There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. 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 Lithium Consolidated (ASX:LI3) shareholders should be worried about its cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Lithium Consolidated Run Out Of Money?
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. In June 2019, Lithium Consolidated had AU$298k in cash, and was debt-free. In the last year, its cash burn was AU$1.6m. That means it had a cash runway of around 2 months as of June 2019. To be frank we are alarmed by how short that cash runway is! Depicted below, you can see how its cash holdings have changed over time.
How Is Lithium Consolidated's Cash Burn Changing Over Time?
In our view, Lithium Consolidated doesn't yet produce significant amounts of operating revenue, since it reported just AU$12k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. It's possible that the 14% reduction in cash burn over the last year is evidence of management tightening their belts as cash reserves deplete. Lithium Consolidated 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 Easily Can Lithium Consolidated Raise Cash?
While Lithium Consolidated 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to drive growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.
Lithium Consolidated's cash burn of AU$1.6m is about 27% of its AU$6.2m market capitalisation. 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.
So, Should We Worry About Lithium Consolidated's Cash Burn?
There are no prizes for guessing that we think Lithium Consolidated's cash burn is a bit of a worry. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its cash burn reduction wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. Once we consider the metrics mentioned in this article together, we're left with very little confidence in the company's ability to manage its cash burn, and we think it will probably need more money. 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 Lithium Consolidated CEO receives in total remuneration.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
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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.