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Companies Like Pure Alumina (ASX:PUA) Can Be Considered Quite Risky

Simply Wall St

Just because a business does not make any money, does not mean that the stock will go down. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

Given this risk, we thought we'd take a look at whether Pure Alumina (ASX:PUA) shareholders should 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). Let's start with an examination of the business's cash, relative to its cash burn.

View our latest analysis for Pure Alumina

When Might Pure Alumina Run Out Of Money?

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. In June 2019, Pure Alumina had AU$1.4m in cash, and was debt-free. In the last year, its cash burn was AU$1.9m. So it had a cash runway of approximately 9 months from June 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.

ASX:PUA Historical Debt, January 16th 2020

How Is Pure Alumina's Cash Burn Changing Over Time?

In our view, Pure Alumina doesn't yet produce significant amounts of operating revenue, since it reported just AU$3.0k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. As it happens, the company's cash burn reduced by 39% 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 Pure Alumina 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 Hard Would It Be For Pure Alumina To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Pure Alumina to raise more cash in the future. 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 to fund growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Since it has a market capitalisation of AU$3.3m, Pure Alumina's AU$1.9m in cash burn equates to about 56% 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).

How Risky Is Pure Alumina's Cash Burn Situation?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Pure Alumina's cash burn reduction was relatively promising. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Pure Alumina's CEO gets paid each year.

Of course Pure Alumina 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 editorial-team@simplywallst.com. 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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.