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Here's Why Canstar Resources (CVE:ROX) Must Play Its Cards Just Right

Simply Wall St

We can readily understand why investors are attracted to unprofitable companies. 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 Canstar Resources (CVE:ROX) shareholders is whether they should be concerned by its rate of 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'.

Check out our latest analysis for Canstar Resources

Does Canstar Resources Have A Long Cash Runway?

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. In March 2019, Canstar Resources had CA$182k in cash, and was debt-free. Looking at the last year, the company burnt through CA$1.3m. So it had a cash runway of approximately 2 months from March 2019. It's extremely surprising to us that the company has allowed its cash runway to get that short! The image below shows how its cash balance has been changing over the last few years.

TSXV:ROX Historical Debt, October 4th 2019

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

Because Canstar Resources isn't currently generating revenue, we consider it an early-stage 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. During the last twelve months, its cash burn actually ramped up 79%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Canstar Resources 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 Easily Can Canstar Resources Raise Cash?

Given its cash burn trajectory, Canstar Resources shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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.

Canstar Resources has a market capitalisation of CA$2.2m and burnt through CA$1.3m last year, which is 57% of the company's market value. From this perspective, it seems that the company spent a hugh amount relative to its market value, and we'd be very wary of a painful capital raising.

How Risky Is Canstar Resources's Cash Burn Situation?

As you can probably tell by now, we're rather concerned about Canstar Resources's cash burn. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. While not as bad as its cash runway, its increasing cash burn is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. 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. Notably, our data indicates that Canstar Resources insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

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. Thank you for reading.