% 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.

Is Constellation Technologies' Cash Burn A Worry?

As you can probably tell by now, we're not too worried about Constellation Technologies' cash burn. In particular, we think its cash burn relative to its market cap stands out as evidence that the company is well on top of its spending. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. 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 Constellation Technologies (2 are a bit concerning!) 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 interesting companies, 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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