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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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So should ECS Botanics Holdings (ASX:ECS) shareholders be worried about its cash burn? For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
When Might ECS Botanics Holdings Run Out Of Money?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. As at December 2020, ECS Botanics Holdings had cash of AU$4.4m and such minimal debt that we can ignore it for the purposes of this analysis. Looking at the last year, the company burnt through AU$3.6m. So it had a cash runway of approximately 15 months from December 2020. 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. Depicted below, you can see how its cash holdings have changed over time.
How Is ECS Botanics Holdings' Cash Burn Changing Over Time?
In our view, ECS Botanics Holdings doesn't yet produce significant amounts of operating revenue, since it reported just AU$1.3m 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. With the cash burn rate up 3.2% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of ECS Botanics Holdings due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can ECS Botanics Holdings Raise Cash?
While its cash burn is only increasing slightly, ECS Botanics Holdings shareholders should still consider the potential need for further cash, down the track. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive 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 AU$45m, ECS Botanics Holdings' AU$3.6m in cash burn equates to about 8.1% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is ECS Botanics Holdings' Cash Burn Situation?
On this analysis of ECS Botanics Holdings' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. 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 ECS Botanics Holdings' situation. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for ECS Botanics Holdings (1 doesn't sit too well with us!) that you should be aware of before investing here.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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