Should You Wait Before Investing In Africa Oil Corp (TSX:AOI)?

Africa Oil Corp (TSX:AOI) continues its loss-making streak, announcing negative earnings for its latest financial year ending. A crucial question to bear in mind when you’re an investor of an unprofitable business, is whether the company will have to raise more capital in the near future. This is because new equity from additional capital raising can thin out the value of current shareholders’ stake in the company. Given that AOI is spending more money than it earns, it will need to fund its expenses via external sources of capital. AOI may need to come to market again, but the question is, when? Below, I’ve analysed the most recent financial data to help answer this question. Check out our latest analysis for Africa Oil

What is cash burn?

AOI currently has $436.86M in the bank, with negative cash flows from operations of -$2.35M. Since it is spending more money than it makes, the business is “burning” through its cash to run its day-to-day operations. The measure of how fast AOI goes through its cash reserves over time is called the cash burn rate. The most significant threat facing AOI’s investor is the company going out of business when it runs out of money and cannot raise any more capital. Not surprisingly, it is more common to find unprofitable companies in the high-risk energy industry. The activities of these companies tend to be project-driven, which generates lumpy cash flows, meaning the business can be loss-making for a period of time while it invests heavily in a new project.

TSX:AOI Income Statement Oct 24th 17
TSX:AOI Income Statement Oct 24th 17

When will AOI need to raise more cash?

AOI has to pay its employees and other necessities such as rent and admin costs in order to keep its business running. These costs are called operational expenses, which is sometimes shortened to opex. In AOI’s case, its opex fell by 14.15% last year, which may signal the company moving towards a more sustainable level of expenses. If the company does not increase its opex next year and remains at the current level of $7.1M, then it should not need to raise further capital for the next few years. Although this is a relatively simplistic calculation, and AOI may continue to reduce its costs further or raise debt capital instead of coming to equity markets, the outcome of this analysis still gives us an idea of the company’s timeline and when things will have to start changing, since its current operation is unsustainable.

What this means for you:

Are you a shareholder? If AOI makes up a reasonable portion of your portfolio, it’s always wise to consider cushioning your holdings with less risky, profitable stocks. The outcome of this analysis should shed some light on AOI’s cash situation and the risks you may or may not have been aware of as a shareholder of the company. Keep in mind that opex is only one side of the coin. I recommend also looking at AOI’s revenues in order to forecast when the company will become breakeven and start producing profits for shareholders.

Are you a potential investor? This analysis isn’t meant to deter you from buying AOI, but rather, to help you better understand the risks involved investing in loss-making companies. The outcome of my analysis suggests that even if AOI maintains this negative rate of opex growth, it will run out of cash within the year. The potential equity raising resulting from this means you could potentially get a better deal on the share price when the company raises capital next.

An experienced management team on the helm increases our confidence in the business – have a peek at AOI’s CEO experience and the tenure of the board here. If risky loss-making stocks do not appeal to you, see my list of highly profitable companies to add to your portfolio..

NB: Figures in this article are calculated using data from the last twelve months, which refer to the 12-month period ending on the last date of the month the financial statement is dated. This may not be consistent with full year annual report figures. Operating expenses include only SG&A and one-year R&D.