Just because a business does not make any money, does not mean that the stock will go down. 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.
Given this risk, we thought we'd take a look at whether First Graphene (ASX:FGR) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might First Graphene Run Out Of Money?
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 June 2020, First Graphene had cash of AU$8.1m and no debt. Looking at the last year, the company burnt through AU$5.9m. Therefore, from June 2020 it had roughly 16 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. You can see how its cash balance has changed over time in the image below.
How Is First Graphene's Cash Burn Changing Over Time?
In our view, First Graphene doesn't yet produce significant amounts of operating revenue, since it reported just AU$290k 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 5.0% over the last year, which suggests that management are maintaining a fairly steady rate of business development, albeit with a slight decrease in spending. Admittedly, we're a bit cautious of First Graphene 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 First Graphene Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for First Graphene 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. Many companies end up issuing new shares to fund future 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.
First Graphene has a market capitalisation of AU$74m and burnt through AU$5.9m last year, which is 8.0% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
So, Should We Worry About First Graphene's Cash Burn?
The good news is that in our view First Graphene's cash burn situation gives shareholders real reason for optimism. Not only was its cash runway quite good, but its cash burn relative to its market cap was a real positive. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about First Graphene's situation. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for First Graphene (3 are a bit unpleasant!) that you should be aware of before investing here.
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.
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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