There's no doubt that money can be made by owning shares of unprofitable businesses. By way of example, Liontown Resources (ASX:LTR) has seen its share price rise 342% over the last year, delighting many shareholders. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given its strong share price performance, we think it's worthwhile for Liontown Resources shareholders to consider whether its cash burn is concerning. 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. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Liontown Resources's Cash Runway?
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. When Liontown Resources last reported its balance sheet in December 2019, it had zero debt and cash worth AU$12m. In the last year, its cash burn was AU$14m. That means it had a cash runway of around 10 months as of December 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Depicted below, you can see how its cash holdings have changed over time.
How Is Liontown Resources's Cash Burn Changing Over Time?
Liontown Resources 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. The skyrocketing cash burn up 137% year on year certainly tests our nerves. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of Liontown 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.
How Hard Would It Be For Liontown Resources To Raise More Cash For Growth?
Given its cash burn trajectory, Liontown Resources shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
Liontown Resources has a market capitalisation of AU$169m and burnt through AU$14m last year, which is 8.3% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
So, Should We Worry About Liontown Resources's Cash Burn?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Liontown Resources's 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 6 warning signs for Liontown Resources (of which 3 can't be ignored!) you should know about.
Of course Liontown 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.
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