U.S. Markets close in 3 hrs 41 mins

Can MGC Pharmaceuticals (ASX:MXC) Afford To Invest In Growth?

Simply Wall St

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for MGC Pharmaceuticals (ASX:MXC) 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for MGC Pharmaceuticals

How Long Is MGC Pharmaceuticals's Cash Runway?

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. When MGC Pharmaceuticals last reported its balance sheet in June 2019, it had zero debt and cash worth AU$2.4m. Looking at the last year, the company burnt through AU$6.7m. That means it had a cash runway of around 4 months as of June 2019. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. Depicted below, you can see how its cash holdings have changed over time.

ASX:MXC Historical Debt, January 15th 2020

How Is MGC Pharmaceuticals's Cash Burn Changing Over Time?

Whilst it's great to see that MGC Pharmaceuticals has already begun generating revenue from operations, last year it only produced AU$656k, 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. Over the last year its cash burn actually increased by 6.1%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Easily Can MGC Pharmaceuticals Raise Cash?

While its cash burn is only increasing slightly, MGC Pharmaceuticals shareholders should still consider the potential need for further cash, down the track. 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.

MGC Pharmaceuticals has a market capitalisation of AU$48m and burnt through AU$6.7m last year, which is 14% of the company's 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 MGC Pharmaceuticals's Cash Burn?

On this analysis of MGC Pharmaceuticals's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. Notably, our data indicates that MGC Pharmaceuticals insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.

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)

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.