We can readily understand why investors are attracted to unprofitable companies. For example, Archer Materials (ASX:AXE) shareholders have done very well over the last year, with the share price soaring by 120%. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
In light of its strong share price run, we think now is a good time to investigate how risky Archer Materials's cash burn is. 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'.
How Long Is Archer Materials's Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Archer Materials last reported its balance sheet in December 2019, it had zero debt and cash worth AU$2.7m. In the last year, its cash burn was AU$2.5m. So it had a cash runway of approximately 13 months from December 2019. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Depicted below, you can see how its cash holdings have changed over time.
How Is Archer Materials's Cash Burn Changing Over Time?
In our view, Archer Materials doesn't yet produce significant amounts of operating revenue, since it reported just AU$190k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With cash burn dropping by 9.9% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Admittedly, we're a bit cautious of Archer Materials due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Archer Materials Raise More Cash Easily?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Archer Materials to raise more cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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.
Archer Materials's cash burn of AU$2.5m is about 6.8% of its AU$37m market capitalisation. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is Archer Materials's Cash Burn Situation?
The good news is that in our view Archer Materials's cash burn situation gives shareholders real reason for optimism. One the one hand we have its solid cash burn reduction, while on the other it can also boast very strong cash burn relative to its market cap. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Archer Materials's situation. On another note, Archer Materials has 7 warning signs (and 3 which are potentially serious) we think you should know about.
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.
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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