We're Keeping An Eye On Arafura Rare Earths' (ASX:ARU) Cash Burn Rate
Just because a business does not make any money, does not mean that the stock will go down. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.
Given this risk, we thought we'd take a look at whether Arafura Rare Earths (ASX:ARU) shareholders should be worried about its cash burn. For the purpose of this article, we'll define cash burn as the amount of cash the company is spending each year to fund its growth (also called its negative free cash flow). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
See our latest analysis for Arafura Rare Earths
Does Arafura Rare Earths Have A Long Cash Runway?
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. As at June 2023, Arafura Rare Earths had cash of AU$129m and no debt. Looking at the last year, the company burnt through AU$72m. That means it had a cash runway of around 22 months as of June 2023. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. You can see how its cash balance has changed over time in the image below.
How Is Arafura Rare Earths' Cash Burn Changing Over Time?
Because Arafura Rare Earths isn't currently generating revenue, we consider it an early-stage business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. The skyrocketing cash burn up 128% year on year certainly tests our nerves. It's fair to say that sort of rate of increase cannot be maintained for very long, without putting pressure on the balance sheet. While the past is always worth studying, it is the future that matters most of all. 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 Arafura Rare Earths To Raise More Cash For Growth?
Given its cash burn trajectory, Arafura Rare Earths shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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 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.
Arafura Rare Earths' cash burn of AU$72m is about 14% of its AU$528m market capitalisation. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.
Is Arafura Rare Earths' Cash Burn A Worry?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Arafura Rare Earths' cash runway was relatively promising. We don't think its cash burn is particularly problematic, but after considering the range of factors in this article, we do think shareholders should be monitoring how it changes over time. On another note, Arafura Rare Earths has 3 warning signs (and 2 which are a bit unpleasant) 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)
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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.
