Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. 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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
Given this risk, we thought we'd take a look at whether Frontier Resources (ASX:FNT) shareholders should 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'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Frontier Resources Run Out Of Money?
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. When Frontier Resources last reported its balance sheet in June 2019, it had zero debt and cash worth AU$4.8m. In the last year, its cash burn was AU$1.2m. Therefore, from June 2019 it had 4.1 years of cash runway. A runway of this length affords the company the time and space it needs to develop the business. The image below shows how its cash balance has been changing over the last few years.
How Is Frontier Resources's Cash Burn Changing Over Time?
In our view, Frontier Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$23k in the last twelve months. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. In fact, it ramped its spending strongly over the last year, increasing cash burn by 119%. With spending growing that quickly, shareholders will be hoping that the money is prudently spent. Admittedly, we're a bit cautious of Frontier Resources due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Frontier Resources To Raise More Cash For Growth?
Given its cash burn trajectory, Frontier Resources shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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.
Since it has a market capitalisation of AU$4.9m, Frontier Resources's AU$1.2m in cash burn equates to about 24% of its market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
So, Should We Worry About Frontier Resources's Cash Burn?
On this analysis of Frontier Resources's cash burn, we think its cash runway was reassuring, while its increasing cash burn has us a bit worried. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Frontier Resources's situation. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Frontier Resources insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
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 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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