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There's no doubt that money can be made by owning shares of unprofitable businesses. 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. 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 should Urban Tea (NASDAQ:MYT) shareholders 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. Let's start with an examination of the business' cash, relative to its cash burn.
How Long Is Urban Tea's 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. When Urban Tea last reported its balance sheet in June 2020, it had zero debt and cash worth US$7.6m. In the last year, its cash burn was US$2.4m. So it had a cash runway of about 3.2 years from June 2020. 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.
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$866k, 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 11% 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.
Can Urban Tea Raise More Cash Easily?
While Urban Tea 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. Companies can raise capital through either debt or equity. 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.
Urban Tea's cash burn of US$2.4m is about 12% of its US$20m market capitalisation. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
How Risky Is Urban Tea's Cash Burn Situation?
As you can probably tell by now, we're not too worried about Urban Tea's cash burn. For example, we think its cash runway suggests that the company is on a good path. Its weak point is its cash burn reduction, but even that wasn't too bad! 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. On another note, Urban Tea has 4 warning signs (and 2 which are a bit concerning) we think you should know about.
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)
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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