We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 Real Energy (ASX:RLE) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is Real Energy'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 Real Energy last reported its balance sheet in June 2019, it had zero debt and cash worth AU$3.3m. Importantly, its cash burn was AU$9.2m over the trailing twelve months. Therefore, from June 2019 it had roughly 4 months of cash runway. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. We should note, however, that if we extrapolate recent trends in its cash burn, then its cash runway would get a lot longer. You can see how its cash balance has changed over time in the image below.
How Is Real Energy's Cash Burn Changing Over Time?
Whilst it's great to see that Real Energy has already begun generating revenue from operations, last year it only produced AU$67k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by a very significant 60%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. Admittedly, we're a bit cautious of Real 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 Easily Can Real Energy Raise Cash?
Given its cash burn trajectory, Real Energy 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 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.
In the last year, Real Energy burned through AU$9.2m, which is just about equal to its AU$9.4m market cap. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
Is Real Energy's Cash Burn A Worry?
As you can probably tell by now, we're rather concerned about Real Energy'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. And although we accept its increasing cash burn wasn't as worrying as its cash burn relative to its market cap, it was still a real negative; as indeed were all the factors we considered in this article. 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. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Real Energy insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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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. Thank you for reading.