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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.
Given this risk, we thought we'd take a look at whether Urban Tea (NASDAQ:MYT) shareholders should be worried about its 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). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
Does Urban Tea Have A Long 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, Urban Tea had US$8.8m in cash, and was debt-free. In the last year, its cash burn was US$2.7m. Therefore, from June 2019 it had 3.3 years of cash runway. There's no doubt that this is a reassuringly long runway. The image below shows how its cash balance has been changing over the last few years.
How Is Urban Tea's Cash Burn Changing Over Time?
Whilst it's great to see that Urban Tea has already begun generating revenue from operations, last year it only produced US$402k, so we don't think it is generating significant revenue, at this point. 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 16% over the last year, which suggests that management are maintaining a fairly steady rate of business development, albeit with a slight decrease in spending. Admittedly, we're a bit cautious of Urban Tea 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 Easily Can Urban Tea Raise Cash?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Urban Tea to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.
Since it has a market capitalisation of US$8.9m, Urban Tea's US$2.7m in cash burn equates to about 30% of its 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 Urban Tea's Cash Burn Situation?
On this analysis of Urban Tea's cash burn, we think its cash runway was reassuring, while its cash burn relative to its market cap has us a bit worried. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. Taking a deeper dive, we've spotted 6 warning signs for Urban Tea you should be aware of, and 4 of them make us uncomfortable.
Of course Urban Tea 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.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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. Thank you for reading.