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2022 was a challenging year for the stock market, but few companies felt the impact harder than Virgin Galactic (SPCE 12.34%). With its shares down almost 70% in the last 12 months, many investors have lost faith in this space exploration start-up. But is the pessimism premature? Let’s discuss whether Virgin Galactic’s risks outweigh the rewards.
Virgin Galactic’s spectacular fall comes amid an increasingly difficult macroeconomic environment. In early 2022, the Federal Reserve began to raise its benchmark interest rate to fight inflation. This move hurts growth stocks by discounting the future value of their cashflows and changing investors’ risk-reward calculations.
For unprofitable companies like Virgin Galactic, higher rates are a double whammy because they can increase the cost of the capital it would need to sustain its cash burn. Third-quarter earnings highlight why cash burn is such a big challenge. With just $767,000 in revenue, Virgin Galactic is a long way from starting its core space tourism operations.
And although transporting payloads and training astronauts can generate some income, profitability remains nowhere in sight. Operating expenses ballooned 71% to $146.3 million as management poured money into research and development. With just $394 million in cash and equivalents, the company may eventually struggle to sustain its current cash burn without raising new debt or issuing more shares, a process that can reduce the value of its current shares outstanding through equity dilution.
Virgin Galactic’s cash burn would not be such a big problem if investors expected it to start profitable commercial operations in a reasonable time frame. After all, there seems to be a decent opportunity to make its business model work. Analysts at Research and Markets expect the global space tourism industry to expand at a compound annual rate of 37.1% to $8.67 billion by 2030 as technology improvements and new entrants to the market drive growth.
While the market is virtually nonexistent now, the thinking is that wealthy people will be willing to splurge on unique, big-ticket experiences. Customized Mount Everest trips (which can cost as much as $115,000) are perhaps a good way to illustrate the concept. Virgin Galactic experiences will be significantly more expensive at $450,00 per seat.
Image source: Getty Images.
But all these projections mean nothing if Virgin Galactic can’t complete its pre-commercialization testing and research and safely transport passengers to space. In August, the company once again delayed the start of commercialization to the second quarter of 2023. It had previously pushed back the debut from the fourth quarter of 2022 to the first quarter of 2023.
Management’s unreliable forecasts erode trust and make investors unlikely to take anything they say seriously going forward.
Virgin Galactic remains an all-or-nothing investment. If the company sticks to its commercialization forecasts, shares will likely rise because the current stock price probably prices in its unreliability. With that said, even if Virgin Galactic takes passengers to space, that doesn’t automatically make the company a good long-term investment.
While some analysts predict strong demand, the space tourism industry is largely unproven. No one knows for sure how the story will play out. Virgin Galactic carries both the risk of never starting operations and failing to create value if it eventually does. Long-term investors should give the stock a wide berth until some of these uncertainties are cleared up.
Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
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