Just because a business does not make any money, does not mean that the stock will go down. 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 while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
Given this risk, we thought we'd take a look at whether Legacy Iron Ore (ASX:LCY) shareholders should 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'.
How Long Is Legacy Iron Ore's Cash Runway?
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. As at September 2019, Legacy Iron Ore had cash of AU$589k and no debt. Looking at the last year, the company burnt through AU$1.8m. Therefore, from September 2019 it had roughly 4 months of cash runway. 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 Legacy Iron Ore's Cash Burn Changing Over Time?
In our view, Legacy Iron Ore doesn't yet produce significant amounts of operating revenue, since it reported just AU$59k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. Over the last year its cash burn actually increased by 2.5%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Legacy Iron Ore 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 Easily Can Legacy Iron Ore Raise Cash?
While its cash burn is only increasing slightly, Legacy Iron Ore shareholders should still consider the potential need for further cash, down the track. 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. 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.
Legacy Iron Ore has a market capitalisation of AU$2.9m and burnt through AU$1.8m last year, which is 63% of the company's market value. Given how large that cash burn is, relative to the market value of the entire company, we'd consider it to be a high risk stock, with the real possibility of extreme dilution.
How Risky Is Legacy Iron Ore's Cash Burn Situation?
There are no prizes for guessing that we think Legacy Iron Ore's cash burn is a bit of a worry. In particular, we think its cash runway suggests it isn't in a good position to keep funding growth. And although we accept its increasing cash burn wasn't as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. The measures we've considered in this article lead us to believe its cash burn is actually quite concerning, and its weak cash position seems likely to cost shareholders one way or another. 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 Legacy Iron Ore CEO is paid..
Of course Legacy Iron Ore 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 email@example.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.
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