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Will Sultan Resources (ASX:SLZ) Spend Its Cash Wisely?

Simply Wall St

Just because a business does not make any money, does not mean that the stock will go down. 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 should Sultan Resources (ASX:SLZ) 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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Sultan Resources

Does Sultan Resources Have A Long 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 Sultan Resources last reported its balance sheet in June 2019, it had zero debt and cash worth AU$3.1m. Looking at the last year, the company burnt through AU$1.5m. Therefore, from June 2019 it had 2.1 years of cash runway. That's decent, giving the company a couple years to develop its business. The image below shows how its cash balance has been changing over the last few years.

ASX:SLZ Historical Debt, October 17th 2019

How Is Sultan Resources's Cash Burn Changing Over Time?

Because Sultan Resources isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. The skyrocketing cash burn up 169% year on year certainly tests our nerves. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Sultan Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Hard Would It Be For Sultan Resources To Raise More Cash For Growth?

While Sultan Resources does have a solid cash runway, its cash burn trajectory may have some shareholders thinking 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 comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).

Sultan Resources's cash burn of AU$1.5m is about 48% of its AU$3.0m market capitalisation. From this perspective, it seems that the company spent a hugh amount relative to its market value, and we'd be very wary of a painful capital raising.

So, Should We Worry About Sultan Resources's Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Sultan Resources's cash runway was relatively promising. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Sultan Resources CEO receives in total remuneration.

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.