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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So, the natural question for Eastern Iron (ASX:EFE) shareholders is whether they should be concerned by its rate of 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'.
Does Eastern Iron 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. In December 2019, Eastern Iron had AU$229k in cash, and was debt-free. Importantly, its cash burn was AU$488k over the trailing twelve months. So it had a cash runway of approximately 6 months from December 2019. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. You can see how its cash balance has changed over time in the image below.
How Is Eastern Iron's Cash Burn Changing Over Time?
Whilst it's great to see that Eastern Iron has already begun generating revenue from operations, last year it only produced AU$6.9k, so we don't think it is generating significant revenue, at this point. 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. Given the length of the cash runway, we'd interpret the 30% reduction in cash burn, in twelve months, as prudent if not necessary for capital preservation. Eastern Iron 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 Hard Would It Be For Eastern Iron To Raise More Cash For Growth?
While Eastern Iron 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. Companies can raise capital through either debt or equity. 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 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).
Eastern Iron's cash burn of AU$488k is about 39% of its AU$1.2m market capitalisation. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.
So, Should We Worry About Eastern Iron's Cash Burn?
On this analysis of Eastern Iron's cash burn, we think its cash burn reduction was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Eastern Iron (of which 4 are potentially serious!) 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 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.
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