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We can readily understand why investors are attracted to unprofitable companies. For example, Allakos (NASDAQ:ALLK) shareholders have done very well over the last year, with the share price soaring by 158%. 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 notwithstanding the buoyant share price, we think it's well worth asking whether Allakos'cash burn is too risky 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
Does Allakos Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In March 2020, Allakos had US$480m in cash, and was debt-free. Importantly, its cash burn was US$69m over the trailing twelve months. So it had a cash runway of about 6.9 years from March 2020. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. Depicted below, you can see how its cash holdings have changed over time.
How Is Allakos' Cash Burn Changing Over Time?
Because Allakos 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 39%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. 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 Allakos To Raise More Cash For Growth?
Given its cash burn trajectory, Allakos shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.
Allakos' cash burn of US$69m is about 1.7% of its US$4.0b market capitalisation. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.
So, Should We Worry About Allakos' Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way Allakos is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. On another note, Allakos has 5 warning signs (and 1 which can't be ignored) we think you should know about.
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)
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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