Just because a business does not make any money, does not mean that the stock will go down. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given this risk, we thought we'd take a look at whether E2 Metals (ASX:E2M) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business's cash, relative to its cash burn.
When Might E2 Metals Run Out Of Money?
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. In December 2019, E2 Metals had AU$2.4m in cash, and was debt-free. Looking at the last year, the company burnt through AU$3.2m. That means it had a cash runway of around 9 months as of December 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. The image below shows how its cash balance has been changing over the last few years.
How Is E2 Metals's Cash Burn Changing Over Time?
Although E2 Metals reported revenue of AU$3.7k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. Remarkably, it actually increased its cash burn by 275% in the last year. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Admittedly, we're a bit cautious of E2 Metals due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can E2 Metals Raise More Cash Easily?
Since its cash burn is moving in the wrong direction, E2 Metals 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$8.3m, E2 Metals's AU$3.2m in cash burn equates to about 38% of its 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.
So, Should We Worry About E2 Metals's Cash Burn?
We must admit that we don't think E2 Metals is in a very strong position, when it comes to its cash burn. Although we can understand if some shareholders find its cash burn relative to its market cap acceptable, we can't ignore the fact that we consider its increasing cash burn to be downright troublesome. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. On another note, we conducted an in-depth investigation of the company, and identified 7 warning signs for E2 Metals (5 are potentially serious!) that you should be aware of before investing here.
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 email@example.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.
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