There's no doubt that money can be made by owning shares of unprofitable businesses. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should Australian Rare Earths (ASX:AR3) shareholders be worried about its cash burn? In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
How Long Is Australian Rare Earths' Cash Runway?
A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. In December 2021, Australian Rare Earths had AU$8.7m in cash, and was debt-free. Looking at the last year, the company burnt through AU$3.5m. So it had a cash runway of about 2.5 years from December 2021. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.
How Is Australian Rare Earths' Cash Burn Changing Over Time?
Because Australian 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. Its cash burn positively exploded in the last year, up 520%. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Australian Rare Earths makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Easily Can Australian Rare Earths Raise Cash?
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. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future growth. We can compare a company's cash burn to its market capitalisation to get a sense for how many new shares a company would have to issue to fund one year's operations.
Australian Rare Earths has a market capitalisation of AU$83m and burnt through AU$3.5m last year, which is 4.2% of the company's market value. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.
How Risky Is Australian Rare Earths' Cash Burn Situation?
On this analysis of Australian Rare Earths' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Australian Rare Earths (1 is potentially serious!) that you should be aware of before investing here.
Of course Australian Rare Earths may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.
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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.