We can readily understand why investors are attracted to unprofitable companies. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for Legend Mining (ASX:LEG) 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. Let's start with an examination of the business's cash, relative to its cash burn.
When Might Legend Mining Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2019, Legend Mining had cash of AU$1.7m and no debt. Importantly, its cash burn was AU$1.1m over the trailing twelve months. Therefore, from June 2019 it had roughly 18 months of cash runway. 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. You can see how its cash balance has changed over time in the image below.
How Is Legend Mining's Cash Burn Changing Over Time?
Because Legend Mining 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 60%. Oftentimes, increased cash burn simply means a company is accelerating its business development, but one should always be mindful that this causes the cash runway to shrink. Legend Mining makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Legend Mining To Raise More Cash For Growth?
While Legend Mining does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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 AU$85m, Legend Mining's AU$1.1m in cash burn equates to about 1.3% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
How Risky Is Legend Mining's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Legend Mining's cash burn relative to its market cap was relatively promising. 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 Legend Mining's situation. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Legend Mining CEO receives in total remuneration.
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.
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.
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. Thank you for reading.