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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for Element 25 (ASX:E25) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is Element 25'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. When Element 25 last reported its balance sheet in June 2019, it had zero debt and cash worth AU$8.8m. Importantly, its cash burn was AU$1.1m over the trailing twelve months. Therefore, from June 2019 it had 7.7 years of cash runway. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. You can see how its cash balance has changed over time in the image below.
How Is Element 25's Cash Burn Changing Over Time?
Whilst it's great to see that Element 25 has already begun generating revenue from operations, last year it only produced AU$36k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 42% over the last year suggests some degree of prudence. Admittedly, we're a bit cautious of Element 25 due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Element 25 Raise More Cash Easily?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Element 25 to raise more cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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 AU$16m, Element 25's AU$1.1m in cash burn equates to about 7.3% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
Is Element 25's Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Element 25's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Its cash burn reduction wasn't quite as good, but was still rather encouraging! 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. 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 Element 25's CEO gets paid each year.
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)
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.
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