We Think RareX (ASX:REE) Needs To Drive Business Growth Carefully

June 15, 2020

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. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So, the natural question for RareX (ASX:REE) shareholders is whether they should be concerned by its rate of cash burn. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. Let's start with an examination of the business's cash, relative to its cash burn.

Check out our latest analysis for RareX

When Might RareX Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. As at December 2019, RareX had cash of AU$2.0m and no debt. Importantly, its cash burn was AU$1.7m over the trailing twelve months. So it had a cash runway of approximately 14 months from December 2019. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. The image below shows how its cash balance has been changing over the last few years.

How Is RareX's Cash Burn Changing Over Time?

Because RareX 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. Over the last year its cash burn actually increased by 5.1%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. RareX 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 RareX To Raise More Cash For Growth?

While its cash burn is only increasing slightly, RareX shareholders should still consider the potential need for further cash, down the track. 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. 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.

RareX has a market capitalisation of AU$20m and burnt through AU$1.7m last year, which is 8.5% 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.

So, Should We Worry About RareX's Cash Burn?

On this analysis of RareX's cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. While we're the kind of investors who are always a bit concerned about the risks involved with cash burning companies, the metrics we have discussed in this article leave us relatively comfortable about RareX's situation. Separately, we looked at different risks affecting the company and spotted 5 warning signs for RareX (of which 3 don't sit too well with us!) 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)

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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. Thank you for reading.