There is no doubt that money can be made by owning shares of unprofitable companies. Indeed, Arafura Resources (ASX: ARU) grew 101% last year, delivering solid gains to shareholders. That said, unprofitable businesses are risky because they could potentially burn all their money and become in distress.
In light of the sharp rise in its share price, we believe the time has come to consider how risky Arafura Resources’ cash consumption is. In this article, we define cash consumption as its annual (negative) free cash flow, which is the amount of money a business spends each year to finance its growth. The first step is to compare its cash consumption with its cash reserves, to give us its “cash flow track”.
See our latest analysis of Arafura resources
Do Arafura resources have a long cash trail?
A company’s cash flow track is calculated by dividing its cash reserve by its cash consumption. When its balance sheet was last released in December 2020, Arafura Resources had no debt and cash worth AU $ 16 million. Looking at last year, the company burned A $ 14 million. This means he had a cash trail of about 14 months as of December 2020. It’s not that bad, but it’s fair to say that the end of the cash trail is in sight, unless consumption cash does not decrease drastically. Below you can see how its cash flow has evolved over time.
How does Arafura Resources’ cash consumption change over time?
Because Arafura Resources is not currently generating revenue, we consider it to be a start-up company. Nonetheless, we can still examine its cash consumption trajectory as part of our assessment of its cash consumption situation. Over the past year, its cash consumption has actually increased by 15%, which suggests that management is increasing its investments in future growth, but not too quickly. This is not necessarily a bad thing, but investors should be aware that it will shorten the cash trail. Arafura Resources is making us a little nervous due to its lack of substantial operating income. We prefer most of the stocks on this list of stocks that analysts expect to grow.
How difficult would Arafura’s resources be to raise more liquidity for growth?
While Arafura Resources has a strong cash trail, its cash-consuming trajectory may cause some shareholders to think ahead when the company may need to raise more cash. Generally speaking, a listed company can raise new liquidity by issuing shares or going into debt. Typically, a company will sell new stocks on its own to raise cash and drive growth. We can compare a company’s cash consumption to its market capitalization to get an idea of how many new shares a company would need to issue to fund its operations for a year.
Given that it has a market capitalization of A $ 193 million, Arafura Resources’ A $ 14 million of cash consumption is approximately 7.1% of its market value. Given that this is a rather small percentage, it would probably be very easy for the company to finance the growth of another year by issuing new shares to investors, or even taking out a loan.
So, should we be worried about Arafura Resources’ cash consumption?
Even though its growing consumption of cash makes us a little nervous, we are forced to mention that we thought Arafura Resources’ consumption of cash relative to its market capitalization was relatively promising. Businesses that burn money are always on the riskier side, but after taking into account all the factors covered in this short article, we’re not too concerned about its rate of cash consumption. Separately, we examined different risks affecting the business and identified 3 warning signs for Arafura Resources (of which 1 cannot be ignored!) you should know.
Of course Arafura Resources may not be the best stock to buy. Then you might want to see this free collection of companies offering a high return on equity, or that list of stocks bought by insiders.
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