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We're Hopeful That Karuna Therapeutics (NASDAQ:KRTX) Will Use Its Cash Wisely

Simply Wall St

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, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for Karuna Therapeutics (NASDAQ:KRTX) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business's cash, relative to its cash burn.

See our latest analysis for Karuna Therapeutics

Does Karuna Therapeutics Have A Long Cash Runway?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Karuna Therapeutics last reported its balance sheet in December 2019, it had zero debt and cash worth US$389m. Importantly, its cash burn was US$31m over the trailing twelve months. That means it had a cash runway of very many years as of December 2019. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.

NasdaqGM:KRTX Historical Debt March 26th 2020

How Is Karuna Therapeutics's Cash Burn Changing Over Time?

Karuna Therapeutics 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. The skyrocketing cash burn up 100% year on year certainly tests our nerves. That sort of ramp in expenditure is no doubt intended to generate worthwhile long term returns. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Easily Can Karuna Therapeutics Raise Cash?

Given its cash burn trajectory, Karuna Therapeutics shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash to drive 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.

Since it has a market capitalisation of US$1.7b, Karuna Therapeutics's US$31m in cash burn equates to about 1.8% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

Is Karuna Therapeutics's Cash Burn A Worry?

It may already be apparent to you that we're relatively comfortable with the way Karuna Therapeutics is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. Although we do find its increasing cash burn to be a bit of a negative, once we consider the other metrics mentioned in this article together, the overall picture is one we are comfortable with. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. On another note, Karuna Therapeutics has 3 warning signs (and 1 which is significant) we think you should know about.

Of course Karuna Therapeutics 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 editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.