Yahoo Finance Can Key Petroleum (ASX:KEY) Afford To Invest In Growth?
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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should Key Petroleum (ASX:KEY) shareholders be worried about its cash burn? 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). The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
See our latest analysis for Key Petroleum
When Might Key Petroleum Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at June 2019, Key Petroleum had cash of AU$447k and no debt. Importantly, its cash burn was AU$1.9m over the trailing twelve months. That means it had a cash runway of around 3 months as of June 2019. With a cash runway that short, we strongly believe that the company must raise cash or else douse its cash burn promptly. The image below shows how its cash balance has been changing over the last few years.
How Is Key Petroleum's Cash Burn Changing Over Time?
Whilst it's great to see that Key Petroleum has already begun generating revenue from operations, last year it only produced AU$460k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. With the cash burn rate up 19% 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. Key Petroleum 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 Key Petroleum To Raise More Cash For Growth?
Since its cash burn is moving in the wrong direction, Key Petroleum shareholders may wish to think ahead to when the company may need to raise more cash. 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. 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.
Key Petroleum's cash burn of AU$1.9m is about 19% of its AU$10m market capitalisation. 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.
So, Should We Worry About Key Petroleum's Cash Burn?
On this analysis of Key Petroleum's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. After considering the data discussed in this article, we don't have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Key Petroleum CEO is paid..
Of course Key Petroleum may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.
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. Thank you for reading.
