Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Carnarvon Petroleum (ASX:CVN) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business's cash, relative to its cash burn.
Does Carnarvon Petroleum 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. When Carnarvon Petroleum last reported its balance sheet in June 2019, it had zero debt and cash worth AU$74m. In the last year, its cash burn was AU$43m. So it had a cash runway of approximately 21 months from June 2019. 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. You can see how its cash balance has changed over time in the image below.
How Is Carnarvon Petroleum's Cash Burn Changing Over Time?
Carnarvon Petroleum didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Its cash burn positively exploded in the last year, up 318%. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Carnarvon Petroleum To Raise More Cash For Growth?
While Carnarvon Petroleum 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. Many companies end up issuing new shares to fund future growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
Carnarvon Petroleum's cash burn of AU$43m is about 6.6% of its AU$648m market capitalisation. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
Is Carnarvon Petroleum's Cash Burn A Worry?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Carnarvon Petroleum's cash burn relative to its market cap was relatively promising. 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. Notably, our data indicates that Carnarvon Petroleum insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.
Of course Carnarvon Petroleum may not be the best stock to buy. So you may wish to see this freecollection of companies boasting high return on equity, or this list of stocks that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.