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Here's Why We're Not Too Worried About Honest Company's (NASDAQ:HNST) Cash Burn Situation

We can readily understand why investors are attracted to unprofitable companies. 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. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

Given this risk, we thought we'd take a look at whether Honest Company (NASDAQ:HNST) shareholders should be worried about its 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Honest Company

When Might Honest Company Run Out Of Money?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In September 2022, Honest Company had US$41m in cash, and was debt-free. Looking at the last year, the company burnt through US$54m. Therefore, from September 2022 it had roughly 9 months of cash runway. Importantly, analysts think that Honest Company will reach cashflow breakeven in around 14 months. So there's a very good chance it won't need more cash, when you consider the burn rate will be reducing in that period. The image below shows how its cash balance has been changing over the last few years.

debt-equity-history-analysis
debt-equity-history-analysis

How Well Is Honest Company Growing?

Over the last year, Honest Company maintained its cash burn at a fairly steady level. And so too did its operating revenue, which is hardly exciting. In light of the data above, we're fairly sanguine about the business growth trajectory. Clearly, however, the crucial factor is whether the company will grow its business going forward. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Hard Would It Be For Honest Company To Raise More Cash For Growth?

Since Honest Company can't yet boast improving growth metrics, the market will likely be considering how it can raise more cash if need be. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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).

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Honest Company has a market capitalisation of US$279m and burnt through US$54m last year, which is 19% of the company's market value. 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.

How Risky Is Honest Company's Cash Burn Situation?

On this analysis of Honest Company's cash burn, we think its cash burn relative to its market cap was reassuring, while its cash runway has us a bit worried. There's no doubt that shareholders can take a lot of heart from the fact that analysts are forecasting it will reach breakeven before too long. 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. Taking an in-depth view of risks, we've identified 3 warning signs for Honest Company that you should be aware of before investing.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

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

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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