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Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So, the natural question for Talon Energy (ASX:TPD) 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'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
When Might Talon Energy Run Out Of Money?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. In June 2021, Talon Energy had AU$9.5m in cash, and was debt-free. Importantly, its cash burn was AU$2.6m over the trailing twelve months. So it had a cash runway of about 3.7 years from June 2021. There's no doubt that this is a reassuringly long runway. Depicted below, you can see how its cash holdings have changed over time.
How Is Talon Energy's Cash Burn Changing Over Time?
In our view, Talon Energy doesn't yet produce significant amounts of operating revenue, since it reported just AU$44k in the last twelve months. 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 127%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of Talon Energy due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Talon Energy To Raise More Cash For Growth?
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. 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$54m, Talon Energy's AU$2.6m in cash burn equates to about 4.8% of its 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.
How Risky Is Talon Energy's Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Talon Energy is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. 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. 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. Taking a deeper dive, we've spotted 5 warning signs for Talon Energy you should be aware of, and 3 of them can't be ignored.
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.
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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.