We can readily understand why investors are attracted to unprofitable companies. By way of example, Eclipse Metals (ASX:EPM) has seen its share price rise 320% over the last year, delighting many shareholders. 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 notwithstanding the buoyant share price, we think it's well worth asking whether Eclipse Metals'cash burn is too risky 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'.
Does Eclipse Metals Have A Long 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. As at June 2020, Eclipse Metals had cash of AU$962k and no debt. Looking at the last year, the company burnt through AU$366k. So it had a cash runway of about 2.6 years from June 2020. Arguably, that's a prudent and sensible length of runway to have. You can see how its cash balance has changed over time in the image below.
How Is Eclipse Metals' Cash Burn Changing Over Time?
Whilst it's great to see that Eclipse Metals has already begun generating revenue from operations, last year it only produced AU$68k, so we don't think it is generating significant revenue, at this point. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing 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. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Eclipse Metals makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can Eclipse Metals Raise More Cash Easily?
Given its cash burn trajectory, Eclipse Metals 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. Many companies end up issuing new shares to fund future 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$28m, Eclipse Metals' AU$366k in cash burn equates to about 1.3% of its market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.
Is Eclipse Metals' Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Eclipse Metals' cash burn. For example, we think its cash burn relative to its market cap suggests that the company is on a good path. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Eclipse Metals (1 doesn't sit too well with us!) that you should be aware of before investing here.
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.
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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