Is Arafura Rare Earths (ASX:ARU) In A Good Position To Invest In Growth?

Just because a business does not make any money, does not mean that the stock will go down. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. 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, the natural question for Arafura Rare Earths (ASX:ARU) shareholders is whether they should be concerned by its rate of 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. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out the opportunities and risks within the AU Metals and Mining industry.

Does Arafura 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. In June 2022, Arafura Rare Earths had AU$25m in cash, and was debt-free. Importantly, its cash burn was AU$31m over the trailing twelve months. Therefore, from June 2022 it had roughly 9 months of cash runway. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.

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

Arafura 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. In fact, it ramped its spending strongly over the last year, increasing cash burn by 144%. That sort of spending growth rate can't continue for very long before it causes balance sheet weakness, generally speaking. While the past is always worth studying, it is the future that matters most of all. So you might want to take a peek at how much the company is expected to grow in the next few years.

How Easily Can Arafura Rare Earths Raise Cash?

Since its cash burn is moving in the wrong direction, Arafura Rare Earths shareholders may wish to think ahead to when the company may need to raise more cash. 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).

Arafura Rare Earths' cash burn of AU$31m is about 5.3% of its AU$596m market capitalisation. Given that is a rather small percentage, it would probably be really easy for the company to fund another year's growth by issuing some new shares to investors, or even by taking out a loan.

So, Should We Worry About Arafura Rare Earths' Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Arafura Rare Earths' cash burn relative to its market cap was relatively promising. Summing up, we think the Arafura Rare Earths' cash burn is a risk, based on the factors we mentioned in this article. Separately, we looked at different risks affecting the company and spotted 5 warning signs for Arafura Rare Earths (of which 3 make us uncomfortable!) you should know about.

Of course Arafura 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.