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Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. For example, Hannans (ASX:HNR) shareholders have done very well over the last year, with the share price soaring by 286%. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So notwithstanding the buoyant share price, we think it's well worth asking whether Hannans' cash burn is too risky. 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
How Long Is Hannans' Cash Runway?
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 December 2020, Hannans had cash of AU$1.7m and no debt. In the last year, its cash burn was AU$1.9m. So it had a cash runway of approximately 11 months from December 2020. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.
How Is Hannans' Cash Burn Changing Over Time?
Because Hannans 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. Over the last year its cash burn actually increased by a very significant 57%. While this spending increase is no doubt intended to drive growth, if the trend continues the company's cash runway will shrink very quickly. Hannans makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Hannans Raise More Cash Easily?
Given its cash burn trajectory, Hannans 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 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 AU$64m, Hannans' AU$1.9m in cash burn equates to about 2.9% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About Hannans' Cash Burn?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Hannans' cash burn relative to its market cap was relatively promising. 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, Hannans has 6 warning signs (and 2 which are a bit concerning) we think you should know about.
Of course Hannans 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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