There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So should Sultan Resources (ASX:SLZ) 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). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Sultan Resources 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. As at December 2019, Sultan Resources had cash of AU$2.7m and no debt. Importantly, its cash burn was AU$919k over the trailing twelve months. So it had a cash runway of about 3.0 years from December 2019. That's decent, giving the company a couple years to develop its business. The image below shows how its cash balance has been changing over the last few years.
How Is Sultan Resources's Cash Burn Changing Over Time?
Because Sultan Resources 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. With cash burn dropping by 8.1% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Sultan Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Sultan Resources Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sultan Resources 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. 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).
Sultan Resources has a market capitalisation of AU$3.6m and burnt through AU$919k last year, which is 26% 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 Sultan Resources's Cash Burn Situation?
On this analysis of Sultan Resources's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. 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. Taking a deeper dive, we've spotted 4 warning signs for Sultan Resources you should be aware of, and 2 of them are a bit concerning.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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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