We Think Arafura Resources (ASX:ARU) Needs To Drive Business Growth Carefully

By
Simply Wall St
Published
September 05, 2021
ASX:ARU
Source: Shutterstock

We can readily understand why investors are attracted to unprofitable companies. For example, Arafura Resources (ASX:ARU) shareholders have done very well over the last year, with the share price soaring by 133%. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

Given its strong share price performance, we think it's worthwhile for Arafura Resources shareholders to consider whether its cash burn is concerning. 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). Let's start with an examination of the business' cash, relative to its cash burn.

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 June 2021, it had zero debt and cash worth AU$11m. Looking at the last year, the company burnt through AU$13m. So it had a cash runway of approximately 10 months from June 2021. To be frank, this kind of short runway puts us on edge, as it indicates the company must reduce its cash burn significantly, or else raise cash imminently. You can see how its cash balance has changed over time in the image below.

debt-equity-history-analysis
ASX:ARU Debt to Equity History September 5th 2021

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. 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. Over the last year its cash burn actually increased by 7.4%, which suggests that management are increasing investment in future growth, but not too quickly. That's not necessarily a bad thing, but investors should be mindful of the fact that will shorten the cash runway. Arafura Resources makes us a little nervous due to its lack of substantial operating revenue. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

Can Arafura Resources Raise More Cash Easily?

While its cash burn is only increasing slightly, Arafura Resources shareholders should still consider the potential need for further cash, down the track. Companies can raise capital through either debt or equity. 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 Resources' cash burn of AU$13m is about 4.9% of its AU$263m 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.

How Risky Is Arafura Resources' Cash Burn Situation?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Arafura Resources' cash burn relative to its market cap was relatively promising. Even though we don't think it has a problem with its cash burn, the analysis we've done in this article does suggest that shareholders should give some careful thought to the potential cost of raising more money in the future. Separately, we looked at different risks affecting the company and spotted 4 warning signs for Arafura Resources (of which 2 are a bit unpleasant!) 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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