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.
So should Alector (NASDAQ:ALEC) shareholders 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’. The first step is to compare its cash burn with its cash reserves, to give us its ‘cash runway’.
When Might Alector 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 Alector last reported its balance sheet in June 2020, it had zero debt and cash worth US$504m. Looking at the last year, the company burnt through US$144m. Therefore, from June 2020 it had 3.5 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.
How Well Is Alector Growing?
Alector actually ramped up its cash burn by a whopping 53% in the last year, which shows it is boosting investment in the business. While that’s concerning on it’s own, the fact that operating revenue was actually down 32% over the same period makes us positively tremulous. Taken together, we think these growth metrics are a little worrying. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.
Can Alector Raise More Cash Easily?
While Alector seems to be in a fairly good position, it’s still worth considering how easily it could raise more cash, even just to fuel faster growth. 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 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.
Alector’s cash burn of US$144m is about 16% of its US$901m market capitalisation. As a result, we’d venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.
Is Alector’s Cash Burn A Worry?
On this analysis of Alector’s cash burn, we think its cash runway was reassuring, while its falling revenue has us a bit worried. While we’re the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about Alector’s situation. Readers need to have a sound understanding of business risks before investing in a stock, and we’ve spotted 3 warning signs for Alector that potential shareholders should take into account before putting money into a stock.
Of course Alector may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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.