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Is Pensana Rare Earths (ASX:PM8) In A Good Position To Invest In Growth?

We can readily understand why investors are attracted to unprofitable companies. Indeed, Pensana Rare Earths (ASX:PM8) stock is up 427% in the last year, providing strong gains for shareholders. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

So notwithstanding the buoyant share price, we think it's well worth asking whether Pensana Rare Earths'cash burn is too risky For the purposes of this article, cash burn is the annual rate at which an unprofitable company spends cash to fund its growth; its negative free cash flow. The first step is to compare its cash burn with its cash reserves, to give us its 'cash runway'.

See our latest analysis for Pensana Rare Earths

When Might Pensana Rare Earths Run Out Of Money?

A company's cash runway is the amount of time it would take to burn through its cash reserves at its current cash burn rate. In June 2020, Pensana Rare Earths had US$4.1m in cash, and was debt-free. Looking at the last year, the company burnt through US$5.3m. Therefore, from June 2020 it had roughly 9 months of cash runway. 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. The image below shows how its cash balance has been changing over the last few years.

debt-equity-history-analysis
debt-equity-history-analysis

How Is Pensana Rare Earths' Cash Burn Changing Over Time?

Because Pensana Rare Earths isn't currently generating revenue, we consider it an early-stage 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 48%, 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. Pensana Rare Earths 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.

How Easily Can Pensana Rare Earths Raise Cash?

Since its cash burn is moving in the wrong direction, Pensana Rare Earths shareholders may wish to think 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. Many companies end up issuing new shares to fund future 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.

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Since it has a market capitalisation of US$163m, Pensana Rare Earths' US$5.3m in cash burn equates to about 3.3% 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.

How Risky Is Pensana Rare Earths' Cash Burn Situation?

Even though its cash runway makes us a little nervous, we are compelled to mention that we thought Pensana Rare Earths' 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 Pensana Rare Earths (of which 2 make us uncomfortable!) you should know about.

Of course, you might find a fantastic investment by looking elsewhere. So take a peek at this free list of companies insiders are buying, and this list of stocks growth stocks (according to analyst forecasts)

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.