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Here's Why We're Not Too Worried About Luxxu Group's (HKG:1327) Cash Burn Situation

Simply Wall St

Just because a business does not make any money, does not mean that the stock will go down. 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?

So should Luxxu Group (HKG:1327) shareholders 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Luxxu Group

Does Luxxu Group Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Luxxu Group last reported its balance sheet in June 2019, it had zero debt and cash worth CN¥222m. Importantly, its cash burn was CN¥10m over the trailing twelve months. So it had a very long cash runway of many years from June 2019. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. Depicted below, you can see how its cash holdings have changed over time.

SEHK:1327 Historical Debt, February 2nd 2020

How Well Is Luxxu Group Growing?

Luxxu Group managed to reduce its cash burn by 80% over the last twelve months, which suggests it's on the right flight path. Unfortunately, however, operating revenue dropped 39% during the same time frame. Considering the factors above, the company doesn’t fare badly when it comes to assessing how it is changing over time. In reality, this article only makes a short study of the company's growth data. You can take a look at how Luxxu Group has developed its business over time by checking this visualization of its revenue and earnings history.

How Hard Would It Be For Luxxu Group To Raise More Cash For Growth?

We are certainly impressed with the progress Luxxu Group has made over the last year, but it is also worth considering how costly it would be if it wanted to raise more cash to fund faster growth. 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. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Luxxu Group has a market capitalisation of CN¥80m and burnt through CN¥10m last year, which is 13% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

So, Should We Worry About Luxxu Group's Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Luxxu Group is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. While we must concede that its falling revenue is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Luxxu Group CEO receives in total remuneration.

Of course Luxxu Group may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.