As the US$304m market cap Drive Shack Inc. (NYSE:DS) released another year of negative earnings, investors may be on edge waiting for breakeven. A crucial question to bear in mind when you’re an investor of an unprofitable business, is whether the company will have to raise more capital in the near future. Selling new shares may dilute the value of existing shares on issue, and since Drive Shack is currently burning more cash than it is making, it’s likely the business will need funding for future growth. Today I’ve examined Drive Shack’s financial data from its most recent earnings update, to roughly assess when the company may need to raise new capital.
What is cash burn?
With a negative free cash flow of -US$69.6m, Drive Shack is chipping away at its US$85m cash reserves in order to run its business. The biggest threat facing Drive Shack investors is the company going out of business when it runs out of money and cannot raise any more capital. Drive Shack operates in the leisure facilities industry, which delivered positive earnings in the past year. This means, on average, its industry peers are profitable. Drive Shack runs the risk of running down its cash supply too fast, or falling behind its profitable peers by investing too little.
When will Drive Shack need to raise more cash?
We can measure Drive Shack’s ongoing cash expenditure requirements by looking at free cash flow, which I define as cash flow from operations minus fixed capital investment, is a measure of how much cash a company generates/loses each year.
In Drive Shack’s case, its cash outflows fell by 108% last year, which may signal the company moving towards a more sustainable level of expenses. But, if the company maintains its cash burn at the current level of -US$69.6m, it may still need additional capital within the next 1.2 years. Although this is a relatively simplistic calculation, and Drive Shack may continue to reduce its costs further or open a new line of credit instead of issuing new shares, this analysis still gives us an idea of the company’s timeline and when things will have to start changing, since its current operation is unsustainable.
Next Steps:Loss-making companies are a risky play, even those that are reducing their cash burn over time. Though, this shouldn’t discourage you from considering entering the stock in the future. The outcome of my analysis suggests that if the company maintains this negative rate of cash burn growth, it will run out of cash in the upcoming years. The potential equity raising resulting from this means you might get a better deal on the share price if the company the company raises capital again. I admit this is a fairly basic analysis for DS’s financial health. Other important fundamentals need to be considered as well. I suggest you continue to research Drive Shack to get a better picture of the company by looking at:
- Historical Performance: What has DS’s returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Drive Shack’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
NB: Figures in this article are calculated using data from the trailing twelve months from 31 December 2018. This may not be consistent with full year annual report figures. Operating expenses include only SG&A and one-year R&D.
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