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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 the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.
So should Australian Rare Earths (ASX:AR3) shareholders 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.
When Might Australian Rare Earths 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 June 2021, Australian Rare Earths had AU$12m in cash, and was debt-free. In the last year, its cash burn was AU$1.1m. So it had a very long cash runway of many years from June 2021. While this is only one measure of its cash burn situation, it certainly gives us the impression that holders have nothing to worry about. Depicted below, you can see how its cash holdings have changed over time.
How Is Australian Rare Earths' Cash Burn Changing Over Time?
Australian Rare Earths 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. Its cash burn positively exploded in the last year, up 9,281%. We certainly hope for shareholders' sake that the money is well spent, because that kind of expenditure increase always makes us nervous. Australian Rare Earths 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 Hard Would It Be For Australian Rare Earths To Raise More Cash For Growth?
Given its cash burn trajectory, Australian Rare Earths shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Many companies end up issuing new shares to fund future 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).
Since it has a market capitalisation of AU$107m, Australian Rare Earths' AU$1.1m in cash burn equates to about 1.0% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.
How Risky Is Australian Rare Earths' Cash Burn Situation?
As you can probably tell by now, we're not too worried about Australian Rare Earths' cash burn. In particular, we think its cash runway stands out as evidence that the company is well on top of its spending. While we must concede that its increasing cash burn is a bit worrying, the other factors mentioned in this article provide great comfort when it comes to the cash burn. After taking into account the various metrics mentioned in this report, we're pretty comfortable with how the company is spending its cash, as it seems on track to meet its needs over the medium term. Taking a deeper dive, we've spotted 4 warning signs for Australian Rare Earths you should be aware of, and 1 of them is concerning.
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.
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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