Can Pensana Rare Earths (ASX:PM8) Afford To Invest In Growth?

Even when a business is losing money, it’s possible for shareholders to make money if they buy a good business at the right price. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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 Pensana Rare Earths (ASX:PM8) 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). Let’s start with an examination of the business’s cash, relative to its cash burn.

View our latest analysis for Pensana Rare Earths

Does Pensana Rare Earths Have A Long Cash Runway?

A company’s cash runway is calculated by dividing its cash hoard by its cash burn. When Pensana Rare Earths last reported its balance sheet in December 2019, it had zero debt and cash worth AU$1.2m. In the last year, its cash burn was AU$6.1m. Therefore, from December 2019 it had roughly 2 months of cash runway. That’s a very short cash runway which indicates an imminent need to douse the cash burn or find more funding. Depicted below, you can see how its cash holdings have changed over time.

ASX:PM8 Historical Debt May 11th 2020
ASX:PM8 Historical Debt May 11th 2020

How Is Pensana Rare Earths’s Cash Burn Changing Over Time?

Because Pensana Rare Earths isn’t currently generating revenue, we consider it an early-stage business. So while we can’t look to sales to understand growth, we can look at how the cash burn is changing to understand how expenditure is trending over time. During the last twelve months, its cash burn actually ramped up 53%. While this spending increase is no doubt intended to drive growth, if the trend continues the company’s cash runway will shrink very quickly. Pensana 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 Pensana Rare Earths To Raise More Cash For Growth?

Since its cash burn is moving in the wrong direction, Pensana Rare Earths shareholders may wish to think ahead to when the company may need to raise more cash. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. 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.

Pensana Rare Earths’s cash burn of AU$6.1m is about 20% of its AU$30m market capitalisation. That’s not insignificant, and if the company had to sell enough shares to fund another year’s growth at the current share price, you’d likely witness fairly costly dilution.

How Risky Is Pensana Rare Earths’s Cash Burn Situation?

As you can probably tell by now, we’re rather concerned about Pensana Rare Earths’s cash burn. Take, for example, its cash runway, which suggests the company may have difficulty funding itself, in the future. And although we accept its cash burn relative to its market cap wasn’t as worrying as its cash runway, it was still a real negative; as indeed were all the factors we considered in this article. After considering the data discussed in this article, we don’t have a lot of confidence that its cash burn rate is prudent, as it seems like it might need more cash soon. Separately, we looked at different risks affecting the company and spotted 6 warning signs for Pensana Rare Earths (of which 2 are a bit concerning!) you should know about.

Of course Pensana 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

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