Companies Like Reconnaissance Energy Africa (CVE:RECO) Are In A Position To Invest In Growth

Even when a business is losing money, it's possible for shareholders to make money if they buy a good business at the right price. Indeed, Reconnaissance Energy Africa (CVE:RECO) stock is up 503% in the last year, providing strong gains for shareholders. Having said that, unprofitable companies are risky because they could potentially burn through all their cash and become distressed.

In light of its strong share price run, we think now is a good time to investigate how risky Reconnaissance Energy Africa's cash burn is. 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'.

Check out our latest analysis for Reconnaissance Energy Africa

Does Reconnaissance Energy Africa Have A Long Cash Runway?

A company's cash runway is calculated by dividing its cash hoard by its cash burn. Reconnaissance Energy Africa has such a small amount of debt that we'll set it aside, and focus on the CA$18m in cash it held at September 2020. Importantly, its cash burn was CA$11m over the trailing twelve months. Therefore, from September 2020 it had roughly 21 months 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. You can see how its cash balance has changed over time in the image below.

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. Admittedly, we're a bit cautious of Reconnaissance Energy Africa due to its lack of significant operating revenues. So we'd generally prefer stocks from this list of stocks that have analysts forecasting growth.

How Easily Can Reconnaissance Energy Africa Raise Cash?

While Reconnaissance Energy Africa 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. Issuing new shares, or taking on debt, are the most common ways for a listed company to raise more money for its business. One of the main advantages held by publicly listed companies is that they can sell shares to investors to raise cash and fund growth. By looking at a company's cash burn relative to its market capitalisation, we gain insight on how much shareholders would be diluted if the company needed to raise enough cash to cover another year's cash burn.

Since it has a market capitalisation of CA$458m, Reconnaissance Energy Africa's CA$11m in cash burn equates to about 2.3% of its market value. So it could almost certainly just borrow a little to fund another year's growth, or else easily raise the cash by issuing a few shares.

Is Reconnaissance Energy Africa's Cash Burn A Worry?

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. Taking a deeper dive, we've spotted 2 warning signs for Reconnaissance Energy Africa you should be aware of, and 1 of them is a bit unpleasant.

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

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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.
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