Just because a business does not make any money, does not mean that the stock will go down. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. 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 Equitorial Exploration (CVE:EXX) 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 Equitorial Exploration 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. As at March 2020, Equitorial Exploration had cash of CA$12k and no debt. In the last year, its cash burn was CA$502k. Therefore, from March 2020 it seems to us it had less than two months of cash runway. It's extremely surprising to us that the company has allowed its cash runway to get that short! Depicted below, you can see how its cash holdings have changed over time.
How Is Equitorial Exploration's Cash Burn Changing Over Time?
Because Equitorial Exploration 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. As it happens, the company's cash burn reduced by 28% over the last year, which suggests that management are mindful of the possibility of running out of cash. Equitorial Exploration 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.
How Easily Can Equitorial Exploration Raise Cash?
While Equitorial Exploration is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Companies can raise capital through either debt or equity. Commonly, a business will sell new shares in itself to raise cash to drive 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.
Since it has a market capitalisation of CA$942k, Equitorial Exploration's CA$502k in cash burn equates to about 53% of its market value. That's high expenditure relative to the value of the entire company, so if it does have to issue shares to fund more growth, that could end up really hurting shareholders returns (through significant dilution).
How Risky Is Equitorial Exploration's Cash Burn Situation?
As you can probably tell by now, we're rather concerned about Equitorial Exploration's cash burn. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its cash burn reduction wasn't as worrying as its cash runway, 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. Taking a deeper dive, we've spotted 5 warning signs for Equitorial Exploration you should be aware of, and 3 of them can't be ignored.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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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.