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

Just because a business does not make any money, does not mean that the stock will go down. 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.

So, the natural question for American Rare Earths (ASX:ARR) shareholders is whether they should be concerned by its rate of 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.

Check out our latest analysis for American Rare Earths

When Might American Rare Earths Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. In June 2023, American Rare Earths had AU$12m in cash, and was debt-free. Looking at the last year, the company burnt through AU$6.9m. So it had a cash runway of approximately 22 months from June 2023. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. The image below shows how its cash balance has been changing over the last few years.

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

Although American Rare Earths reported revenue of AU$67k last year, it didn't actually have any revenue from operations. To us, that makes it a pre-revenue company, so we'll look to its cash burn trajectory as an assessment of its cash burn situation. Over the last year its cash burn actually increased by 33%, which suggests that management are increasing investment in future growth, but not too quickly. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. American 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.

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. 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. 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 has a market capitalisation of AU$56m and burnt through AU$6.9m last year, which is 12% of the company's market value. 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.

How Risky Is American Rare Earths' Cash Burn Situation?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought American Rare Earths' cash runway was relatively promising. 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 American Rare Earths' situation. Taking a deeper dive, we've spotted 3 warning signs for American Rare Earths you should be aware of, and 2 of them are significant.

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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.