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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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Xtract Resources (LON:XTR) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Xtract Resources's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, Xtract Resources had UK£354k in cash, and was debt-free. Importantly, its cash burn was UK£674k over the trailing twelve months. Therefore, from June 2019 it had roughly 6 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.
How Is Xtract Resources's Cash Burn Changing Over Time?
Although Xtract Resources had revenue of UK£1.2m in the last twelve months, its operating revenue was only UK£1.2m in that time period. Given how low that operating leverage is, we think it's too early to put much weight on the revenue growth, so we'll focus on how the cash burn is changing, instead. As it happens, the company's cash burn reduced by 28% over the last year, which suggests that management are mindful of the possibility of running out of cash. In reality, this article only makes a short study of the company's growth data. This graph of historic revenue growth shows how Xtract Resources is building its business over time.
Can Xtract Resources Raise More Cash Easily?
While Xtract Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.
Xtract Resources has a market capitalisation of UK£4.6m and burnt through UK£674k last year, which is 15% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
Is Xtract Resources's Cash Burn A Worry?
On this analysis of Xtract Resources's cash burn, we think its cash burn reduction was reassuring, while its cash runway 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. 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: Xtract Resources insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.
Of course Xtract Resources 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.
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.
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.