Emmerson PLC (LON:EML) continues its loss-making streak, announcing negative earnings for its latest financial year ending. The single most important question to ask when you’re investing in a loss-making company is – will it need to raise cash again, and if so, when? This is because new equity from additional capital raising can thin out the value of current shareholders’ stake in the company. Given that Emmerson is spending more money than it earns, it will need to fund its expenses via external sources of capital. Looking at Emmerson’s latest financial data, I will estimate when the company may run out of cash and need to raise more money.
What is cash burn?
With a negative free cash flow of -UK£3.1m, Emmerson is chipping away at its UK£1.6m cash reserves in order to run its business. Companies with high cash burn rates can eventually turn into ashes, which makes it the biggest risk an investor in loss-making companies face. Not surprisingly, it is more common to find unprofitable companies in the high-risk metals and mining industry. The activities of these companies tend to be project-driven, which generates lumpy cash flows, meaning the business can be loss-making for a period of time while it invests heavily in a new project.
When will Emmerson need to raise more cash?
When negative, free cash flow (which I define as cash from operations minus fixed capital investment) can be an effective measure of how much Emmerson has to spend each year in order to keep its business running.
In Emmerson’s case, its cash outflows fell by 75% last year, which may signal the company moving towards a more sustainable level of expenses. However, the current level of cash is not enough to sustain Emmerson’s operations and the company may need to raise more capital within the year. Even though this is analysis is fairly basic, and Emmerson still can cut its overhead further, or open a new line of credit instead of issuing new shares, this analysis still helps us understand how sustainable the Emmerson operation is, and when things may have to change.
This analysis isn’t meant to deter you from Emmerson, but rather, to help you better understand the risks involved investing in loss-making companies. The cash burn analysis result indicates a cash constraint for the company, due to its current level of cash reserves. An opportunity may exist for you to enter into the stock at an attractive price, should Emmerson be required to raise new funds to continue operating. Keep in mind I haven't considered other factors such as how EML is expected to perform in the future. You should continue to research Emmerson to get a more holistic view of the company by looking at:
Historical Performance: What has EML's returns been like over the past? Go into more detail in the past track record analysis and take a look at the free visual representations of our analysis for more clarity.
Management Team: An experienced management team on the helm increases our confidence in the business – take a look at who sits on Emmerson’s board and the CEO’s back ground.
Other High-Performing Stocks: If you believe you should cushion your portfolio with something less risky, scroll through our free list of these great stocks here.
NB: Figures in this article are calculated using data from the trailing twelve months from 30 June 2019. This may not be consistent with full year annual report figures. Operating expenses include only SG&A and one-year R&D.
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