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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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
So, the natural question for Ionic Rare Earths (ASX:IXR) shareholders is whether they should be concerned by its rate of cash burn. 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. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
When Might Ionic Rare Earths Run Out Of Money?
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 June 2020, Ionic Rare Earths had AU$830k in cash, and was debt-free. In the last year, its cash burn was AU$1.3m. Therefore, from June 2020 it had roughly 7 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. Depicted below, you can see how its cash holdings have changed over time.
How Is Ionic Rare Earths' Cash Burn Changing Over Time?
While Ionic Rare Earths did record statutory revenue of AU$424 over the last year, it didn't have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. With the cash burn rate up 47% in the last year, it seems that the company is ratcheting up investment in the business over time. 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 Ionic Rare Earths due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How Hard Would It Be For Ionic Rare Earths To Raise More Cash For Growth?
Given its cash burn trajectory, Ionic Rare Earths shareholders should already be thinking about how easy it might be for it to raise further cash in the future. 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 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.
Ionic Rare Earths' cash burn of AU$1.3m is about 3.7% of its AU$36m market capitalisation. 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.
So, Should We Worry About Ionic Rare Earths' Cash Burn?
Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Ionic Rare Earths' cash burn relative to its market cap was relatively promising. Summing up, we think the Ionic Rare Earths' cash burn is a risk, based on the factors we mentioned in this article. Separately, we looked at different risks affecting the company and spotted 6 warning signs for Ionic Rare Earths (of which 3 don't sit too well with us!) you should know about.
Of course Ionic 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.
This article by Simply Wall St is general in nature. 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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