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Here's Why We're Watching European Cobalt's (ASX:EUC) 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, 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So should European Cobalt (ASX:EUC) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for European Cobalt

How Long Is European Cobalt's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, European Cobalt had AU$11m in cash, and was debt-free. Importantly, its cash burn was AU$6.8m over the trailing twelve months. So it had a cash runway of approximately 20 months from June 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. Depicted below, you can see how its cash holdings have changed over time.

ASX:EUC Historical Debt, November 15th 2019

How Is European Cobalt's Cash Burn Changing Over Time?

In our view, European Cobalt doesn't yet produce significant amounts of operating revenue, since it reported just AU$345k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. During the last twelve months, its cash burn actually ramped up 85%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. European Cobalt 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 European Cobalt Raise Cash?

Given its cash burn trajectory, European Cobalt shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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.

European Cobalt has a market capitalisation of AU$16m and burnt through AU$6.8m last year, which is 43% of the company's market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).

So, Should We Worry About European Cobalt's Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought European Cobalt's cash runway was relatively promising. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the European Cobalt CEO is paid..

Of course European Cobalt 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.

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.