We can readily understand why investors are attracted to unprofitable companies. 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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should IODM (ASX:IOD) 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'.
How Long Is IODM's Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at June 2022, IODM had cash of AU$1.2m and no debt. Importantly, its cash burn was AU$1.8m over the trailing twelve months. So it had a cash runway of approximately 8 months from June 2022. 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 IODM's Cash Burn Changing Over Time?
Although IODM had revenue of AU$1.2m in the last twelve months, its operating revenue was only AU$803k in that time period. Given how low that operating leverage is, we think it's too early to put much weight on the revenue growth, so we'll focus on how the cash burn is changing, instead. With the cash burn rate up 8.9% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of IODM due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For IODM To Raise More Cash For Growth?
Since its cash burn is increasing (albeit only slightly), IODM shareholders should still be mindful of the possibility it will require more cash in the future. Companies can raise capital through either debt or equity. 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.
Since it has a market capitalisation of AU$151m, IODM's AU$1.8m in cash burn equates to about 1.2% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About IODM's Cash Burn?
On this analysis of IODM's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. 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. Readers need to have a sound understanding of business risks before investing in a stock, and we've spotted 3 warning signs for IODM that potential shareholders should take into account before putting money into a stock.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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