We can readily understand why investors are attracted to unprofitable companies. For example, Alderan Resources (ASX:AL8) shareholders have done very well over the last year, with the share price soaring by 196%. 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.
Given its strong share price performance, we think it's worthwhile for Alderan Resources shareholders to consider whether its cash burn is concerning. 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.
Does Alderan Resources Have A Long Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at June 2020, Alderan Resources had cash of AU$2.1m and no debt. Importantly, its cash burn was AU$1.8m over the trailing twelve months. So it had a cash runway of approximately 14 months from June 2020. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. Depicted below, you can see how its cash holdings have changed over time.
How Is Alderan Resources' Cash Burn Changing Over Time?
While Alderan Resources did record statutory revenue of AU$189 over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. The 64% reduction in its cash burn over the last twelve months may be good for protecting the balance sheet but it hardly points to imminent growth. Alderan Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Alderan Resources Raise More Cash Easily?
There's no doubt Alderan Resources' rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. 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.
Alderan Resources has a market capitalisation of AU$34m and burnt through AU$1.8m last year, which is 5.3% of the company's market value. 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 Alderan Resources' Cash Burn?
The good news is that in our view Alderan Resources' cash burn situation gives shareholders real reason for optimism. One the one hand we have its solid cash burn relative to its market cap, while on the other it can also boast very strong cash burn reduction. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Alderan Resources (2 are significant!) that you should be aware of before investing here.
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)
This article by Simply Wall St is general in nature. 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.
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