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 history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should DroneShield (ASX:DRO) shareholders be worried about its cash burn? In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
How Long Is DroneShield'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. DroneShield has such a small amount of debt that we'll set it aside, and focus on the AU$5.5m in cash it held at December 2019. In the last year, its cash burn was AU$6.0m. Therefore, from December 2019 it had roughly 11 months of cash runway. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. The image below shows how its cash balance has been changing over the last few years.
How Is DroneShield's Cash Burn Changing Over Time?
In the last year, DroneShield did book revenue of AU$3.6m, but its revenue from operations was less, at just AU$3.6m. Given how low that operating leverage is, we think it's too early to put much weight on the revenue growth, so we'll focus on how the cash burn is changing, instead. With the cash burn rate up 9.7% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. In reality, this article only makes a short study of the company's growth data. This graph of historic revenue growth shows how DroneShield is building its business over time.
How Hard Would It Be For DroneShield To Raise More Cash For Growth?
While its cash burn is only increasing slightly, DroneShield shareholders should still consider the potential need for further cash, down the track. 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. 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.
DroneShield has a market capitalisation of AU$29m and burnt through AU$6.0m last year, which is 21% of the company's market value. 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.
Is DroneShield's Cash Burn A Worry?
DroneShield is not in a great position when it comes to its cash burn situation. Although we can understand if some shareholders find its cash burn relative to its market cap acceptable, we can't ignore the fact that we consider its cash runway to be downright troublesome. Looking at the factors mentioned in this short report, we do think that its cash burn is a bit risky, and it does make us slightly nervous about the stock. Taking a deeper dive, we've spotted 7 warning signs for DroneShield you should be aware of, and 2 of them are significant.
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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