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We're Not Very Worried About Reconnaissance Energy Africa's (CVE:RECO) Cash Burn Rate

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  • RECAF

There's no doubt that money can be made by owning shares of unprofitable businesses. For example, Reconnaissance Energy Africa (CVE:RECO) shareholders have done very well over the last year, with the share price soaring by 557%. Nonetheless, only a fool would ignore the risk that a loss making company burns through its cash too quickly.

Given its strong share price performance, we think it's worthwhile for Reconnaissance Energy Africa shareholders to consider whether its cash burn is concerning. 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'.

See our latest analysis for Reconnaissance Energy Africa

How Long Is Reconnaissance Energy Africa's Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. As at September 2020, Reconnaissance Energy Africa had cash of CA$18m and such minimal debt that we can ignore it for the purposes of this analysis. Importantly, its cash burn was CA$11m over the trailing twelve months. So it had a cash runway of approximately 21 months from September 2020. While that cash runway isn't too concerning, sensible holders would be peering into the distance, and considering what happens if the company runs out of cash. 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 Reconnaissance Energy Africa's Cash Burn Changing Over Time?

Because Reconnaissance Energy Africa 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. Remarkably, it actually increased its cash burn by 1,273% in the last year. With that kind of spending growth its cash runway will shorten quickly, as it simultaneously uses its cash while increasing the burn rate. Reconnaissance Energy Africa 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 Reconnaissance Energy Africa Raise Cash?

Given its cash burn trajectory, Reconnaissance Energy Africa shareholders may wish to consider how easily it could raise more cash, despite its solid cash runway. 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. 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 CA$477m, Reconnaissance Energy Africa's CA$11m in cash burn equates to about 2.2% of its market value. That means it could easily issue a few shares to fund more growth, and might well be in a position to borrow cheaply.

So, Should We Worry About Reconnaissance Energy Africa's Cash Burn?

Even though its increasing cash burn makes us a little nervous, we are compelled to mention that we thought Reconnaissance Energy Africa's 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. On another note, Reconnaissance Energy Africa has 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

Of course Reconnaissance Energy Africa 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.

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 (at) simplywallst.com.