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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should Octanex (ASX:OXX) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Octanex's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In December 2019, Octanex had AU$886k in cash, and was debt-free. Importantly, its cash burn was AU$1.4m over the trailing twelve months. Therefore, from December 2019 it had roughly 8 months of cash runway. 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 Octanex's Cash Burn Changing Over Time?
Because Octanex 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. With the cash burn rate up 7.9% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Octanex makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Octanex Raise Cash?
While its cash burn is only increasing slightly, Octanex 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. 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$1.7m, Octanex's AU$1.4m in cash burn equates to about 83% of its market value. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
Is Octanex's Cash Burn A Worry?
As you can probably tell by now, we're rather concerned about Octanex's cash burn. Take, for example, its cash burn relative to its market cap, which suggests the company may have difficulty funding itself, in the future. While not as bad as its cash burn relative to its market cap, its increasing cash burn is also a concern, and considering everything mentioned above, we're struggling to find much to be optimistic about. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. On another note, Octanex has 4 warning signs (and 3 which are a bit unpleasant) we think you should know about.
Of course Octanex 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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