Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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 should Global Petroleum (ASX:GBP) shareholders 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Global Petroleum's Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. As at June 2019, Global Petroleum had cash of US$2.8m and no debt. Looking at the last year, the company burnt through US$2.1m. Therefore, from June 2019 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. Depicted below, you can see how its cash holdings have changed over time.
How Is Global Petroleum's Cash Burn Changing Over Time?
Global Petroleum didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Even though it doesn't get us excited, the 25% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Global Petroleum makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Global Petroleum 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 Global Petroleum to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to drive 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.
Global Petroleum has a market capitalisation of AU$4.3m and burnt through US$2.1m last year, which is 74% of the company's market value. That's very high expenditure relative to the company's size, suggesting it is an extremely high risk stock.
Is Global Petroleum's Cash Burn A Worry?
On this analysis of Global Petroleum's cash burn, we think its cash burn reduction was reassuring, while its cash burn relative to its market cap has us a bit worried. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. 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 Global Petroleum's CEO gets paid each year.
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.
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