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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.
Given this risk, we thought we'd take a look at whether Carnarvon Petroleum (ASX:CVN) shareholders should 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Carnarvon Petroleum 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. In December 2020, Carnarvon Petroleum had AU$106m in cash, and was debt-free. Looking at the last year, the company burnt through AU$14m. That means it had a cash runway of about 7.7 years as of December 2020. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. The image below shows how its cash balance has been changing over the last few years.
How Is Carnarvon Petroleum's Cash Burn Changing Over Time?
Because Carnarvon Petroleum isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. The 77% reduction in its cash burn over the last twelve months may be good for protecting the balance sheet but it hardly points to imminent growth. 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 Carnarvon Petroleum Raise More Cash Easily?
There's no doubt Carnarvon Petroleum's rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Many companies end up issuing new shares to fund future 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).
Carnarvon Petroleum's cash burn of AU$14m is about 3.5% of its AU$391m market capitalisation. 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.
Is Carnarvon Petroleum's Cash Burn A Worry?
As you can probably tell by now, we're not too worried about Carnarvon Petroleum's cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. But it's fair to say that its cash burn relative to its market cap was also very reassuring. After considering a range of factors in this article, we're pretty relaxed about its cash burn, since the company seems to be in a good position to continue to fund its growth. Taking an in-depth view of risks, we've identified 1 warning sign for Carnarvon Petroleum that you should be aware of before investing.
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. 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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