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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for Great Western Exploration (ASX:GTE) 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.
How Long Is Great Western Exploration'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 Great Western Exploration last reported its balance sheet in June 2019, it had zero debt and cash worth AU$1.2m. In the last year, its cash burn was AU$2.1m. That means it had a cash runway of around 7 months as of June 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. The image below shows how its cash balance has been changing over the last few years.
How Is Great Western Exploration's Cash Burn Changing Over Time?
While Great Western Exploration did record statutory revenue of AU$21k 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 32% over the last year, which suggests that management are mindful of the possibility of running out of cash. Great Western Exploration makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Great Western Exploration To Raise More Cash For Growth?
While Great Western Exploration 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.
Great Western Exploration has a market capitalisation of AU$4.4m and burnt through AU$2.1m last year, which is 47% of the company's market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
Is Great Western Exploration's Cash Burn A Worry?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Great Western Exploration's cash burn reduction was relatively promising. 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. Notably, our data indicates that Great Western Exploration insiders have been trading the shares. You can discover if they are buyers or sellers by clicking on this link.
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.