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We can readily understand why investors are attracted to unprofitable companies. For example, Talon Energy (ASX:TPD) shareholders have done very well over the last year, with the share price soaring by 233%. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
Given its strong share price performance, we think it's worthwhile for Talon Energy shareholders to consider whether its cash burn is concerning. 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'.
Does Talon Energy Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Talon Energy last reported its balance sheet in June 2021, it had zero debt and cash worth AU$9.5m. In the last year, its cash burn was AU$2.6m. Therefore, from June 2021 it had 3.7 years of cash runway. A runway of this length affords the company the time and space it needs to develop the business. Depicted below, you can see how its cash holdings have changed over time.
How Is Talon Energy's Cash Burn Changing Over Time?
Whilst it's great to see that Talon Energy has already begun generating revenue from operations, last year it only produced AU$44k, 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. The skyrocketing cash burn up 127% year on year certainly tests our nerves. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. Admittedly, we're a bit cautious of Talon Energy 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 Easily Can Talon Energy Raise Cash?
Given its cash burn trajectory, Talon Energy shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive growth. By comparing a company's annual cash burn to its total market capitalisation, we can estimate roughly how many shares it would have to issue in order to run the company for another year (at the same burn rate).
Talon Energy has a market capitalisation of AU$60m and burnt through AU$2.6m last year, which is 4.3% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
Is Talon Energy's Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Talon Energy's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While we must concede that its increasing cash burn is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Talon Energy (of which 3 shouldn't be ignored!) you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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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