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Here's Why We're Watching Verona Pharma's (LON:VRP) Cash Burn Situation

Simply Wall St

Just because a business does not make any money, does not mean that the stock will go down. 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 history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given this risk, we thought we'd take a look at whether Verona Pharma (LON:VRP) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Verona Pharma

When Might Verona Pharma Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2019, Verona Pharma had UK£47m in cash, and was debt-free. Importantly, its cash burn was UK£24m over the trailing twelve months. Therefore, from June 2019 it had roughly 23 months of cash runway. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. You can see how its cash balance has changed over time in the image below.

AIM:VRP Historical Debt, October 17th 2019

How Is Verona Pharma's Cash Burn Changing Over Time?

Verona Pharma didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. With cash burn dropping by 4.4% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Easily Can Verona Pharma Raise Cash?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Verona Pharma to raise 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.

Verona Pharma's cash burn of UK£24m is about 46% of its UK£53m market capitalisation. From this perspective, it seems that the company spent a hugh amount relative to its market value, and we'd be very wary of a painful capital raising.

So, Should We Worry About Verona Pharma's Cash Burn?

Even though its cash burn relative to its market cap makes us a little nervous, we are compelled to mention that we thought Verona Pharma's cash runway was relatively promising. 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. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Verona Pharma insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.

Of course Verona Pharma 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.