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Here's Why Sandfire Resources America (CVE:SFR) Must Use Its Cash Wisely

Simply Wall St

There's no doubt that money can be made by owning shares of unprofitable businesses. Indeed, Sandfire Resources America (CVE:SFR) stock is up 178% in the last year, providing strong gains for shareholders. 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.

In light of its strong share price run, we think now is a good time to investigate how risky Sandfire Resources America's cash burn is. 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'.

View our latest analysis for Sandfire Resources America

When Might Sandfire Resources America Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Sandfire Resources America last reported its balance sheet in September 2019, it had zero debt and cash worth CA$1.3m. In the last year, its cash burn was CA$17m. So it seems to us it had a cash runway of less than two months from September 2019. To be frank we are alarmed by how short that cash runway is! The image below shows how its cash balance has been changing over the last few years.

TSXV:SFR Historical Debt, February 18th 2020

How Is Sandfire Resources America's Cash Burn Changing Over Time?

Sandfire Resources America didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. With the cash burn rate up 41% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Sandfire Resources America 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.

How Hard Would It Be For Sandfire Resources America To Raise More Cash For Growth?

Given its cash burn trajectory, Sandfire Resources America 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. Many companies end up issuing new shares to fund future 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.

Sandfire Resources America has a market capitalisation of CA$205m and burnt through CA$17m last year, which is 8.2% of the company's market value. 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.

So, Should We Worry About Sandfire Resources America's Cash Burn?

On this analysis of Sandfire Resources America's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Considering all the measures mentioned in this report, we reckon that its cash burn is fairly risky, and if we held shares we'd be watching like a hawk for any deterioration. For us, it's always important to consider risks around cash burn rates. But investors should look at a whole range of factors when researching a new stock. For example, it could be interesting to see how much the Sandfire Resources America CEO receives in total remuneration.

Of course Sandfire Resources America 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.