We can readily understand why investors are attracted to unprofitable companies. By way of example, Caravel Minerals (ASX:CVV) has seen its share price rise 314% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given its strong share price performance, we think it's worthwhile for Caravel Minerals shareholders to consider whether its cash burn is concerning. 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.
How Long Is Caravel Minerals' 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. As at December 2020, Caravel Minerals had cash of AU$3.8m and no debt. In the last year, its cash burn was AU$1.4m. Therefore, from December 2020 it had 2.7 years of cash runway. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.
How Is Caravel Minerals' Cash Burn Changing Over Time?
Caravel Minerals 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. Even though it doesn't get us excited, the 32% reduction in cash burn year on year does suggest the company can continue operating for quite some time. Admittedly, we're a bit cautious of Caravel Minerals due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Caravel Minerals To Raise More Cash For Growth?
Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Caravel Minerals to raise more cash in the future. 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 and 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.
Caravel Minerals has a market capitalisation of AU$172m and burnt through AU$1.4m last year, which is 0.8% of the company's 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 Caravel Minerals' Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Caravel Minerals is burning through its cash. In particular, we think its cash burn relative to its market cap stands out as evidence that the company is well on top of its spending. Its cash burn reduction wasn't quite as good, but was still rather encouraging! Looking at all the measures in this article, together, we're not worried about its rate of cash burn, which seems to be under control. On another note, Caravel Minerals has 5 warning signs (and 3 which are significant) 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.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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