We're Not Very Worried About American Rare Earths' (ASX:ARR) Cash Burn Rate

We can readily understand why investors are attracted to unprofitable companies. 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. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

Given this risk, we thought we'd take a look at whether American Rare Earths (ASX:ARR) 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.

Check out our latest analysis for American Rare Earths

SWOT Analysis for American Rare Earths

Does American Rare Earths Have A Long 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. As at December 2022, American Rare Earths had cash of AU$16m and no debt. In the last year, its cash burn was AU$7.2m. That means it had a cash runway of about 2.1 years as of December 2022. Arguably, that's a prudent and sensible length of runway to have. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. Depicted below, you can see how its cash holdings have changed over time.

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

While American Rare Earths did record statutory revenue of AU$55k over the last year, it didn't have any revenue from operations. That means we consider it a pre-revenue business, and we will focus our growth analysis on cash burn, for now. The skyrocketing cash burn up 138% year on year certainly tests our nerves. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. Admittedly, we're a bit cautious of American Rare Earths due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.

How Hard Would It Be For American Rare Earths To Raise More Cash For Growth?

Given its cash burn trajectory, American 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. Commonly, a business will sell new shares in itself to raise cash and drive 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.

American Rare Earths' cash burn of AU$7.2m is about 14% of its AU$54m market capitalisation. Given that situation, it's fair to say the company wouldn't have much trouble raising more cash for growth, but shareholders would be somewhat diluted.

Is American Rare Earths' Cash Burn A Worry?

On this analysis of American Rare Earths' cash burn, we think its cash runway was reassuring, while its increasing cash burn has us a bit worried. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for American Rare Earths (2 are a bit unpleasant!) that you should be aware of before investing here.

Of course American 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.