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There's no doubt that money can be made by owning shares of unprofitable businesses. By way of example, Latin Resources (ASX:LRS) has seen its share price rise 173% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given its strong share price performance, we think it's worthwhile for Latin Resources shareholders to consider whether its cash burn is concerning. 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). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Latin Resources Run Out Of Money?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. In June 2021, Latin Resources had AU$2.8m in cash, and was debt-free. Looking at the last year, the company burnt through AU$3.8m. That means it had a cash runway of around 9 months as of June 2021. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. The image below shows how its cash balance has been changing over the last few years.
How Is Latin Resources' Cash Burn Changing Over Time?
While Latin Resources did record statutory revenue of AU$154k over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. Its cash burn positively exploded in the last year, up 262%. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Latin Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Latin Resources Raise More Cash Easily?
Since its cash burn is moving in the wrong direction, Latin Resources shareholders may wish to think ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.
Since it has a market capitalisation of AU$57m, Latin Resources' AU$3.8m in cash burn equates to about 6.6% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is Latin Resources' Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Latin Resources' cash burn relative to its market cap was relatively promising. 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. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Latin Resources (of which 3 can't be ignored!) you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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