There's no doubt that money can be made by owning shares of unprofitable businesses. By way of example, L & A International Holdings (HKG:8195) has seen its share price rise 181% over the last year, delighting many shareholders. 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 notwithstanding the buoyant share price, we think it's well worth asking whether L & A International Holdings's cash burn is too risky In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is L & A International Holdings's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. L & A International Holdings has such a small amount of debt that we'll set it aside, and focus on the HK$16m in cash it held at September 2019. Importantly, its cash burn was HK$35m over the trailing twelve months. That means it had a cash runway of around 5 months as of September 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. The image below shows how its cash balance has been changing over the last few years.
How Well Is L & A International Holdings Growing?
Notably, L & A International Holdings actually ramped up its cash burn very hard and fast in the last year, by 126%, signifying heavy investment in the business. On top of that, the fact that operating revenue was basically flat over the same period compounds the concern. Considering both these metrics, we're a little concerned about how the company is developing. In reality, this article only makes a short study of the company's growth data. You can take a look at how L & A International Holdings has developed its business over time by checking this visualization of its revenue and earnings history.
Can L & A International Holdings Raise More Cash Easily?
Given the trajectory of L & A International Holdings's cash burn, many investors will already be thinking about how it might raise more 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.
L & A International Holdings's cash burn of HK$35m is about 15% of its HK$241m market capitalisation. 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.
Is L & A International Holdings's Cash Burn A Worry?
On this analysis of L & A International Holdings's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. On another note, L & A International Holdings has 4 warning signs (and 2 which are potentially serious) we think you should know about.
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)
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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. 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. Thank you for reading.