Yahoo Finance Here's Why We're Watching Middle Island Resources' (ASX:MDI) Cash Burn Situation
There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
Given this risk, we thought we'd take a look at whether Middle Island Resources (ASX:MDI) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
See our latest analysis for Middle Island Resources
When Might Middle Island Resources Run Out Of Money?
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. Middle Island Resources has such a small amount of debt that we'll set it aside, and focus on the AU$6.7m in cash it held at December 2020. Importantly, its cash burn was AU$5.8m over the trailing twelve months. That means it had a cash runway of around 14 months as of December 2020. 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. The image below shows how its cash balance has been changing over the last few years.
How Is Middle Island Resources' Cash Burn Changing Over Time?
In our view, Middle Island Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$3.5k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Its cash burn positively exploded in the last year, up 224%. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Middle Island Resources 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 Middle Island Resources To Raise More Cash For Growth?
While Middle Island Resources 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.
Middle Island Resources has a market capitalisation of AU$31m and burnt through AU$5.8m last year, which is 19% of the company's market value. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
Is Middle Island Resources' Cash Burn A Worry?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Middle Island Resources' cash runway was relatively promising. 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. On another note, we conducted an in-depth investigation of the company, and identified 6 warning signs for Middle Island Resources (4 can't be ignored!) that you should be aware of before investing here.
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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. 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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