Just because a business does not make any money, does not mean that the stock will go down. For example, Encounter Resources (ASX:ENR) shareholders have done very well over the last year, with the share price soaring by 125%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given its strong share price performance, we think it's worthwhile for Encounter Resources shareholders to consider whether its cash burn is concerning. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Encounter Resources Run Out Of Money?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In June 2019, Encounter Resources had AU$2.5m in cash, and was debt-free. In the last year, its cash burn was AU$2.6m. So it had a cash runway of approximately 12 months from June 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. You can see how its cash balance has changed over time in the image below.
How Is Encounter Resources's Cash Burn Changing Over Time?
While Encounter Resources did record statutory revenue of AU$468k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. Given the length of the cash runway, we'd interpret the 38% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Admittedly, we're a bit cautious of Encounter Resources 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 Hard Would It Be For Encounter Resources To Raise More Cash For Growth?
While Encounter Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. 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.
Encounter Resources has a market capitalisation of AU$38m and burnt through AU$2.6m last year, which is 6.8% of the company's market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is Encounter Resources's Cash Burn Situation?
On this analysis of Encounter Resources's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Encounter Resources insiders have been trading shares in the company. Click here to find out if they 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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