We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for Estrella Resources (ASX:ESR) shareholders is whether they should be concerned by its rate of 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.
How Long Is Estrella Resources'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 Estrella Resources last reported its balance sheet in June 2019, it had zero debt and cash worth AU$279k. In the last year, its cash burn was AU$1.2m. Therefore, from June 2019 it had roughly 3 months of cash runway. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. The image below shows how its cash balance has been changing over the last few years.
How Is Estrella Resources's Cash Burn Changing Over Time?
While Estrella Resources did record statutory revenue of AU$45k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. As it happens, the company's cash burn reduced by 48% over the last year, which suggests that management are mindful of the possibility of running out of cash. Admittedly, we're a bit cautious of Estrella Resources due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Estrella Resources Raise Cash?
While Estrella 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. 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 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.
Estrella Resources has a market capitalisation of AU$5.3m and burnt through AU$1.2m last year, which is 23% of the company's market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.
So, Should We Worry About Estrella Resources's Cash Burn?
On this analysis of Estrella Resources's cash burn, we think its cash burn reduction was reassuring, while its cash runway has us a bit worried. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Estrella Resources CEO receives in total remuneration.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.