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, 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given this risk, we thought we'd take a look at whether Honest Company (NASDAQ:HNST) 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. Let's start with an examination of the business' cash, relative to its cash burn.
When Might Honest Company Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In September 2021, Honest Company had US$90m in cash, and was debt-free. Importantly, its cash burn was US$54m over the trailing twelve months. Therefore, from September 2021 it had roughly 20 months of cash runway. Importantly, though, analysts think that Honest Company will reach cashflow breakeven before then. If that happens, then the length of its cash runway, today, would become a moot point. You can see how its cash balance has changed over time in the image below.
How Well Is Honest Company Growing?
It was quite stunning to see that Honest Company increased its cash burn by 274% over the last year. That does give us pause, and we can't take much solace in the operating revenue growth of 5.2% in the same time frame. Considering these two factors together makes us nervous about the direction the company seems to be heading. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
Can Honest Company Raise More Cash Easily?
Given the trajectory of Honest Company's cash burn, many investors will already be thinking about how it might raise more cash in the future. 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 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 US$617m, Honest Company's US$54m in cash burn equates to about 8.7% 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.
How Risky Is Honest Company's Cash Burn Situation?
As you can probably tell by now, we're not too worried about Honest Company's cash burn. For example, we think its cash burn relative to its market cap suggests that the company is on a good path. While we must concede that its increasing cash burn is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. There's no doubt that shareholders can take a lot of heart from the fact that analysts are forecasting it will reach breakeven before too long. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. An in-depth examination of risks revealed 1 warning sign for Honest Company that readers should think about before committing capital to this stock.
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)
What are the risks and opportunities for Honest Company?
Trading at 55.9% below our estimate of its fair value
Significant insider selling over the past 3 months
Has less than 1 year of cash runway
Currently unprofitable and not forecast to become profitable over the next 3 years
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.