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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given this risk, we thought we'd take a look at whether Ethos Gold (CVE:ECC) 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. Let's start with an examination of the business's cash, relative to its cash burn.
How Long Is Ethos Gold's Cash Runway?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Ethos Gold last reported its balance sheet in December 2019, it had zero debt and cash worth CA$3.4m. In the last year, its cash burn was CA$6.4m. That means it had a cash runway of around 6 months as of December 2019. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. The image below shows how its cash balance has been changing over the last few years.
How Is Ethos Gold's Cash Burn Changing Over Time?
Because Ethos Gold isn't currently generating revenue, we consider it an early-stage business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Remarkably, it actually increased its cash burn by 363% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Ethos Gold due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Ethos Gold To Raise More Cash For Growth?
Given its cash burn trajectory, Ethos Gold shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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.
Ethos Gold's cash burn of CA$6.4m is about 87% of its CA$7.3m market capitalisation. Given just how high that expenditure is, relative to the company's market value, we think there's an elevated risk of funding distress, and we would be very nervous about holding the stock.
So, Should We Worry About Ethos Gold's Cash Burn?
As you can probably tell by now, we're rather concerned about Ethos Gold's cash burn. Take, for example, its cash burn relative to its market cap, which suggests the company may have difficulty funding itself, in the future. And although we accept its cash runway wasn't as worrying as its cash burn relative to its market cap, it was still a real negative; as indeed were all the factors we considered in this article. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. On another note, Ethos Gold has 5 warning signs (and 3 which are significant) we think you should know about.
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. 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. Thank you for reading.