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South Star Mining (CVE:STS) Is Very Risky Based On Its Cash Burn

Simply Wall St

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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

So, the natural question for South Star Mining (CVE:STS) shareholders is whether they should be concerned by its rate of 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.

See our latest analysis for South Star Mining

When Might South Star Mining 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. When South Star Mining last reported its balance sheet in June 2019, it had zero debt and cash worth CA$993k. In the last year, its cash burn was CA$2.0m. That means it had a cash runway of around 6 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. You can see how its cash balance has changed over time in the image below.

TSXV:STS Historical Debt, October 15th 2019

How Is South Star Mining's Cash Burn Changing Over Time?

South Star Mining didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. The skyrocketing cash burn up 121% year on year certainly tests our nerves. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. South Star Mining 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 South Star Mining Raise Cash?

Since its cash burn is moving in the wrong direction, South Star Mining shareholders may wish to think ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.

South Star Mining's cash burn of CA$2.0m is about the same as its market capitalisation of CA$1.9m. 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 South Star Mining's Cash Burn Situation?

There are no prizes for guessing that we think South Star Mining's cash burn is a bit of a worry. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. 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. 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. Notably, our data indicates that South Star Mining 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)

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.

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. Thank you for reading.