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We're A Little Worried About Anglo African Oil & Gas's (LON:AAOG) Cash Burn Rate

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There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So should Anglo African Oil & Gas (LON:AAOG) 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

See our latest analysis for Anglo African Oil & Gas

Does Anglo African Oil & Gas Have A Long Cash Runway?

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 June 2019, Anglo African Oil & Gas had cash of UK£739k and no debt. In the last year, its cash burn was UK£12m. So it seems to us it had a cash runway of less than two months from June 2019. Importantly, the one analyst we see covering the stock thinks that Anglo African Oil & Gas will reach cashflow breakeven in around 6 months. That means it doesn't have a great deal of breathing room, but it shouldn't really need more cash, considering that cash burn should be continually reducing. Depicted below, you can see how its cash holdings have changed over time.

AIM:AAOG Historical Debt, December 2nd 2019
AIM:AAOG Historical Debt, December 2nd 2019

How Is Anglo African Oil & Gas's Cash Burn Changing Over Time?

In our view, Anglo African Oil & Gas doesn't yet produce significant amounts of operating revenue, since it reported just UK£201k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. In fact, it ramped its spending strongly over the last year, increasing cash burn by 110%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

Can Anglo African Oil & Gas Raise More Cash Easily?

Given its cash burn trajectory, Anglo African Oil & Gas shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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).

Anglo African Oil & Gas's cash burn of UK£12m is about 120% of its UK£10m market capitalisation. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.

How Risky Is Anglo African Oil & Gas's Cash Burn Situation?

Anglo African Oil & Gas is not in a great position when it comes to its cash burn situation. Although we can understand if some shareholders find its increasing cash burn acceptable, we can't ignore the fact that we consider its cash runway to be downright troublesome. It's clearly very positive to see that at least one analyst is forecasting the company will break even fairly soon After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Anglo African Oil & Gas CEO is paid..

Of course Anglo African Oil & Gas may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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.

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.