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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So should Novus Therapeutics (NASDAQ:NVUS) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Novus Therapeutics Run Out Of Money?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Novus Therapeutics last reported its balance sheet in December 2019, it had zero debt and cash worth US$8.8m. Importantly, its cash burn was US$14m over the trailing twelve months. Therefore, from December 2019 it had roughly 8 months of cash runway. Importantly, analysts think that Novus Therapeutics will reach cashflow breakeven in 4 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. You can see how its cash balance has changed over time in the image below.
How Is Novus Therapeutics's Cash Burn Changing Over Time?
Novus Therapeutics didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Over the last year its cash burn actually increased by 17%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Novus Therapeutics To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, Novus Therapeutics shareholders may wish to think ahead to when the company may need to raise more cash. 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).
Novus Therapeutics's cash burn of US$14m is about 249% of its US$5.6m market capitalisation. Given just how high that expenditure is, relative to the company's market value, we think there's an elevated risk of funding distress, and we would be very nervous about holding the stock.
Is Novus Therapeutics's Cash Burn A Worry?
As you can probably tell by now, we're rather concerned about Novus Therapeutics's cash burn. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. And although we accept its increasing cash burn wasn't as worrying as its cash burn relative to its market cap, it was still a real negative; as indeed were all the factors we considered in this article. Shareholders can take heart from the fact that analysts are forecasting it will reach breakeven. 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. Taking a deeper dive, we've spotted 5 warning signs for Novus Therapeutics you should be aware of, and 2 of them shouldn't be ignored.
Of course Novus Therapeutics 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 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.
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