There's no doubt that money can be made by owning shares of unprofitable businesses. 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 3D Oil (ASX:TDO) 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.
Does 3D Oil Have A Long Cash Runway?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at June 2019, 3D Oil had cash of AU$1.9m and no debt. In the last year, its cash burn was AU$1.9m. Therefore, from June 2019 it had roughly 12 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Depicted below, you can see how its cash holdings have changed over time.
How Is 3D Oil's Cash Burn Changing Over Time?
In our view, 3D Oil doesn't yet produce significant amounts of operating revenue, since it reported just AU$28k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With the cash burn rate up 43% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. 3D Oil 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 3D Oil Raise Cash?
While 3D Oil does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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$22m, 3D Oil's AU$1.9m in cash burn equates to about 8.5% of its market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is 3D Oil's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought 3D Oil's cash burn relative to its market cap was relatively promising. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that 3D Oil 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)
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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