Can Red Metal (ASX:RDM) Afford To Invest In Growth?
We can readily understand why investors are attracted to unprofitable companies. By way of example, Red Metal (ASX:RDM) has seen its share price rise 135% over the last year, delighting many shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
So notwithstanding the buoyant share price, we think it's well worth asking whether Red Metal's cash burn is too risky. 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
Check out our latest analysis for Red Metal
When Might Red Metal 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. In December 2023, Red Metal had AU$5.4m in cash, and was debt-free. Importantly, its cash burn was AU$10m over the trailing twelve months. Therefore, from December 2023 it had roughly 7 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. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. Depicted below, you can see how its cash holdings have changed over time.
How Well Is Red Metal Growing?
Notably, Red Metal actually ramped up its cash burn very hard and fast in the last year, by 101%, signifying heavy investment in the business. On top of that, the fact that operating revenue was basically flat over the same period compounds the concern. Considering both these metrics, we're a little concerned about how the company is developing. In reality, this article only makes a short study of the company's growth data. This graph of historic earnings and revenue shows how Red Metal is building its business over time.
How Hard Would It Be For Red Metal To Raise More Cash For Growth?
Since Red Metal has been boosting its cash burn, the market will likely be considering how it can raise more cash if need be. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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.
Since it has a market capitalisation of AU$48m, Red Metal's AU$10m in cash burn equates to about 21% of its market value. That's fairly notable cash burn, so if the company had to sell shares to cover the cost of another year's operations, shareholders would suffer some costly dilution.
So, Should We Worry About Red Metal's Cash Burn?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Red Metal's revenue growth was relatively promising. After looking at that range of measures, we think shareholders should be extremely attentive to how the company is using its cash, as the cash burn makes us uncomfortable. Separately, we looked at different risks affecting the company and spotted 6 warning signs for Red Metal (of which 2 are potentially serious!) you should know about.
If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.
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.