- Oops!Something went wrong.Please try again later.
We can readily understand why investors are attracted to unprofitable companies. For example, Arafura Resources (ASX:ARU) shareholders have done very well over the last year, with the share price soaring by 122%. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
Given its strong share price performance, we think it's worthwhile for Arafura Resources shareholders to consider whether its cash burn is concerning. In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. Let's start with an examination of the business' cash, relative to its cash burn.
When Might Arafura Resources Run Out Of Money?
A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Arafura Resources last reported its balance sheet in December 2021, it had zero debt and cash worth AU$42m. In the last year, its cash burn was AU$18m. So it had a cash runway of about 2.3 years from December 2021. Arguably, that's a prudent and sensible length of runway to have. You can see how its cash balance has changed over time in the image below.
How Is Arafura Resources' Cash Burn Changing Over Time?
Arafura Resources didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Over the last year its cash burn actually increased by 32%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of Arafura Resources due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.
Can Arafura Resources Raise More Cash Easily?
While Arafura Resources does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Companies can raise capital through either debt or equity. 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.
Arafura Resources has a market capitalisation of AU$550m and burnt through AU$18m last year, which is 3.3% of the company's market value. That's a low proportion, so we figure the company would be able to raise more cash to fund growth, with a little dilution, or even to simply borrow some money.
How Risky Is Arafura Resources' Cash Burn Situation?
As you can probably tell by now, we're not too worried about Arafura Resources' cash burn. For example, we think its cash burn relative to its market cap suggests that the company is on a good path. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. On another note, Arafura Resources has 4 warning signs (and 2 which are concerning) 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 companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)
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.