There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So, the natural question for e-Therapeutics (LON:ETX) 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.
Does e-Therapeutics Have A Long Cash Runway?
You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. As at July 2019, e-Therapeutics had cash of UK£5.2m and no debt. Importantly, its cash burn was UK£2.4m over the trailing twelve months. Therefore, from July 2019 it had 2.1 years of cash runway. Arguably, that's a prudent and sensible length of runway to have. The image below shows how its cash balance has been changing over the last few years.
How Is e-Therapeutics's Cash Burn Changing Over Time?
In our view, e-Therapeutics doesn't yet produce significant amounts of operating revenue, since it reported just UK£232k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. While it hardly paints a picture of imminent growth, the fact that it has reduced its cash burn by 50% over the last year suggests some degree of prudence. 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 e-Therapeutics To Raise More Cash For Growth?
While e-Therapeutics is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash to drive 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.
e-Therapeutics has a market capitalisation of UK£8.5m and burnt through UK£2.4m last year, which is 29% 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.
Is e-Therapeutics's Cash Burn A Worry?
On this analysis of e-Therapeutics's cash burn, we think its cash burn reduction was reassuring, while its cash burn relative to its market cap has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. When you don't have traditional metrics like earnings per share and free cash flow to value a company, many are extra motivated to consider qualitative factors such as whether insiders are buying or selling shares. Please Note: e-Therapeutics insiders have been trading shares, according to our data. Click here to check whether insiders have been buying or selling.
Of course e-Therapeutics 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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