We can readily understand why investors are attracted to unprofitable companies. 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.
Given this risk, we thought we'd take a look at whether Focus Graphite (CVE:FMS) 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 Focus Graphite's 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. In March 2020, Focus Graphite had CA$219k in cash, and was debt-free. Looking at the last year, the company burnt through CA$6.4m. 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 Focus Graphite's Cash Burn Changing Over Time?
Because Focus Graphite 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. Over the last year its cash burn actually increased by 28%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Focus Graphite 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 Easily Can Focus Graphite Raise Cash?
Given its cash burn trajectory, Focus Graphite 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.
Focus Graphite's cash burn of CA$6.4m is about 85% of its CA$7.5m market capitalisation. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.
How Risky Is Focus Graphite's Cash Burn Situation?
There are no prizes for guessing that we think Focus Graphite's cash burn is a bit of a worry. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its increasing cash burn 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. Its cash burn burn situation feels about as relaxing as riding your bicycle home in the rain without so much as a jumper. It's likely to need more cash in the near term; and that could well hurt returns. On another note, we conducted an in-depth investigation of the company, and identified 3 warning signs for Focus Graphite (2 shouldn't be ignored!) that you should be aware of before investing here.
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.