We can readily understand why investors are attracted to unprofitable companies. 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. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should Argonaut Resources (ASX:ARE) shareholders 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). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
How Long Is Argonaut Resources'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 Argonaut Resources last reported its balance sheet in December 2019, it had zero debt and cash worth AU$896k. Importantly, its cash burn was AU$3.8m over the trailing twelve months. Therefore, from December 2019 it had roughly 3 months of cash runway. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. The image below shows how its cash balance has been changing over the last few years.
How Is Argonaut Resources's Cash Burn Changing Over Time?
Because Argonaut Resources isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Over the last year its cash burn actually increased by a very significant 99%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Argonaut Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Argonaut Resources Raise Cash?
Since its cash burn is moving in the wrong direction, Argonaut Resources 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. Many companies end up issuing new shares to fund future 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.
Since it has a market capitalisation of AU$4.7m, Argonaut Resources's AU$3.8m in cash burn equates to about 80% of its market value. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
So, Should We Worry About Argonaut Resources's Cash Burn?
As you can probably tell by now, we're rather concerned about Argonaut Resources'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. Its cash burn situation feels about as comfortable as sitting next to the lavatory on a long haul flight. The need for more cash seems just around the corner, and any dilution is likely to be rather severe. Taking a deeper dive, we've spotted 4 warning signs for Argonaut Resources you should be aware of, and 1 of them is a bit concerning.
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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