We're Not Very Worried About Arafura Resources' (ASX:ARU) Cash Burn Rate

There's no doubt that money can be made by owning shares of unprofitable businesses. Indeed, Arafura Resources (ASX:ARU) stock is up 101% in the last year, providing strong gains for shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

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 article, we define cash burn as its annual (negative) free cash flow, which is the amount of money a company spends each year to fund its growth. 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

Does Arafura Resources Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. When Arafura Resources last reported its balance sheet in December 2020, it had zero debt and cash worth AU$16m. Looking at the last year, the company burnt through AU$14m. That means it had a cash runway of around 14 months as of December 2020. That's not too bad, but it's fair to say the end of the cash runway is in sight, unless cash burn reduces drastically. Depicted below, you can see how its cash holdings have changed over time.

How Is Arafura Resources' Cash Burn Changing Over Time?

Because Arafura Resources isn't currently generating revenue, we consider it an early-stage 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 15%, 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. We prefer most of the stocks on this list of stocks that analysts expect to grow.

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

While Arafura Resources 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. 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. 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.

Since it has a market capitalisation of AU$193m, Arafura Resources' AU$14m in cash burn equates to about 7.1% of its market value. 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?

Even though its increasing cash burn 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. Cash burning companies are always on the riskier side of things, but after considering all of the factors discussed in this short piece, we're not too worried about its rate of cash burn. Separately, we looked at different risks affecting the company and spotted 3 warning signs for Arafura Resources (of which 1 can't be ignored!) you should know about.

Of course Arafura Resources may not be the best stock to buy. So you may wish to see this free collection of companies boasting high return on equity, or this list of stocks that insiders are buying.

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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.
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