Companies Like Arafura Resources (ASX:ARU) Are In A Position To Invest In Growth

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Arafura Resources (ASX:ARU) shareholders have done very well over the last year, with the share price soaring by 156%. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?

In light of its strong share price run, we think now is a good time to investigate how risky Arafura Resources' 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'. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

Check out our latest analysis for Arafura Resources

When Might Arafura Resources Run Out Of Money?

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. When Arafura Resources last reported its balance sheet in December 2021, it had zero debt and cash worth AU$42m. In the last year, its cash burn was AU$18m. So it had a cash runway of about 2.3 years from December 2021. Arguably, that's a prudent and sensible length of runway to have. Depicted below, you can see how its cash holdings have changed over time.

How Is Arafura Resources' Cash Burn Changing Over Time?

Arafura Resources 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. With the cash burn rate up 32% in the last year, it seems that the company is ratcheting up investment in the business over time. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. 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 Resources Raise Cash?

Given its cash burn trajectory, Arafura Resources shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. Companies can raise capital through either debt or equity. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund 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 Resources' cash burn of AU$18m is about 3.3% of its AU$541m 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 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. For example, we think its cash burn relative to its market cap suggests that the company is on a good path. While its increasing cash burn wasn't great, the other factors mentioned in this article more than make up for weakness on that measure. 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. Taking a deeper dive, we've spotted 6 warning signs for Arafura Resources you should be aware of, and 3 of them don't sit too well with us.

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

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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.