Trailing twelve-month data shows us that Aravive, Inc.'s (NASDAQ:ARAV) earnings loss has accumulated to -US$65.3m. Although some investors expected this, their belief in the path to profitability for Aravive may be wavering. The single most important question to ask when you’re investing in a loss-making company is – will it need to raise cash again, and if so, when? Cash is crucial to run a business, and if a company burns through its reserves fast, it will need to raise further funds. This may not always be on good terms, which could hurt current shareholders if the new deal lowers the value of their shares. Looking at Aravive’s latest financial data, I will estimate when the company may run out of cash and need to raise more money.
What is cash burn?
With a negative free cash flow of -US$22.6m, Aravive is chipping away at its US$48m cash reserves in order to run its business. The biggest threat facing Aravive investors is the company going out of business when it runs out of money and cannot raise any more capital. Unprofitable companies operating in the exciting, fast-growing biotech industry often face this problem, and Aravive is no exception. These companies face the trade-off between running the risk of depleting its cash reserves too fast, or falling behind competition on innovation and gaining market share by investing too slowly.
When will Aravive need to raise more cash?
When negative, free cash flow (which I define as cash from operations minus fixed capital investment) can be an effective measure of how much Aravive has to spend each year in order to keep its business running.
Free cash outflows grew by 14% over the past year, which is fairly normal for a small-cap. This means that, if Aravive continues to grow its free cash outflows at this rate, given how much money it currently has in the bank, it will need to raise capital again in 2.1 years. Furthermore, even if Aravive kept its cash burn rate at the current -US$22.6m, it may need to raise capital in about 2.1 years. Even though this is analysis is fairly basic, and Aravive still can cut its overhead in the near future, or open a new line of credit instead of issuing new shares, this analysis still helps us understand how sustainable the Aravive operation is, and when things may have to change.
Loss-making companies are a risky play, especially those that are still growing its cash burn at a high rate. Though, this shouldn’t discourage you from considering entering the stock in the future. The cash burn analysis result indicates a cash constraint for the company, due to its high cash burn growth and its level of cash reserves. This suggests an opportunity to enter into the stock, potentially at an attractive price, should Aravive need to raise capital to fund its growth. This is only a rough assessment of financial health, and ARAV likely also has company-specific issues impacting its cash management decisions. I recommend you continue to research Aravive to get a better picture of the company by looking at:
Future Outlook: What are well-informed industry analysts predicting for ARAV’s future growth? Take a look at our free research report of analyst consensus for ARAV’s outlook.
Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Aravive’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 30 June 2019. 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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