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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So should Valaris (NYSE:VAL) shareholders 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 Valaris 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 March 2021, Valaris had US$292m in cash, and was debt-free. Looking at the last year, the company burnt through US$143m. That means it had a cash runway of about 2.0 years as of March 2021. Importantly, analysts think that Valaris will reach cashflow breakeven in 2 years. So there's a very good chance it won't need more cash, when you consider the burn rate will be reducing in that period. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Valaris Growing?
Happily, Valaris is travelling in the right direction when it comes to its cash burn, which is down 79% over the last year. But it was a bit disconcerting to see operating revenue down 39% in that time. Considering the factors above, the company doesn’t fare badly when it comes to assessing how it is changing over time. 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 Valaris Raise More Cash Easily?
While Valaris seems to be in a fairly good position, it's still worth considering how easily it could raise more cash, even just to fuel faster 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).
Since it has a market capitalisation of US$2.0b, Valaris' US$143m in cash burn equates to about 7.2% 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 Valaris' Cash Burn Situation?
As you can probably tell by now, we're not too worried about Valaris' cash burn. In particular, we think its cash burn reduction stands out as evidence that the company is well on top of its spending. Although we do find its falling revenue 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. Shareholders can take heart from the fact that analysts are forecasting it will reach breakeven. 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. While we always like to monitor cash burn for early stage companies, qualitative factors such as the CEO pay can also shed light on the situation. Click here to see free what the Valaris CEO is paid..
Of course Valaris 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.
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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