There's no doubt that money can be made by owning shares of unprofitable businesses. 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 Fitzroy River (ASX:FZR) shareholders should be worried about its cash burn. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Fitzroy River's 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. When Fitzroy River last reported its balance sheet in December 2018, it had zero debt and cash worth AU$1.4m. In the last year, its cash burn was AU$162k. Therefore, from December 2018 it had 8.9 years of cash runway. Even though this is but one measure of the company's cash burn, the thought of such a long cash runway warms our bellies in a comforting way. You can see how its cash balance has changed over time in the image below.
How Is Fitzroy River's Cash Burn Changing Over Time?
Whilst it's great to see that Fitzroy River has already begun generating revenue from operations, last year it only produced AU$337k, 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. The 74% 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. Fitzroy River 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 Fitzroy River Raise More Cash Easily?
There's no doubt Fitzroy River'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. 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. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.
Fitzroy River's cash burn of AU$162k is about 1.1% of its AU$15m market capitalisation. 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.
How Risky Is Fitzroy River's Cash Burn Situation?
As you can probably tell by now, we're not too worried about Fitzroy River's cash burn. For example, we think its cash runway suggests that the company is on a good path. But it's fair to say that its cash burn reduction was also very reassuring. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. 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 Fitzroy River CEO is paid..
Of course Fitzroy River may not be the best stock to buy. So you may wish to see this freecollection of companies boasting high return on equity, or this list of stocks that insiders are buying.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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. Simply Wall St has no position in the stocks mentioned. Thank you for reading.