There's no doubt that money can be made by owning shares of unprofitable businesses. 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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for Karoon Energy (ASX:KAR) shareholders is whether they should be concerned by its rate of 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Karoon Energy Run Out Of Money?
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 June 2019, Karoon Energy had cash of AU$326m and such minimal debt that we can ignore it for the purposes of this analysis. Importantly, its cash burn was AU$33m over the trailing twelve months. That means it had a cash runway of about 9.9 years as of June 2019. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. You can see how its cash balance has changed over time in the image below.
How Is Karoon Energy's Cash Burn Changing Over Time?
In the last year, Karoon Energy did book revenue of AU$2.3m, but its revenue from operations was less, at just AU$2.3m. We don't think that's enough operating revenue for us to understand too much from revenue growth rates, since the company is growing off a low base. So we'll focus on the cash burn, today. Even though it doesn't get us excited, the 35% reduction in cash burn year on year does suggest the company can continue operating for quite some time. While the past is always worth studying, it is the future that matters most of all. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
Can Karoon Energy Raise More Cash Easily?
While Karoon Energy is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. 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 to 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).
Karoon Energy has a market capitalisation of AU$294m and burnt through AU$33m last year, which is 11% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
Is Karoon Energy's Cash Burn A Worry?
It may already be apparent to you that we're relatively comfortable with the way Karoon Energy is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. Its cash burn reduction wasn't quite as good, but was still rather encouraging! 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. While it's important to consider hard data like the metrics discussed above, many investors would also be interested to note that Karoon Energy insiders have been trading shares in the company. Click here to find out if they have been buying or selling.
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)
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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. Thank you for reading.