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Here's Why We're Watching Melbana Energy's (ASX:MAY) 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for Melbana Energy (ASX:MAY) shareholders is whether they should be concerned by its rate of cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). Let's start with an examination of the business's cash, relative to its cash burn.

View our latest analysis for Melbana Energy

When Might Melbana Energy Run Out Of Money?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In June 2019, Melbana Energy had AU$3.4m in cash, and was debt-free. Looking at the last year, the company burnt through AU$3.2m. So it had a cash runway of approximately 13 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:MAY Historical Debt, December 9th 2019
ASX:MAY Historical Debt, December 9th 2019

How Is Melbana Energy's Cash Burn Changing Over Time?

Melbana Energy didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 47% over the last year suggests some degree of prudence. Melbana Energy 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 Hard Would It Be For Melbana Energy To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Melbana Energy to 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. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Since it has a market capitalisation of AU$19m, Melbana Energy's AU$3.2m in cash burn equates to about 17% of its 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.

How Risky Is Melbana Energy's Cash Burn Situation?

Melbana Energy appears to be in pretty good health when it comes to its cash burn situation. Not only was its cash burn relative to its market cap quite good, but its cash burn reduction was a real positive. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Melbana Energy's CEO gets paid each year.

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 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.

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. Thank you for reading.