There's no doubt that money can be made by owning shares of unprofitable businesses. For example, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given this risk, we thought we'd take a look at whether Challenger Exploration (ASX:CEL) shareholders should 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'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

Check out our latest analysis for Challenger Exploration

Does Challenger Exploration Have A Long Cash Runway?

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 2020, Challenger Exploration had AU$15m in cash, and was debt-free. Looking at the last year, the company burnt through AU$4.4m. Therefore, from December 2020 it had 3.4 years of cash runway. There's no doubt that this is a reassuringly long runway. You can see how its cash balance has changed over time in the image below. debt-equity-history-analysis

How Is Challenger Exploration's Cash Burn Changing Over Time?

Challenger Exploration 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. With the cash burn rate up 18% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Challenger Exploration makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.



How Hard Would It Be For Challenger Exploration To Raise More Cash For Growth?

Given its cash burn trajectory, Challenger Exploration shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash and drive 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).

Challenger Exploration has a market capitalisation of AU$232m and burnt through AU$4.4m last year, which is 1.9% of the company's market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.

How Risky Is Challenger Exploration's Cash Burn Situation?

It may already be apparent to you that we're relatively comfortable with the way Challenger Exploration is burning through its cash. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. Separately, we looked at different risks affecting the company and spotted 2 warning signs for Challenger Exploration (of which 1 is concerning!) you should know about.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this freelist of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

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.

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