U.S. Markets closed

Here's Why Surge Exploration (CVE:SUR) Must Use Its Cash Wisely

Simply Wall St

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. 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 Surge Exploration (CVE:SUR) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Surge Exploration

When Might Surge Exploration Run Out Of Money?

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. As at September 2019, Surge Exploration had cash of CA$282k and no debt. Looking at the last year, the company burnt through CA$1.2m. Therefore, from September 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.

TSXV:SUR Historical Debt, January 24th 2020

How Is Surge Exploration's Cash Burn Changing Over Time?

Surge Exploration 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. Given the length of the cash runway, we'd interpret the 29% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we're a bit cautious of Surge Exploration 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 Surge Exploration 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 Surge Exploration to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.

Surge Exploration's cash burn of CA$1.2m is about 78% of its CA$1.5m market capitalisation. Given how large that cash burn is, relative to the market value of the entire company, we'd consider it to be a high risk stock, with the real possibility of extreme dilution.

So, Should We Worry About Surge Exploration's Cash Burn?

As you can probably tell by now, we're rather concerned about Surge Exploration's cash burn. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. While not as bad as its cash burn relative to its market cap, its cash burn reduction is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. The measures we've considered in this article lead us to believe its cash burn is actually quite concerning, and its weak cash position seems likely to cost shareholders one way or another. 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 Surge Exploration's CEO gets paid each year.

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)

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.

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. Thank you for reading.