Just because a business does not make any money, does not mean that the stock will go down. For example, Constellation Technologies (ASX:CT1) shareholders have done very well over the last year, with the share price soaring by 145%. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given its strong share price performance, we think it's worthwhile for Constellation Technologies shareholders to consider whether its cash burn is concerning. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
Does Constellation Technologies 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 Constellation Technologies last reported its balance sheet in June 2020, it had zero debt and cash worth AU$4.4m. 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. 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$691k, 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. 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. Constellation Technologies makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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$37m, Constellation Technologies' AU$1.9m in cash burn equates to about 5.3% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is Constellation Technologies' Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Constellation Technologies is burning through its cash. 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. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. 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. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Constellation Technologies (of which 3 are concerning!) 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. 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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