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We Think Red Metal (ASX:RDM) Needs To Drive Business Growth Carefully

Simply Wall St

There's no doubt that money can be made by owning shares of unprofitable businesses. 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 while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So should Red Metal (ASX:RDM) shareholders 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'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

View our latest analysis for Red Metal

How Long Is Red Metal's Cash Runway?

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. In June 2019, Red Metal had AU$916k in cash, and was debt-free. Looking at the last year, the company burnt through AU$2.0m. That means it had a cash runway of around 5 months as of June 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

ASX:RDM Historical Debt, October 14th 2019

How Is Red Metal's Cash Burn Changing Over Time?

In our view, Red Metal doesn't yet produce significant amounts of operating revenue, since it reported just AU$1.0m in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. As it happens, the company's cash burn reduced by 6.2% 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 Red Metal 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 Red Metal 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 Red Metal to raise more cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.

Red Metal's cash burn of AU$2.0m is about 7.9% of its AU$25m market capitalisation. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

So, Should We Worry About Red Metal's Cash Burn?

On this analysis of Red Metal's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. 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. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Red Metal's CEO gets paid each year.

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)

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.