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Here's Why We're Watching Menlo Therapeutics's (NASDAQ:MNLO) Cash Burn Situation

Simply Wall St

We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for Menlo Therapeutics (NASDAQ:MNLO) 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

Check out our latest analysis for Menlo Therapeutics

When Might Menlo Therapeutics Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Menlo Therapeutics last reported its balance sheet in June 2019, it had zero debt and cash worth US$109m. Looking at the last year, the company burnt through US$61m. So it had a cash runway of approximately 21 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. The image below shows how its cash balance has been changing over the last few years.

NasdaqGS:MNLO Historical Debt, October 16th 2019

How Is Menlo Therapeutics's Cash Burn Changing Over Time?

Because Menlo Therapeutics isn't currently generating revenue, we consider it an early-stage 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. Over the last year its cash burn actually increased by 31%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

How Easily Can Menlo Therapeutics Raise Cash?

While Menlo Therapeutics does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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.

Menlo Therapeutics has a market capitalisation of US$110m and burnt through US$61m last year, which is 56% 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).

Is Menlo Therapeutics's Cash Burn A Worry?

On this analysis of Menlo Therapeutics's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. 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. 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 Menlo Therapeutics's CEO gets paid each year.

Of course Menlo Therapeutics 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.