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Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given this risk, we thought we'd take a look at whether Rhythm Pharmaceuticals (NASDAQ:RYTM) shareholders should be worried about its 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.
Does Rhythm Pharmaceuticals Have A Long Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. As at December 2019, Rhythm Pharmaceuticals had cash of US$292m and no debt. Importantly, its cash burn was US$126m over the trailing twelve months. Therefore, from December 2019 it had 2.3 years of cash runway. Notably, analysts forecast that Rhythm Pharmaceuticals will break even (at a free cash flow level) in about 2 years. That means it doesn't have a great deal of breathing room, but it shouldn't really need more cash, considering that cash burn should be continually reducing. Depicted below, you can see how its cash holdings have changed over time.
How Is Rhythm Pharmaceuticals's Cash Burn Changing Over Time?
Rhythm Pharmaceuticals 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 101%. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. 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 Rhythm Pharmaceuticals To Raise More Cash For Growth?
Given its cash burn trajectory, Rhythm Pharmaceuticals shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.
Since it has a market capitalisation of US$817m, Rhythm Pharmaceuticals's US$126m in cash burn equates to about 15% of its market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
How Risky Is Rhythm Pharmaceuticals's Cash Burn Situation?
On this analysis of Rhythm Pharmaceuticals's cash burn, we think its cash runway was reassuring, while its increasing cash burn has us a bit worried. One real positive is that analysts are forecasting that the company will reach breakeven. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, Rhythm Pharmaceuticals has 3 warning signs (and 1 which is significant) we think you should know about.
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)
If you spot an error that warrants correction, please contact the editor at email@example.com. 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.