Just because a business does not make any money, does not mean that the stock will go down. 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.
Given this risk, we thought we'd take a look at whether Magenta Therapeutics (NASDAQ:MGTA) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business's cash, relative to its cash burn.
When Might Magenta Therapeutics Run Out Of Money?
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. As at December 2019, Magenta Therapeutics had cash of US$146m and no debt. Looking at the last year, the company burnt through US$60m. So it had a cash runway of about 2.4 years from December 2019. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.
How Is Magenta Therapeutics's Cash Burn Changing Over Time?
Magenta Therapeutics didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. Over the last year its cash burn actually increased by 21%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Magenta Therapeutics To Raise More Cash For Growth?
While Magenta Therapeutics 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. 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 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).
Magenta Therapeutics has a market capitalisation of US$255m and burnt through US$60m last year, which is 24% of the company's market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.
How Risky Is Magenta Therapeutics's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Magenta Therapeutics's cash runway was relatively promising. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Magenta Therapeutics's situation. On another note, Magenta Therapeutics has 4 warning signs (and 2 which can't be ignored) we think you should know about.
Of course Magenta Therapeutics 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.
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