There's no doubt that money can be made by owning shares of unprofitable businesses. 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 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 Melbana Energy (ASX:MAY) 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.
When Might Melbana Energy Run Out Of Money?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In December 2019, Melbana Energy had AU$1.9m in cash, and was debt-free. Importantly, its cash burn was AU$3.0m over the trailing twelve months. Therefore, from December 2019 it had roughly 8 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 Melbana Energy's Cash Burn Changing Over Time?
Because Melbana Energy isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Given the length of the cash runway, we'd interpret the 42% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we're a bit cautious of Melbana Energy 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 Melbana Energy To Raise More Cash For Growth?
While Melbana Energy 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.
Since it has a market capitalisation of AU$19m, Melbana Energy's AU$3.0m in cash burn equates to about 16% of its 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.
How Risky Is Melbana Energy's Cash Burn Situation?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Melbana Energy's cash burn reduction 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. Taking an in-depth view of risks, we've identified 4 warning signs for Melbana Energy that you should be aware of before investing.
Of course Melbana Energy 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.
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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.