We're Keeping An Eye On Australian Rare Earths' (ASX:AR3) Cash Burn Rate

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, although Amazon.com made losses for many years after listing, if you had bought and held the shares since 1999, you would have made a fortune. But while the successes are well known, investors should not ignore the very many unprofitable companies that simply burn through all their cash and collapse.

So should Australian Rare Earths (ASX:AR3) shareholders be worried about its cash burn? In this article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

View our latest analysis for Australian Rare Earths

Does Australian Rare Earths Have A Long Cash Runway?

A cash runway is defined as the length of time it would take a company to run out of money if it kept spending at its current rate of cash burn. As at June 2022, Australian Rare Earths had cash of AU$13m and no debt. Looking at the last year, the company burnt through AU$6.1m. So it had a cash runway of about 2.1 years from June 2022. Notably, one analyst forecasts that Australian Rare Earths will break even (at a free cash flow level) in about 4 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. 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?

Australian Rare Earths didn't record any revenue over the last year, indicating that it's an early stage company still developing its 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. Remarkably, it actually increased its cash burn by 454% in the last year. Given that sharp increase in spending, the company's cash runway will shrink rapidly as it depletes its cash reserves. Clearly, however, the crucial factor is whether the company will grow its business going forward. For that reason, it makes a lot of sense to take a look at our analyst forecasts for the company.

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. 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.

Australian Rare Earths has a market capitalisation of AU$52m and burnt through AU$6.1m last year, which is 12% of the company's market value. As a result, we'd venture that the company could raise more cash for growth without much trouble, albeit at the cost of some dilution.

Is Australian Rare Earths' Cash Burn A Worry?

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. Shareholders can take heart from the fact that at least one analyst is forecasting it will reach breakeven. 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 Australian Rare Earths' situation. On another note, Australian Rare Earths has 4 warning signs (and 1 which is concerning) 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.