Companies Like Arafura Resources (ASX:ARU) Are In A Position To Invest In 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. Indeed, Arafura Resources (ASX:ARU) stock is up 189% in the last year, providing strong gains for shareholders. But the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.

In light of its strong share price run, we think now is a good time to investigate how risky Arafura Resources' cash burn is. For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Arafura Resources

How Long Is Arafura Resources' Cash Runway?

You can calculate a company's cash runway by dividing the amount of cash it has by the rate at which it is spending that cash. In June 2020, Arafura Resources had AU$23m in cash, and was debt-free. In the last year, its cash burn was AU$12m. So it had a cash runway of approximately 23 months from June 2020. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. Importantly, if we extrapolate recent cash burn trends, the cash runway would be noticeably longer. You can see how its cash balance has changed over time in the image below.

How Is Arafura Resources' Cash Burn Changing Over Time?

In our view, Arafura Resources doesn't yet produce significant amounts of operating revenue, since it reported just AU$58k in the last twelve months. As a result, we think it's a bit early to focus on the revenue growth, so we'll limit ourselves to looking at how the cash burn is changing over time. With cash burn dropping by 17% it seems management feel the company is spending enough to advance its business plans at an appropriate pace. Admittedly, we're a bit cautious of Arafura Resources 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 Easily Can Arafura Resources Raise Cash?

While Arafura Resources is showing a solid reduction in its cash burn, it's still worth considering how easily it could raise more cash, even just to fuel faster growth. Generally speaking, a listed business can raise new cash through issuing shares or taking on debt. Commonly, a business will sell new shares in itself to raise cash and drive 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 Resources' cash burn of AU$12m is about 4.7% of its AU$257m 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 Resources' Cash Burn?

It may already be apparent to you that we're relatively comfortable with the way Arafura Resources is burning through its cash. In particular, we think its cash burn relative to its market cap stands out as evidence that the company is well on top of its spending. On this analysis its cash burn reduction was its weakest feature, but we are not concerned about it. Considering all the factors discussed in this article, we're not overly concerned about the company's cash burn, although we do think shareholders should keep an eye on how it develops. On another note, we conducted an in-depth investigation of the company, and identified 3 warning signs for Arafura Resources (1 is significant!) that you should be aware of before investing here.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of interesting companies, and this list of stocks growth stocks (according to analyst forecasts)

When trading Arafura Resources or any other investment, use the platform considered by many to be the Professional's Gateway to the Worlds Market, Interactive Brokers. You get the lowest-cost* trading on stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

This article by Simply Wall St is general in nature. 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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

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