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Can Sagalio Energy (ASX:SAN) Afford To Invest In Growth?

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Just because a business does not make any money, does not mean that the stock will go down. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. 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.

Given this risk, we thought we'd take a look at whether Sagalio Energy (ASX:SAN) shareholders should 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.

View our latest analysis for Sagalio Energy

When Might Sagalio 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. As at December 2019, Sagalio Energy had cash of US$316k and no debt. Importantly, its cash burn was US$384k over the trailing twelve months. So it had a cash runway of approximately 10 months from December 2019. 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.

ASX:SAN Historical Debt May 29th 2020
ASX:SAN Historical Debt May 29th 2020

How Is Sagalio Energy's Cash Burn Changing Over Time?

While Sagalio Energy did record statutory revenue of US$58k over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. As it happens, the company's cash burn reduced by 2.5% over the last year, which suggests that management may be mindful of the risks of their depleting cash reserves. Admittedly, we're a bit cautious of Sagalio Energy due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For Sagalio Energy To Raise More Cash For Growth?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Sagalio Energy to raise more cash in the future. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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.

Sagalio Energy's cash burn of US$384k is about 282% of its US$136k market capitalisation. Given just how high that expenditure is, relative to the company's market value, we think there's an elevated risk of funding distress, and we would be very nervous about holding the stock.

How Risky Is Sagalio Energy's Cash Burn Situation?

On this analysis of Sagalio Energy's cash burn, we think its cash burn reduction was reassuring, while its cash burn relative to its market cap has us a bit worried. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. Its important for readers to be cognizant of the risks that can affect the company's operations, and we've picked out 4 warning signs for Sagalio Energy that investors should know when investing in the stock.

Of course Sagalio 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.

Love or hate this article? Concerned about the content? Get in touch with us directly. Alternatively, email 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. 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.