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. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Rhythm Pharmaceuticals (NASDAQ:RYTM) shareholders should be worried about its cash burn. 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Rhythm Pharmaceuticals' Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at March 2022, Rhythm Pharmaceuticals had cash of US$241m and no debt. Looking at the last year, the company burnt through US$160m. So it had a cash runway of approximately 18 months from March 2022. Importantly, analysts think that Rhythm Pharmaceuticals will reach cashflow breakeven in 4 years. Essentially, that means the company will either reduce its cash burn, or else require more cash. Depicted below, you can see how its cash holdings have changed over time.
How Is Rhythm Pharmaceuticals' Cash Burn Changing Over Time?
In our view, Rhythm Pharmaceuticals doesn't yet produce significant amounts of operating revenue, since it reported just US$4.6m in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. Over the last year its cash burn actually increased by 33%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. While the past is always worth studying, it is the future that matters most of all. 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 Rhythm Pharmaceuticals Raise Cash?
Given its cash burn trajectory, Rhythm Pharmaceuticals shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. 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.
Since it has a market capitalisation of US$187m, Rhythm Pharmaceuticals' US$160m in cash burn equates to about 85% of its market value. Given just how high that expenditure is, relative to the company's market value, we think there's an elevated risk of funding distress, and we would be very nervous about holding the stock.
How Risky Is Rhythm Pharmaceuticals' Cash Burn Situation?
Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Rhythm Pharmaceuticals' cash runway was relatively promising. One real positive is that analysts are forecasting that the company will reach breakeven. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. Taking an in-depth view of risks, we've identified 3 warning signs for Rhythm Pharmaceuticals that you should be aware of before investing.
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)
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.