There's no doubt that money can be made by owning shares of unprofitable businesses. 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.
So should Horizon Petroleum (CVE:HPL) shareholders be worried about its cash burn? For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
Does Horizon Petroleum Have A Long 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 May 2019, Horizon Petroleum had cash of CA$278k and no debt. Looking at the last year, the company burnt through CA$1.1m. So it had a cash runway of approximately 3 months from May 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. The image below shows how its cash balance has been changing over the last few years.
How Is Horizon Petroleum's Cash Burn Changing Over Time?
Because Horizon Petroleum 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. As it happens, the company's cash burn reduced by 46% over the last year, which suggests that management are mindful of the possibility of running out of cash. Admittedly, we're a bit cautious of Horizon Petroleum due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Horizon Petroleum Raise Cash?
While Horizon Petroleum is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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 CA$2.4m, Horizon Petroleum's CA$1.1m in cash burn equates to about 45% of its market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
Is Horizon Petroleum's Cash Burn A Worry?
There are no prizes for guessing that we think Horizon Petroleum's cash burn is a bit of a worry. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. On the other hand at least it could boast rather strong cash burn reduction, which no doubt gives shareholders some comfort. 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. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Horizon Petroleum insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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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.