Yahoo Finance Here's Why We're Watching Encounter Resources' (ASX:ENR) Cash Burn Situation
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There's no doubt that money can be made by owning shares of unprofitable businesses. 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. 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.
So, the natural question for Encounter Resources (ASX:ENR) shareholders is whether they should be concerned by its rate of cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
View our latest analysis for Encounter Resources
Does Encounter Resources Have A Long 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 Encounter Resources last reported its balance sheet in December 2019, it had zero debt and cash worth AU$2.5m. Importantly, its cash burn was AU$3.2m over the trailing twelve months. That means it had a cash runway of around 9 months as of December 2019. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. Importantly, if we extrapolate recent cash burn trends, the cash runway would be a lot longer. You can see how its cash balance has changed over time in the image below.
How Is Encounter Resources' Cash Burn Changing Over Time?
While Encounter Resources did record statutory revenue of AU$35k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. With the cash burn rate up 34% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Admittedly, we're a bit cautious of Encounter Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Hard Would It Be For Encounter Resources To Raise More Cash For Growth?
Given its cash burn trajectory, Encounter Resources shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.
Encounter Resources' cash burn of AU$3.2m is about 7.0% of its AU$45m market capitalisation. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is Encounter Resources' Cash Burn Situation?
On this analysis of Encounter Resources' cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. On another note, Encounter Resources has 5 warning signs (and 2 which can't be ignored) we think you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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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