Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 should Gibb River Diamonds (ASX:GIB) shareholders be worried about its cash burn? In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Gibb River Diamonds Run Out Of Money?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at December 2019, Gibb River Diamonds had cash of AU$1.0m and no debt. Looking at the last year, the company burnt through AU$315k. Therefore, from December 2019 it had 3.2 years of cash runway. There's no doubt that this is a reassuringly long runway. The image below shows how its cash balance has been changing over the last few years.
How Is Gibb River Diamonds's Cash Burn Changing Over Time?
Gibb River Diamonds didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. So while we can't look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. Notably, its cash burn was actually down by 76% in the last year, which is a real positive in terms of resilience, but uninspiring when it comes to investment for growth. Admittedly, we're a bit cautious of Gibb River Diamonds due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can Gibb River Diamonds Raise More Cash Easily?
There's no doubt Gibb River Diamonds's rapidly reducing cash burn brings comfort, but even if it's only hypothetical, it's always worth asking how easily it could raise more money to fund further growth. Companies can raise capital through either debt or equity. 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.
Gibb River Diamonds has a market capitalisation of AU$4.3m and burnt through AU$315k last year, which is 7.3% of the company's market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
Is Gibb River Diamonds's Cash Burn A Worry?
It may already be apparent to you that we're relatively comfortable with the way Gibb River Diamonds is burning through its cash. For example, we think its cash runway suggests that the company is on a good path. But it's fair to say that its cash burn relative to its market cap was also very reassuring. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash. On another note, Gibb River Diamonds has 4 warning signs (and 2 which are a bit concerning) we think you should know about.
Of course Gibb River Diamonds 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 email@example.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.
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