Stock Analysis

We Think Allakos (NASDAQ:ALLK) Can Afford To Drive Business Growth

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NasdaqGS:ALLK
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Just because a business does not make any money, does not mean that the stock will go down. 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 while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So should Allakos (NASDAQ:ALLK) 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

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Does Allakos Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2021, Allakos had cash of US$560m and no debt. Importantly, its cash burn was US$174m over the trailing twelve months. Therefore, from June 2021 it had 3.2 years of cash runway. Notably, analysts forecast that Allakos will break even (at a free cash flow level) in about 4 years. That means it doesn't have a great deal of breathing room, but it shouldn't really need more cash, considering that cash burn should be continually reducing. Depicted below, you can see how its cash holdings have changed over time.

debt-equity-history-analysis
NasdaqGS:ALLK Debt to Equity History August 16th 2021

How Is Allakos' Cash Burn Changing Over Time?

Allakos didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. In fact, it ramped its spending strongly over the last year, increasing cash burn by 120%. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Easily Can Allakos Raise Cash?

Given its cash burn trajectory, Allakos 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. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.

Allakos' cash burn of US$174m is about 3.9% of its US$4.4b market capitalisation. 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.

So, Should We Worry About Allakos' Cash Burn?

As you can probably tell by now, we're not too worried about Allakos' cash burn. For example, we think its cash runway 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. Shareholders can take heart from the fact that analysts are forecasting it will reach breakeven. 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. Taking an in-depth view of risks, we've identified 3 warning signs for Allakos that you should be aware of before investing.

Of course Allakos 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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