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Companies Like Sphinx Resources (CVE:SFX) Can Be Considered Quite Risky

Simply Wall St

We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So, the natural question for Sphinx Resources (CVE:SFX) shareholders is whether they should be concerned by its rate of 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Sphinx Resources

How Long Is Sphinx Resources's Cash Runway?

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. As at November 2019, Sphinx Resources had cash of CA$289k and no debt. Importantly, its cash burn was CA$1.4m over the trailing twelve months. That means it had a cash runway of around 2 months as of November 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

TSXV:SFX Historical Debt, January 16th 2020

How Is Sphinx Resources's Cash Burn Changing Over Time?

In our view, Sphinx Resources doesn't yet produce significant amounts of operating revenue, since it reported just CA$20k 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 107%. 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 Sphinx 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 Sphinx Resources Raise Cash?

Given its cash burn trajectory, Sphinx Resources shareholders should already be thinking about how easy it might be for it to raise further 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 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.

Sphinx Resources's cash burn of CA$1.4m is about 44% of its CA$3.2m market capitalisation. From this perspective, it seems that the company spent a huge amount relative to its market value, and we'd be very wary of a painful capital raising.

How Risky Is Sphinx Resources's Cash Burn Situation?

There are no prizes for guessing that we think Sphinx Resources's cash burn is a bit of a worry. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. And although we accept its cash burn relative to its market cap wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Sphinx Resources CEO receives in total remuneration.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

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.

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