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. 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 the harsh reality is that very many loss making companies burn through all their cash and go bankrupt.
So, the natural question for Arafura Resources (ASX:ARU) shareholders is whether they should be concerned by its rate of cash burn. 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'.
Does Arafura Resources Have A Long Cash Runway?
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. In June 2021, Arafura Resources had AU$11m in cash, and was debt-free. Importantly, its cash burn was AU$13m over the trailing twelve months. That means it had a cash runway of around 10 months as of June 2021. That's quite a short cash runway, indicating the company must either reduce its annual cash burn or replenish its cash. You can see how its cash balance has changed over time in the image below.
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. 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. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Arafura Resources makes us a little nervous due to its lack of substantial operating revenue. We prefer most of the stocks on this list of stocks that analysts expect to grow.
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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. Commonly, a business will sell new shares in itself to raise cash and drive 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 Resources' cash burn of AU$13m is about 4.2% of its AU$310m 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.
Is Arafura Resources' Cash Burn A Worry?
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. On another note, we conducted an in-depth investigation of the company, and identified 4 warning signs for Arafura Resources (2 are a bit concerning!) 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)
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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.