Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given this risk, we thought we'd take a look at whether Rhythm Biosciences (ASX:RHY) 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). Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Rhythm Biosciences's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2019, Rhythm Biosciences had AU$4.8m in cash, and was debt-free. Importantly, its cash burn was AU$3.1m over the trailing twelve months. That means it had a cash runway of around 19 months as of June 2019. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. Depicted below, you can see how its cash holdings have changed over time.
How Is Rhythm Biosciences's Cash Burn Changing Over Time?
In our view, Rhythm Biosciences doesn't yet produce significant amounts of operating revenue, since it reported just AU$142k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. During the last twelve months, its cash burn actually ramped up 56%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Rhythm Biosciences makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Rhythm Biosciences To Raise More Cash For Growth?
While Rhythm Biosciences does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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).
Rhythm Biosciences has a market capitalisation of AU$11m and burnt through AU$3.1m last year, which is 29% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
Is Rhythm Biosciences's Cash Burn A Worry?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Rhythm Biosciences's cash runway was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. We think it's very important to consider the cash burn for loss making companies, but other considerations such as the amount the CEO is paid can also enhance your understanding of the business. You can click here to see what Rhythm Biosciences's CEO gets paid each year.
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)
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.