We're Hopeful That Australian Rare Earths (ASX:AR3) Will Use Its Cash Wisely

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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So should Australian Rare Earths (ASX:AR3) shareholders be worried about its cash burn? In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Australian Rare Earths

How Long Is Australian Rare Earths' Cash Runway?

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. In December 2021, Australian Rare Earths had AU$8.7m in cash, and was debt-free. In the last year, its cash burn was AU$3.5m. That means it had a cash runway of about 2.5 years as of December 2021. That's decent, giving the company a couple years to develop its business. Depicted below, you can see how its cash holdings have changed over time.

How Is Australian Rare Earths' Cash Burn Changing Over Time?

Australian Rare Earths didn't record any revenue over the last year, indicating that it's an early stage company still developing its business. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. Remarkably, it actually increased its cash burn by 520% in the last year. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. 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.

Can Australian Rare Earths Raise More Cash Easily?

Given its cash burn trajectory, Australian Rare Earths shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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).

Since it has a market capitalisation of AU$75m, Australian Rare Earths' AU$3.5m in cash burn equates to about 4.6% of its 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 Australian Rare Earths' Cash Burn?

On this analysis of Australian Rare Earths' cash burn, we think its cash burn relative to its market cap was reassuring, while its increasing cash burn has us a bit worried. Based on the factors mentioned in this article, we think its cash burn situation warrants some attention from shareholders, but we don't think they should be worried. On another note, Australian Rare Earths has 4 warning signs (and 1 which can't be ignored) we think you should know about.

Of course Australian 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.

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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.