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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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for Luff Enterprises (CSE:LUFF) shareholders is whether they should be concerned by its rate of 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.
When Might Luff Enterprises 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 December 2019, Luff Enterprises had CA$4.4m in cash, and was debt-free. Importantly, its cash burn was CA$15m over the trailing twelve months. That means it had a cash runway of around 3 months as of December 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.
How Is Luff Enterprises's Cash Burn Changing Over Time?
Whilst it's great to see that Luff Enterprises has already begun generating revenue from operations, last year it only produced CA$744k, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. We'd venture that the 67% reduction in cash burn over the last year shows that management are, at least, mindful of its ongoing need for cash. Admittedly, we're a bit cautious of Luff Enterprises 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 Easily Can Luff Enterprises Raise Cash?
There's no doubt Luff Enterprises's rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. 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 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.
Since it has a market capitalisation of CA$10.0m, Luff Enterprises's CA$15m in cash burn equates to about 154% of its market value. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
Is Luff Enterprises's Cash Burn A Worry?
As you can probably tell by now, we're rather concerned about Luff Enterprises's cash burn. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. But the silver lining was its cash burn reduction, which was encouraging. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. On another note, we conducted an in-depth investigation of the company, and identified 6 warning signs for Luff Enterprises (5 are a bit concerning!) that you should be aware of before investing here.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
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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. 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. Thank you for reading.