Australian Rare Earths (ASX:AR3) Is In A Good Position To Deliver On Growth Plans

There's no doubt that money can be made by owning shares of unprofitable businesses. 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?

Given this risk, we thought we'd take a look at whether Australian Rare Earths (ASX:AR3) 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). We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Australian Rare Earths

When Might Australian Rare Earths Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Australian Rare Earths last reported its balance sheet in December 2021, it had zero debt and cash worth AU$8.7m. Importantly, its cash burn was AU$3.5m over the trailing twelve months. 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. The image below shows how its cash balance has been changing over the last few years.

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 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.

Can Australian Rare Earths Raise More Cash Easily?

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. 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.

Australian Rare Earths' cash burn of AU$3.5m is about 6.0% of its AU$58m 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 Australian Rare Earths' Cash Burn?

On this analysis of Australian Rare Earths' cash burn, we think its cash runway 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. Taking a deeper dive, we've spotted 3 warning signs for Australian Rare Earths you should be aware of, and 1 of them is a bit concerning.

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)

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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.