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We Think Talon Petroleum (ASX:TPD) Needs To Drive Business Growth Carefully

Simply Wall St

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 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, the natural question for Talon Petroleum (ASX:TPD) 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). Let's start with an examination of the business's cash, relative to its cash burn.

Check out our latest analysis for Talon Petroleum

When Might Talon Petroleum 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. In June 2019, Talon Petroleum had AU$2.6m in cash, and was debt-free. In the last year, its cash burn was AU$1.2m. Therefore, from June 2019 it had 2.2 years of cash runway. Arguably, that's a prudent and sensible length of runway to have. You can see how its cash balance has changed over time in the image below.

ASX:TPD Historical Debt, October 23rd 2019

How Is Talon Petroleum's Cash Burn Changing Over Time?

In our view, Talon Petroleum doesn't yet produce significant amounts of operating revenue, since it reported just AU$114k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. In fact, it ramped its spending strongly over the last year, increasing cash burn by 151%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Talon Petroleum makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Hard Would It Be For Talon Petroleum To Raise More Cash For Growth?

Given its cash burn trajectory, Talon Petroleum shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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).

Talon Petroleum has a market capitalisation of AU$5.3m and burnt through AU$1.2m last year, which is 22% 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 Talon Petroleum's Cash Burn Situation?

On this analysis of Talon Petroleum's cash burn, we think its cash runway was reassuring, while its increasing cash burn has us a bit worried. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. 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 Talon Petroleum's CEO gets paid each year.

Of course Talon Petroleum 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.

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.