We Think Arafura Rare Earths (ASX:ARU) Can Afford To Drive Business Growth

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. By way of example, Arafura Rare Earths (ASX:ARU) has seen its share price rise 247% over the last year, delighting many shareholders. 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.

In light of its strong share price run, we think now is a good time to investigate how risky Arafura Rare Earths' cash burn is. In this report, we will consider the company's annual negative free cash flow, henceforth referring to it as the 'cash burn'. We'll start by comparing its cash burn with its cash reserves in order to calculate its cash runway.

View our latest analysis for Arafura Rare Earths

How Long Is Arafura 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. When Arafura Rare Earths last reported its balance sheet in December 2022, it had zero debt and cash worth AU$125m. Looking at the last year, the company burnt through AU$51m. Therefore, from December 2022 it had 2.4 years of cash runway. 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 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. The skyrocketing cash burn up 183% 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. 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 Arafura Rare Earths Raise More Cash Easily?

Given its cash burn trajectory, Arafura 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.

Arafura Rare Earths' cash burn of AU$51m is about 4.0% of its AU$1.3b market capitalisation. 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 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. 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. Separately, we looked at different risks affecting the company and spotted 6 warning signs for Arafura Rare Earths (of which 3 are potentially serious!) 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.

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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.