We can readily understand why investors are attracted to unprofitable companies. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So should Velocys (LON:VLS) shareholders 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' cash, relative to its cash burn.
When Might Velocys Run Out Of Money?
A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2022, Velocys had UK£19m in cash, and was debt-free. Importantly, its cash burn was UK£23m over the trailing twelve months. So it had a cash runway of approximately 10 months from June 2022. Notably, analysts forecast that Velocys will break even (at a free cash flow level) in about 2 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 Velocys' Cash Burn Changing Over Time?
In the last year, Velocys did book revenue of UK£94k, but its revenue from operations was less, at just UK£94k. We don't think that's enough operating revenue for us to understand too much from revenue growth rates, since the company is growing off a low base. So we'll focus on the cash burn, today. In fact, it ramped its spending strongly over the last year, increasing cash burn by 105%. 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. So you might want to take a peek at how much the company is expected to grow in the next few years.
How Hard Would It Be For Velocys To Raise More Cash For Growth?
Given its cash burn trajectory, Velocys shareholders should already be thinking about how easy it might be for it to raise further cash in the future. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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.
Velocys has a market capitalisation of UK£67m and burnt through UK£23m last year, which is 35% of the company's market value. That's not insignificant, and if the company had to sell enough shares to fund another year's growth at the current share price, you'd likely witness fairly costly dilution.
How Risky Is Velocys' Cash Burn Situation?
We must admit that we don't think Velocys is in a very strong position, when it comes to its cash burn. Although we can understand if some shareholders find its cash runway acceptable, we can't ignore the fact that we consider its increasing cash burn to be downright troublesome. One real positive is that analysts are forecasting that the company will reach breakeven. Summing up, we think the Velocys' cash burn is a risk, based on the factors we mentioned in this article. On another note, we conducted an in-depth investigation of the company, and identified 5 warning signs for Velocys (1 makes us a bit uncomfortable!) that you should be aware of before investing here.
Of course Velocys 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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