Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So, the natural question for Rockhopper Exploration (LON:RKH) 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Rockhopper Exploration 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. As at June 2019, Rockhopper Exploration had cash of US$27m and no debt. Looking at the last year, the company burnt through US$20m. That means it had a cash runway of around 16 months as of June 2019. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Rockhopper Exploration Growing?
Rockhopper Exploration boosted investment sharply in the last year, with cash burn ramping by 82%. While that's concerning on it's own, the fact that operating revenue was actually down 3.7% over the same period makes us positively tremulous. Considering both these metrics, we're a little concerned about how the company is developing. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.
Can Rockhopper Exploration Raise More Cash Easily?
Rockhopper Exploration revenue is declining and its cash burn is increasing, so many may be considering its need to raise more cash in the future. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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.
Rockhopper Exploration's cash burn of US$20m is about 22% of its UK£70m market capitalisation. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
So, Should We Worry About Rockhopper Exploration's Cash Burn?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Rockhopper Exploration's cash runway was relatively promising. Summing up, we think the Rockhopper Exploration's cash burn is a risk, based on the factors we mentioned in this article. 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 Rockhopper Exploration CEO receives in total remuneration.
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