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We're Hopeful That K2 Energy (ASX:KTE) 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 Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So, the natural question for K2 Energy (ASX:KTE) 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.

See our latest analysis for K2 Energy

Does K2 Energy 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. As at June 2019, K2 Energy had cash of AU$513k and no debt. Importantly, its cash burn was AU$84k over the trailing twelve months. Therefore, from June 2019 it had 6.1 years of cash runway. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.

ASX:KTE Historical Debt, September 30th 2019
ASX:KTE Historical Debt, September 30th 2019

How Is K2 Energy's Cash Burn Changing Over Time?

Because K2 Energy isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. In fact, it ramped its spending strongly over the last year, increasing cash burn by 198%. That sort of ramp in expenditure is no doubt intended to generate worthwhile long term returns. Admittedly, we're a bit cautious of K2 Energy due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

Can K2 Energy Raise More Cash Easily?

Given its cash burn trajectory, K2 Energy shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. 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 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).

K2 Energy has a market capitalisation of AU$1.8m and burnt through AU$84k last year, which is 4.7% of the company's 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 K2 Energy's Cash Burn Situation?

It may already be apparent to you that we're relatively comfortable with the way K2 Energy is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. Although we do find its increasing cash burn to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. 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. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that K2 Energy insiders have been trading shares in the company. Click here to find out if they have been buying or selling.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

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.