We can readily understand why investors are attracted to unprofitable companies. By way of example, Virginia Energy Resources (CVE:VUI) has seen its share price rise 629% over the last year, delighting many 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.
So notwithstanding the buoyant share price, we think it's well worth asking whether Virginia Energy Resources' cash burn is too risky. 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
How Long Is Virginia Energy Resources' Cash Runway?
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. Virginia Energy Resources has such a small amount of debt that we'll set it aside, and focus on the US$536k in cash it held at September 2021. Importantly, its cash burn was US$540k over the trailing twelve months. Therefore, from September 2021 it had roughly 12 months of cash runway. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. Depicted below, you can see how its cash holdings have changed over time.
How Is Virginia Energy Resources' Cash Burn Changing Over Time?
Because Virginia Energy Resources 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. Remarkably, it actually increased its cash burn by 691% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Admittedly, we're a bit cautious of Virginia Energy Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
How Easily Can Virginia Energy Resources Raise Cash?
Since its cash burn is moving in the wrong direction, Virginia Energy Resources shareholders may wish to think ahead to when the company may need to raise more cash. 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).
Since it has a market capitalisation of US$31m, Virginia Energy Resources' US$540k in cash burn equates to about 1.7% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
So, Should We Worry About Virginia Energy Resources' Cash Burn?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Virginia Energy Resources' cash burn relative to its market cap was relatively promising. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. On another note, Virginia Energy Resources has 6 warning signs (and 3 which are a bit concerning) we think you should know about.
Of course Virginia Energy Resources 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.