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Here's Why Eagle Mountain Mining (ASX:EM2) Must Use Its Cash Wisely

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 while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for Eagle Mountain Mining (ASX:EM2) 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Eagle Mountain Mining

Does Eagle Mountain Mining Have A Long 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. Eagle Mountain Mining has such a small amount of debt that we'll set it aside, and focus on the AU$1.9m in cash it held at June 2019. Importantly, its cash burn was AU$6.7m over the trailing twelve months. Therefore, from June 2019 it had roughly 3 months of cash runway. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. You can see how its cash balance has changed over time in the image below.

ASX:EM2 Historical Debt, November 2nd 2019

How Is Eagle Mountain Mining's Cash Burn Changing Over Time?

While Eagle Mountain Mining did record statutory revenue of AU$12.0 over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Its cash burn positively exploded in the last year, up 213%. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Eagle Mountain Mining 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 Eagle Mountain Mining To Raise More Cash For Growth?

Since its cash burn is moving in the wrong direction, Eagle Mountain Mining shareholders may wish to think ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. 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$17m, Eagle Mountain Mining's AU$6.7m in cash burn equates to about 40% of its market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).

How Risky Is Eagle Mountain Mining's Cash Burn Situation?

There are no prizes for guessing that we think Eagle Mountain Mining's cash burn is a bit of a worry. In particular, we think its increasing cash burn suggests it isn't in a good position to keep funding growth. And although we accept its cash burn relative to its market cap wasn't as worrying as its increasing cash burn, it was still a real negative; as indeed were all the factors we considered in this article. 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. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Eagle Mountain Mining insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.

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.