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We're Hopeful That Emerald Resources (ASX:EMR) Will Use Its Cash Wisely

Simply Wall St

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. 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 Emerald Resources (ASX:EMR) shareholders should be worried about its cash burn. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

See our latest analysis for Emerald Resources

Does Emerald Resources Have A Long Cash Runway?

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. When Emerald Resources last reported its balance sheet in December 2018, it had zero debt and cash worth AU$25m. Importantly, its cash burn was AU$7.4m over the trailing twelve months. That means it had a cash runway of about 3.3 years as of December 2018. A runway of this length affords the company the time and space it needs to develop the business. You can see how its cash balance has changed over time in the image below.

ASX:EMR Historical Debt, September 25th 2019

How Is Emerald Resources's Cash Burn Changing Over Time?

In our view, Emerald Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$58k 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 cash burn dropping by 5.3% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Emerald Resources 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 Emerald Resources To Raise More Cash For Growth?

While Emerald Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. 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. 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).

Emerald Resources has a market capitalisation of AU$116m and burnt through AU$7.4m last year, which is 6.4% of the company's market value. 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.

How Risky Is Emerald Resources's Cash Burn Situation?

As you can probably tell by now, we're not too worried about Emerald Resources's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. On this analysis its cash burn reduction was its weakest feature, but we are not concerned about it. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: Emerald Resources insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.

Of course Emerald Resources may not be the best stock to buy. So you may wish to see this freecollection 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.