We can readily understand why investors are attracted to unprofitable companies. For example, Challenger Exploration (ASX:CEL) shareholders have done very well over the last year, with the share price soaring by 120%. 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 notwithstanding the buoyant share price, we think it's well worth asking whether Challenger Exploration'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. Let's start with an examination of the business' cash, relative to its cash burn.

View our latest analysis for Challenger Exploration

When Might Challenger Exploration Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. When Challenger Exploration last reported its balance sheet in December 2020, it had zero debt and cash worth AU$15m. Importantly, its cash burn was AU$4.4m over the trailing twelve months. So it had a cash runway of about 3.4 years from December 2020. 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?

Although Challenger Exploration reported revenue of AU$30k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. 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. Admittedly, we're a bit cautious of Challenger Exploration due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.



How Easily Can Challenger Exploration Raise Cash?

While Challenger Exploration does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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 and 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.

Challenger Exploration has a market capitalisation of AU$202m and burnt through AU$4.4m last year, which is 2.2% of the company's market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

Is Challenger Exploration's Cash Burn A Worry?

As you can probably tell by now, we're not too worried about Challenger Exploration's cash burn. 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 4 warning signs for Challenger Exploration (of which 2 are significant!) 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. 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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