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 Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for King River Resources (ASX:KRR) shareholders is whether they should be concerned by its rate of 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is King River Resources'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 2019, King River Resources had cash of AU$3.0m and no debt. Importantly, its cash burn was AU$4.2m over the trailing twelve months. So it had a cash runway of approximately 8 months from June 2019. 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. You can see how its cash balance has changed over time in the image below.
How Is King River Resources's Cash Burn Changing Over Time?
Whilst it's great to see that King River Resources has already begun generating revenue from operations, last year it only produced AU$4.5k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by a very significant 61%. 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. Admittedly, we're a bit cautious of King River Resources 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 Easily Can King River Resources Raise Cash?
Given its cash burn trajectory, King River Resources shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.
King River Resources has a market capitalisation of AU$24m and burnt through AU$4.2m last year, which is 18% 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 King River Resources's Cash Burn?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought King River Resources's cash burn relative to its market cap was relatively promising. Summing up, we think the King River Resources's cash burn is a risk, based on the factors we mentioned in this article. 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 King River Resources CEO receives in total remuneration.
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 email@example.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.
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