Here's Why We're Watching Constellation Technologies' (ASX:CT1) Cash Burn Situation

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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for Constellation Technologies (ASX:CT1) 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Constellation Technologies

When Might Constellation Technologies Run Out Of Money?

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. As at December 2020, Constellation Technologies had cash of AU$4.5m and such minimal debt that we can ignore it for the purposes of this analysis. Importantly, its cash burn was AU$3.2m over the trailing twelve months. Therefore, from December 2020 it had roughly 17 months of cash runway. 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. You can see how its cash balance has changed over time in the image below.

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$1.2m, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Remarkably, it actually increased its cash burn by 384% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Constellation Technologies due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Easily Can Constellation Technologies Raise Cash?

Given its cash burn trajectory, Constellation Technologies shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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 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.

Since it has a market capitalisation of AU$27m, Constellation Technologies' AU$3.2m in cash burn equates to about 12% of its market value. 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.

Is Constellation Technologies' Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Constellation Technologies' cash burn relative to its market cap was relatively promising. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. On another note, Constellation Technologies has 5 warning signs (and 2 which don't sit too well with us) we think you should know about.

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)

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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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