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. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.
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. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.
Does Australian Rare Earths Have A Long Cash Runway?
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. When Australian Rare Earths last reported its balance sheet in June 2021, it had zero debt and cash worth AU$12m. In the last year, its cash burn was AU$1.1m. That means it had a cash runway of very many years as of 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. You can see how its cash balance has changed over time in the image below.
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. 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. 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. Admittedly, we're a bit cautious of Australian Rare Earths due to its lack of significant operating revenues. 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?
While Australian Rare Earths does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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).
Australian Rare Earths has a market capitalisation of AU$90m and burnt through AU$1.1m last year, which is 1.2% of the company's market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.
How Risky Is Australian Rare Earths' Cash Burn Situation?
It may already be apparent to you that we're relatively comfortable with the way Australian Rare Earths is burning through its cash. 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. Looking at all the measures in this article, together, we're not worried about its rate of cash burn; the company seems well on top of its medium-term spending needs. On another note, Australian Rare Earths has 4 warning signs (and 1 which is a bit concerning) we think you should know about.
Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)
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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