We can readily understand why investors are attracted to unprofitable companies. 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 Lachlan Star (ASX:LSA) shareholders should be worried about its 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Lachlan Star 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. When Lachlan Star last reported its balance sheet in December 2019, it had zero debt and cash worth AU$1.4m. In the last year, its cash burn was AU$387k. That means it had a cash runway of about 3.6 years as of December 2019. A runway of this length affords the company the time and space it needs to develop the business. You can see how its cash balance has changed over time in the image below.
How Is Lachlan Star's Cash Burn Changing Over Time?
Because Lachlan Star 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 21%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of Lachlan Star due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Lachlan Star To Raise More Cash For Growth?
Given its cash burn trajectory, Lachlan Star shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. 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.
Since it has a market capitalisation of AU$3.0m, Lachlan Star's AU$387k in cash burn equates to about 13% 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.
So, Should We Worry About Lachlan Star's Cash Burn?
It may already be apparent to you that we're relatively comfortable with the way Lachlan Star is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. Although its increasing cash burn does give us reason for pause, the other metrics we discussed in this article form a positive picture overall. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Lachlan Star (of which 2 are a bit concerning!) you should know about.
Of course Lachlan Star 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 firstname.lastname@example.org. 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.
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