Trailing twelve-month data shows us that Alchemy Resources Limited's (ASX:ALY) earnings loss has accumulated to -AU$485.2k. Although some investors expected this, their belief in the path to profitability for Alchemy Resources may be wavering. 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 Alchemy Resources is currently burning more cash than it is making, it’s likely the business will need funding for future growth. Today I’ve examined Alchemy Resources’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?
Alchemy Resources currently has AU$1.0m in the bank, with negative free cash flow of -AU$1.7m. The biggest threat facing Alchemy Resources investors is the company going out of business when it runs out of money and cannot raise any more capital. Not surprisingly, it is more common to find unprofitable companies in the high-risk metals and mining industry. The activities of these companies tend to be project-driven, which generates lumpy cash flows, meaning the business can be loss-making for a period of time while it invests heavily in a new project.
When will Alchemy Resources need to raise more cash?
One way to measure the cost to Alchemy Resources of keeping the business running, is by using free cash flow (which I define as cash flow from operations minus fixed capital investment).
In Alchemy Resources’s case, its cash outflows fell by 40% last year, which may signal the company moving towards a more sustainable level of expenses. Given the level of cash left in the bank, if Alchemy Resources maintained its cash burn rate of -AU$1.7m, it could still run out of cash within the next few of months. Although this is a relatively simplistic calculation, and Alchemy Resources may continue to reduce its costs further or open a new line of credit instead of issuing new shares, this analysis still helps us understand how sustainable the Alchemy Resources operation is, and when things may have to change.
This analysis isn’t meant to deter you from Alchemy Resources, but rather, to help you better understand the risks involved investing in loss-making companies. The cash burn analysis result indicates a cash constraint for the company, due to its current level of cash reserves. This may lead to share price pressure in the near term, should Alchemy Resources be forced to raise capital to fund its growth. I admit this is a fairly basic analysis for ALY's financial health. Other important fundamentals need to be considered as well. I suggest you continue to research Alchemy Resources to get a more holistic view of the company by looking at:
- Historical Performance: What has ALY'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 Alchemy Resources’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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