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We're A Little Worried About Rose Petroleum's (LON:ROSE) Cash Burn Rate

We can readily understand why investors are attracted to unprofitable companies. For example, although software-as-a-service business Salesforce.com lost money for years while it grew recurring revenue, if you held shares since 2005, you'd have done very well indeed. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

So, the natural question for Rose Petroleum (LON:ROSE) shareholders is whether they should be concerned by its rate of cash burn. 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Rose Petroleum

When Might Rose Petroleum 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. In June 2019, Rose Petroleum had US$461k in cash, and was debt-free. Looking at the last year, the company burnt through US$2.2m. Therefore, from June 2019 it had roughly 2 months of cash runway. That's a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

AIM:ROSE Historical Debt March 30th 2020
AIM:ROSE Historical Debt March 30th 2020

How Is Rose Petroleum's Cash Burn Changing Over Time?

Because Rose Petroleum isn't currently generating revenue, we consider it an early-stage 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. As it happens, the company's cash burn reduced by 54% over the last year, which suggests that management are mindful of the possibility of running out of cash. Admittedly, we're a bit cautious of Rose Petroleum 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 Hard Would It Be For Rose Petroleum To Raise More Cash For Growth?

There's no doubt Rose Petroleum'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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash to fund 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.

Rose Petroleum has a market capitalisation of US$2.0m and burnt through US$2.2m last year, which is 114% of the company's market value. That suggests the company may have some funding difficulties, and we'd be very wary of the stock.

How Risky Is Rose Petroleum's Cash Burn Situation?

There are no prizes for guessing that we think Rose Petroleum's cash burn is a bit of a worry. In particular, we think its cash burn relative to its market cap suggests it isn't in a good position to keep funding growth. But the silver lining was its cash burn reduction, which was encouraging. Looking at the metrics in this article all together, we consider its cash burn situation to be rather dangerous, and likely to cost shareholders one way or the other. On another note, Rose Petroleum has 5 warning signs (and 1 which is potentially serious) we think you should know about.

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

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.