We can easily understand why investors are attracted to unprofitable companies. For exemple, Lake resources (ASX:LKE) has seen its share price rise 235% in the past year, delighting many shareholders. But the harsh reality is that many, many loss-making companies burn all their money and go bankrupt.
In light of the strong rise in its share price, we think the time is right to examine how risky Lake Resources’ cash burn is. For the purposes of this article, cash burn is the annual rate at which an unprofitable business spends money to finance its growth; its negative free cash flow. We will start by comparing its cash consumption with its cash reserves in order to calculate its cash trail.
See our latest analysis for Lake Resources
Does Lake Resources have a long cash trail?
You can calculate a company’s cash trail by dividing the amount of cash it has on hand by the rate at which it spends that money. When Lake Resources last published its balance sheet in June 2021, it had no debt and cash worth A$26 million. Looking at last year, the company spent A$7.2 million. It therefore had a cash trail of approximately 3.5 years as of June 2021. Notably, analysts expect Lake Resources to break even (at the level of free cash flow) in approximately 4 years. This means he doesn’t have a lot of wiggle room, but he shouldn’t really need more cash, given that cash consumption should continuously decrease. You can see how his cash balance has changed over time in the image below.
How is Lake Resources’ cash burn changing over time?
Lake Resources has not recorded any revenue for the past year, indicating that it is an early-stage company that is still expanding its business. So, while we can’t look to sales to understand growth, we can look at cash burn trends to understand spending trends over time. With a cash burn rate up 7.8% over the past year, it looks like the company is increasing its investment in the business over time. However, the company’s true cash trail will therefore be shorter than suggested above, if expenses continue to rise. While the past is always worth studying, it is the future that matters most. You might want to take a look at the company’s expected growth over the next few years.
Can Lake Resources raise more money easily?
Although its cash burn is only increasing slightly, Lake Resources shareholders should still consider the potential need for additional cash, down the road. Companies can raise capital either through debt or equity. Typically, a company will sell new stock on its own to raise cash and drive growth. By comparing a company’s annual cash burn to its total market capitalization, we can roughly estimate how many shares it would need to issue to keep the company running for another year (at the same burn rate).
Lake Resources has a market capitalization of A$1.1 billion and spent A$7.2 million last year, or 0.7% of the company’s market value. So he could almost certainly borrow a little to fund another year’s growth, or he could easily raise cash by issuing a few shares.
How risky is Lake Resources’ cash burn situation?
It may already be obvious to you that we are relatively comfortable with how Lake Resources spends its cash. For example, we think its cash trail suggests the business is on the right track. While its growing cash burn was not significant, the other factors mentioned in this article more than offset the weakness in this metric. A real bright spot is that analysts expect the company to break even. Considering all the factors in this report, we are not at all worried about its cash burn, as the company appears to be well capitalized to spend as needed. Separately, we looked at different risks affecting the business and identified 4 warning signs for Lake Resources (of which 1 is worrying!) that you should know about.
If you prefer to consult another company with better fundamentals, do not miss this free list of interesting companies, which have a high return on equity and low debt or this list of stocks which should all grow.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.