We Think Rhythm Pharmaceuticals (NASDAQ:RYTM) Needs To Drive Business Growth Carefully

Just because a business does not make any money, does not mean that the stock will go down. For example, Rhythm Pharmaceuticals (NASDAQ:RYTM) shareholders have done very well over the last year, with the share price soaring by 118%. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

Given its strong share price performance, we think it's worthwhile for Rhythm Pharmaceuticals shareholders to consider whether its cash burn is concerning. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

View our latest analysis for Rhythm Pharmaceuticals

How Long Is Rhythm Pharmaceuticals' 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. In June 2022, Rhythm Pharmaceuticals had US$236m in cash, and was debt-free. Importantly, its cash burn was US$166m over the trailing twelve months. That means it had a cash runway of around 17 months as of June 2022. Notably, analysts forecast that Rhythm Pharmaceuticals will break even (at a free cash flow level) in about 4 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. The image below shows how its cash balance has been changing over the last few years.

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$13m in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by 36%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. 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.

How Easily Can Rhythm Pharmaceuticals Raise Cash?

While Rhythm Pharmaceuticals does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash and drive 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.

Rhythm Pharmaceuticals has a market capitalisation of US$1.3b and burnt through US$166m last year, which is 12% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

Is Rhythm Pharmaceuticals' Cash Burn A Worry?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Rhythm Pharmaceuticals' cash burn relative to its market cap was relatively promising. One real positive is that analysts are forecasting that the company will reach breakeven. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. On another note, we conducted an in-depth investigation of the company, and identified 3 warning signs for Rhythm Pharmaceuticals (1 can't be ignored!) that you should be aware of before investing here.

Of course Rhythm Pharmaceuticals 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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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.