Trailing twelve-month data shows us that Energy Resources of Australia Ltd's (ASX:ERA) earnings loss has accumulated to -AU$307.7m. Although some investors expected this, their belief in the path to profitability for Energy Resources of Australia may be wavering. The single most important question to ask when you’re investing in a loss-making company is – will it need to raise cash again, and if so, when? This is because new equity from additional capital raising can thin out the value of current shareholders’ stake in the company. Given that Energy Resources of Australia is spending more money than it earns, it will need to fund its expenses via external sources of capital. Today I’ve examined Energy Resources of Australia’s financial data from its most recent earnings update, to roughly assess when the company may need to raise new capital.
What is cash burn?
Energy Resources of Australia currently has AU$349m in the bank, with negative free cash flow of -AU$35.5m. Companies with high cash burn rates can eventually turn into ashes, which makes it the biggest risk an investor in loss-making companies face. Unprofitable companies operating in the highly risky energy industry often face this problem, and Energy Resources of Australia is no exception. Although these companies can be unprofitable now, they tend to take on project-work, which can payoff sometime in the future.
When will Energy Resources of Australia need to raise more cash?
We can measure Energy Resources of Australia's ongoing cash expenditure requirements by looking at free cash flow, which I define as cash flow from operations minus fixed capital investment, is a measure of how much cash a company generates/loses each year.
In Energy Resources of Australia’s case, its cash outflows fell by 118% last year, which may signal the company moving towards a more sustainable level of expenses. If free cash outflows are maintained at the current level of -AU$35.5m, then given the current level of cash in the bank, Energy Resources of Australia will not need to raise capital any time within the next three years. Although this is a relatively simplistic calculation, and Energy Resources of Australia may continue to reduce its costs further or open a new line of credit instead of issuing new shares, this analysis still helps us understand how sustainable the Energy Resources of Australia operation is, and when things may have to change.
Investors shouldn’t expect Energy Resources of Australia to raise capital anytime soon, according to the outcome of this analysis. Though, there are many factors that we haven’t considered in our basic analysis, this outcome gives a relatively broad overview of the company’s cash financial situation. Now that we’ve accounted for cash burn growth, you should also look at expected revenue growth in order to gauge when the company may become breakeven. I admit this is a fairly basic analysis for ERA's financial health. Other important fundamentals need to be considered as well. I suggest you continue to research Energy Resources of Australia to get a more holistic view of the company by looking at:
- Historical Performance: What has ERA's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
- Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Energy Resources of Australia’s board and the CEO’s back ground.
- Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
NB: Figures in this article are calculated using data from the trailing twelve months from 30 June 2019. This may not be consistent with full year annual report figures. Operating expenses include only SG&A and one-year R&D.
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