Even when a business is losing money, it’s possible for shareholders to make money if they buy a good business at the right price. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So should Max Resource (CVE:MXR) 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. First, we’ll determine its cash runway by comparing its cash burn with its cash reserves.
Does Max Resource Have A Long Cash Runway?
You can calculate a company’s cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. When Max Resource last reported its balance sheet in June 2019, it had zero debt and cash worth CA$391k. Importantly, its cash burn was CA$3.9m over the trailing twelve months. Therefore, from June 2019 it seems to us it had less than two months of cash runway. To be frank we are alarmed by how short that cash runway is! You can see how its cash balance has changed over time in the image below.
How Is Max Resource’s Cash Burn Changing Over Time?
Max Resource didn’t record any revenue over the last year, indicating that it’s an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. During the last twelve months, its cash burn actually ramped up 94%. While this spending increase is no doubt intended to drive growth, if the trend continues the company’s cash runway will shrink very quickly. Max Resource 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 Hard Would It Be For Max Resource To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, Max Resource shareholders may wish to think ahead to when the company may need to raise more cash. 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).
Max Resource has a market capitalisation of CA$6.2m and burnt through CA$3.9m last year, which is 63% of the company’s market value. Given how large that cash burn is, relative to the market value of the entire company, we’d consider it to be a high risk stock, with the real possibility of extreme dilution.
How Risky Is Max Resource’s Cash Burn Situation?
There are no prizes for guessing that we think Max Resource’s cash burn is a bit of a worry. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its increasing cash burn wasn’t as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Its cash burn burn situation feels about as relaxing as riding your bicycle home in the rain without so much as a jumper. It’s likely to need more cash in the near term; and that could well hurt returns. For us, it’s always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Max Resource CEO receives in total remuneration.Of course Max Resource 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.
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.