Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. Indeed, Red Hill Iron (ASX:RHI) stock is up 114% in the last year, providing strong gains for shareholders. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So notwithstanding the buoyant share price, we think it's well worth asking whether Red Hill Iron's cash burn is too risky. 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.

See our latest analysis for Red Hill Iron

When Might Red Hill Iron Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In December 2020, Red Hill Iron had AU$408k in cash, and was debt-free. Importantly, its cash burn was AU$450k over the trailing twelve months. That means it had a cash runway of around 11 months as of December 2020. 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. You can see how its cash balance has changed over time in the image below.

How Is Red Hill Iron's Cash Burn Changing Over Time?

Whilst it's great to see that Red Hill Iron has already begun generating revenue from operations, last year it only produced AU$5.0k, so we don't think it is generating significant revenue, at this point. Therefore, for the purposes of this analysis we'll focus on how the cash burn is tracking. As it happens, the company's cash burn reduced by 20% over the last year, which suggests that management are mindful of the possibility of running out of cash. Red Hill Iron 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 Easily Can Red Hill Iron Raise Cash?

Even though it has reduced its cash burn recently, shareholders should still consider how easy it would be for Red Hill Iron to raise more cash in the future. 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. 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.

Red Hill Iron's cash burn of AU$450k is about 1.7% of its AU$27m market capitalisation. 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 Red Hill Iron's Cash Burn Situation?

On this analysis of Red Hill Iron's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Red Hill Iron (of which 3 are potentially serious!) 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)

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.