There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for eMetals (ASX:EMT) shareholders is whether they should be concerned by its rate of cash burn. 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'.
How Long Is eMetals's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, eMetals had AU$268k in cash, and was debt-free. Looking at the last year, the company burnt through AU$584k. So it had a cash runway of approximately 6 months from June 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. You can see how its cash balance has changed over time in the image below.
How Is eMetals's Cash Burn Changing Over Time?
Whilst it's great to see that eMetals has already begun generating revenue from operations, last year it only produced AU$4.2k, so we don't think it is generating significant revenue, at this point. 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. Over the last year its cash burn actually increased by 44%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of eMetals 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 Hard Would It Be For eMetals To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, eMetals shareholders may wish to think ahead to when the company may need to raise more cash. 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. 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).
eMetals has a market capitalisation of AU$5.8m and burnt through AU$584k last year, which is 10% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
How Risky Is eMetals's Cash Burn Situation?
On this analysis of eMetals's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. 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 eMetals CEO receives in total remuneration.
Of course eMetals 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 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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