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Here's Why We're A Bit Worried About Tlou Energy's (ASX:TOU) Cash Burn Situation

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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given this risk, we thought we'd take a look at whether Tlou Energy (ASX:TOU) 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'. 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 Tlou Energy

Does Tlou Energy 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. As at June 2019, Tlou Energy had cash of AU$5.2m and no debt. In the last year, its cash burn was AU$11m. Therefore, from June 2019 it had roughly 6 months of cash runway. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

ASX:TOU Historical Debt, October 23rd 2019

How Is Tlou Energy's Cash Burn Changing Over Time?

Because Tlou Energy isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Over the last year its cash burn actually increased by a very significant 70%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Tlou Energy makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Easily Can Tlou Energy Raise Cash?

Given its cash burn trajectory, Tlou Energy shareholders should already be thinking about how easy it might be for it to raise further 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. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Tlou Energy has a market capitalisation of AU$40m and burnt through AU$11m last year, which is 28% of the company's market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.

How Risky Is Tlou Energy's Cash Burn Situation?

We must admit that we don't think Tlou Energy is in a very strong position, when it comes to its cash burn. While its cash burn relative to its market cap wasn't too bad, its cash runway does leave us rather nervous. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Tlou Energy insiders have been trading shares in the company. Click here to find out if they 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.