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

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. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

So should Arafura Rare Earths (ASX:ARU) shareholders 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). 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 Arafura Rare Earths

SWOT Analysis for Arafura Rare Earths

When Might Arafura Rare Earths Run Out Of Money?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at December 2022, Arafura Rare Earths had cash of AU$125m and no debt. In the last year, its cash burn was AU$51m. So it had a cash runway of about 2.4 years from December 2022. Notably, analysts forecast that Arafura Rare Earths will break even (at a free cash flow level) in about 3 years. That means unless the company reduces its cash burn quickly, it may well look to raise more cash. 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. Nonetheless, we can still examine its cash burn trajectory as part of our assessment of its cash burn situation. In fact, it ramped its spending strongly over the last year, increasing cash burn by 183%. 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. So you might want to take a peek at how much the company is expected to grow in the next few years.

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

While Arafura Rare Earths does have a solid cash runway, its cash burn trajectory may have some shareholders thinking ahead to when the company may need to raise more cash. 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.

Arafura Rare Earths' cash burn of AU$51m is about 7.8% of its AU$655m 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.

How Risky Is Arafura Rare Earths' Cash Burn Situation?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Arafura Rare Earths' cash runway was relatively promising. Shareholders can take heart from the fact that analysts are forecasting it will reach breakeven. 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 4 warning signs for Arafura Rare Earths (of which 2 are significant!) you should know about.

If you would prefer to check out another company with better fundamentals, then do not miss this free list of interesting companies, that have HIGH return on equity and low debt or this list of stocks which are all forecast to grow.

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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.