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, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. 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 Check-Cap (NASDAQ:CHEK) 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. Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is Check-Cap's Cash Runway?
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. As at September 2020, Check-Cap had cash of US$21m and no debt. Importantly, its cash burn was US$13m over the trailing twelve months. Therefore, from September 2020 it had roughly 19 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. You can see how its cash balance has changed over time in the image below.
How Is Check-Cap's Cash Burn Changing Over Time?
Because Check-Cap isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Over the last year its cash burn actually increased by 7.0%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Easily Can Check-Cap Raise Cash?
Since its cash burn is increasing (albeit only slightly), Check-Cap shareholders should still be mindful of the possibility it will require more cash in the future. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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.
Since it has a market capitalisation of US$21m, Check-Cap's US$13m in cash burn equates to about 62% of its market value. Given how large that cash burn is, relative to the market value of the entire company, we'd consider it to be a high risk stock, with the real possibility of extreme dilution.
Is Check-Cap's Cash Burn A Worry?
On this analysis of Check-Cap's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Summing up, we think the Check-Cap's cash burn is a risk, based on the factors we mentioned in this article. Taking a deeper dive, we've spotted 5 warning signs for Check-Cap you should be aware of, and 2 of them are significant.
Of course Check-Cap 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.
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.
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