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Is Carpentaria Resources (ASX:CAP) In A Good Position To Invest In Growth?

Simply Wall St

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 while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So, the natural question for Carpentaria Resources (ASX:CAP) shareholders is whether they should be concerned by its rate of cash burn. 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. Let's start with an examination of the business's cash, relative to its cash burn.

Check out our latest analysis for Carpentaria Resources

How Long Is Carpentaria Resources's 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 December 2019, Carpentaria Resources had cash of AU$1.9m and no debt. In the last year, its cash burn was AU$2.0m. Therefore, from December 2019 it had roughly 12 months of cash runway. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. The image below shows how its cash balance has been changing over the last few years.

ASX:CAP Historical Debt June 15th 2020

How Is Carpentaria Resources's Cash Burn Changing Over Time?

Carpentaria Resources 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. Cash burn was pretty flat over the last year, which suggests that management are holding spending steady while the business advances its strategy. Carpentaria Resources makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can Carpentaria Resources Raise More Cash Easily?

While its cash burn is only increasing slightly, Carpentaria Resources shareholders should still consider the potential need for further cash, down the track. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to 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.

Carpentaria Resources's cash burn of AU$2.0m is about 36% of its AU$5.5m market capitalisation. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.

So, Should We Worry About Carpentaria Resources's Cash Burn?

Carpentaria Resources is not in a great position when it comes to its cash burn situation. Although we can understand if some shareholders find its increasing cash burn acceptable, we can't ignore the fact that we consider its cash burn relative to its market cap to be downright troublesome. Summing up, we think the Carpentaria Resources's cash burn is a risk, based on the factors we mentioned in this article. Taking a deeper dive, we've spotted 3 warning signs for Carpentaria Resources you should be aware of, and 1 of them is concerning.

Of course Carpentaria Resources may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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. Thank you for reading.