Here's Why We're Not Too Worried About American Rare Earths' (ASX:ARR) Cash Burn Situation
We can readily understand why investors are attracted to unprofitable companies. For example, biotech and mining exploration companies often lose money for years before finding success with a new treatment or mineral discovery. But while history lauds those rare successes, those that fail are often forgotten; who remembers Pets.com?
So should American Rare Earths (ASX:ARR) shareholders be worried about its cash burn? 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). First, we'll determine its cash runway by comparing its cash burn with its cash reserves.
Check out our latest analysis for American Rare Earths
How Long Is American Rare Earths' 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. When American Rare Earths last reported its June 2024 balance sheet in September 2024, it had zero debt and cash worth AU$16m. Looking at the last year, the company burnt through AU$8.2m. Therefore, from June 2024 it had 2.0 years of cash runway. 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. The image below shows how its cash balance has been changing over the last few years.
How Is American Rare Earths' Cash Burn Changing Over Time?
Because American Rare Earths 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. With the cash burn rate up 19% in the last year, it seems that the company is ratcheting up investment in the business over time. However, the company's true cash runway will therefore be shorter than suggested above, if spending continues to increase. Admittedly, we're a bit cautious of American Rare Earths due to its lack of significant operating revenues. We prefer most of the stocks on this list of stocks that analysts expect to grow.
Can American Rare Earths Raise More Cash Easily?
While American Rare Earths 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. Companies can raise capital through either debt or equity. Many companies end up issuing new shares to fund future 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).
Since it has a market capitalisation of AU$146m, American Rare Earths' AU$8.2m in cash burn equates to about 5.6% of its market value. 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.
How Risky Is American Rare Earths' Cash Burn Situation?
Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought American Rare Earths' cash burn relative to its market cap was relatively promising. 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, American Rare Earths has 3 warning signs (and 2 which are a bit concerning) we think you should know about.
Of course American Rare Earths 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 with high insider ownership.
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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.