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.
So, the natural question for Sovereign Metals (ASX:SVM) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Check out our latest analysis for Sovereign Metals
Does Sovereign Metals Have A Long Cash Runway?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. In December 2021, Sovereign Metals had AU$3.9m in cash, and was debt-free. In the last year, its cash burn was AU$7.6m. That means it had a cash runway of around 6 months as of December 2021. Notably, one analyst forecasts that Sovereign Metals will break even (at a free cash flow level) in about 4 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. You can see how its cash balance has changed over time in the image below.
How Is Sovereign Metals' Cash Burn Changing Over Time?
Sovereign Metals didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 125%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
Can Sovereign Metals Raise More Cash Easily?
Given its cash burn trajectory, Sovereign Metals 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).
Sovereign Metals' cash burn of AU$7.6m is about 3.2% of its AU$236m market capitalisation. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
Is Sovereign Metals' Cash Burn A Worry?
On this analysis of Sovereign Metals' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Shareholders can take heart from the fact that at least one analyst is forecasting it will reach breakeven. Summing up, we think the Sovereign Metals' cash burn is a risk, based on the factors we mentioned in this article. On another note, Sovereign Metals has 5 warning signs (and 2 which make us uncomfortable) we think you should know about.
Of course Sovereign Metals 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.
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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.