We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 Toro Energy (ASX:TOE) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Toro Energy'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. When Toro Energy last reported its balance sheet in December 2021, it had zero debt and cash worth AU$8.2m. In the last year, its cash burn was AU$5.1m. Therefore, from December 2021 it had roughly 19 months of cash runway. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.
How Is Toro Energy's Cash Burn Changing Over Time?
Toro Energy didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. With the cash burn rate up 11% 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. Toro Energy 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 Easily Can Toro Energy Raise Cash?
While Toro Energy 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. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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).
Since it has a market capitalisation of AU$82m, Toro Energy's AU$5.1m in cash burn equates to about 6.2% of its market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is Toro Energy's Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Toro Energy's cash burn relative to its market cap was relatively promising. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. Separately, we looked at different risks affecting the company and spotted 3 warning signs for Toro Energy (of which 1 shouldn't be ignored!) you should know about.
Of course Toro Energy 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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