We can readily understand why investors are attracted to unprofitable companies. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. 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 this risk, we thought we'd take a look at whether Castile Resources (ASX:CST) shareholders should be worried about its 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
When Might Castile Resources Run Out Of Money?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In December 2019, Castile Resources had AU$106k in cash, and was debt-free. Importantly, its cash burn was AU$983k over the trailing twelve months. That means it had a cash runway of under two months as of December 2019. It's extremely surprising to us that the company has allowed its cash runway to get that short! You can see how its cash balance has changed over time in the image below.
How Is Castile Resources's Cash Burn Changing Over Time?
Whilst it's great to see that Castile Resources has already begun generating revenue from operations, last year it only produced AU$62.0, 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. The skyrocketing cash burn up 158% year on year certainly tests our nerves. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Admittedly, we're a bit cautious of Castile Resources due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Castile Resources Raise Cash?
Since its cash burn is moving in the wrong direction, Castile Resources shareholders may wish to think ahead to when the company may need to raise more cash. 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.
Since it has a market capitalisation of AU$11m, Castile Resources's AU$983k in cash burn equates to about 8.6% of its 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.
How Risky Is Castile Resources's Cash Burn Situation?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Castile Resources's cash burn relative to its market cap was relatively promising. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. Taking a deeper dive, we've spotted 3 warning signs for Castile Resources you should be aware of, and 2 of them are a bit concerning.
Of course Castile 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.
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.
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