We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should AusQuest (ASX:AQD) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. Let's start with an examination of the business's cash, relative to its cash burn.
When Might AusQuest Run Out Of Money?
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 2019, AusQuest had cash of AU$1.8m and no debt. In the last year, its cash burn was AU$9.5m. So it had a cash runway of approximately 2 months from June 2019. To be frank we are alarmed by how short that cash runway is! However, if we extrapolate the company's recent cash burn trend, then it would have a longer cash run way. Depicted below, you can see how its cash holdings have changed over time.
How Is AusQuest's Cash Burn Changing Over Time?
Whilst it's great to see that AusQuest has already begun generating revenue from operations, last year it only produced AU$924k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. In fact, it ramped its spending strongly over the last year, increasing cash burn by 144%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of AusQuest due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can AusQuest Raise More Cash Easily?
Given its cash burn trajectory, AusQuest shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.
AusQuest's cash burn of AU$9.5m is about 133% of its AU$7.1m market capitalisation. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
So, Should We Worry About AusQuest's Cash Burn?
There are no prizes for guessing that we think AusQuest's cash burn is a bit of a worry. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. And although we accept its increasing cash burn wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Its cash burn situation feels about as comfortable as sitting next to the lavatory on a long haul flight. It's likely to need more cash in the near term; and that could well hurt returns. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the AusQuest CEO receives in total remuneration.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.