CA - Reconnaissance Energy: A New CEO To Support Search For Hydrocarbons Buy

2023-08-09 21:12:01 ET

Summary

• Reconnaissance Energy Africa released its financial results for the 15 months ending on March 31, 2023, reporting net revenues of $6.2M.
• The company's stock price is currently trading at $1.3/share, up 41% year-to-date but down 62% over the past 52 weeks.
• ReconAfrica appointed a new CEO, who has over 35 years of experience in the oil and gas industry.
• The reserve report for the Damara Fold Belt shows 1,172 Bcf of risked gas net to ReconAfrica.

A few days ago, Reconnaissance Energy Africa ( RECAF ) (TSXV:RECO:CA), released its results for the 15 months ending on March 31 ^st , 2023, and made some relevant announcements, including the appointment of a new CEO.

In this article, I will provide a review of the financial results as well as of the reserve report published by Reconnaissance Energy Africa, also known as ReconAfrica, and I will explain my BUY recommendation.

Here is my previous article about ReconAfrica .

Stock price

The stock is currently trading at $1.14/share, equivalent to a market capitalization of $238 M, and it is up 41% year-to-date while it is down 62% over the past 52 weeks. Indeed, ReconAfrica is a stock that is quite volatile and whose value is mostly based on news and expectations of oil/gas discovery. After reaching a peak of $4.5/share in September 2022 (52-week maximum), the stock price declined up to $0.8/share in May 2023 (52-week minimum). However, in the last week, ReconAfrica was able to regain part of the lost value with a +44% rally from the beginning of July up to today, mostly supported by positive rumors.

Financial Results

ReconAfrica reported its results for a period of 15 months, covering FY2022 and Q1-2023, making a comparison with the previous year a bit difficult and not so significant. Financial documents published by ReconAfrica c an be found on SEDAR+ website (repository of financial filings for Canadian companies).

Net revenues for the 15 months were $6.2M, of which $32.6 M were revenues from the sale of hydrocarbon produced in Mexico while $26.4 were royalties.

Moving to the cost side, total operating expenses were $56 M with the following two largest items accounting for almost 90% of the total OpEx:

• G&A: during the 15 months that ended on March 31 ^st , 2023, G&A were $30 M, about 100% more than the previous year mostly due to the increase of corporate development expenses (+$2.1 M), staff and personnel (+$4 M) and professional fees (+$5.6 M).
• Share-based payment: as of March 31 ^st , ReconAfrica recorded $21.2 M of share-based payments vs $17.8 M of the previous year. The expected life of these shares is 5 years and the risk-free interest rate used in the Black-Scholes pricing model is 2.75%.

Looking at the income statement, one can notice the presence of $21 M of interest expenses despite ReconAfrica having no financial debt towards banks. The reason is that ReconAfrica has a royalty payable liability of $95 M that relates to the Chiapas fields in Mexico and that has been due since October 2019. However, ReconAfrica never paid the outstanding liability therefore increasing the interest to be paid and even exposing itself to potential fines from the Tax Authority of Mexico.

Net income was obviously negative at -$73M.

Cash flows and main risk

Cash flow from operations was negative at -$2.7 M and cash flow from investments was -$68 M mostly due to $50 M of investments in exploration activities and evaluation of assets. Cash flow from financing was positive, at +$47 M, since the company issued new shares to fund its operations. Net cash at the end of March 2023 was almost $39 M. However, it should be mentioned that ReconAfrica indicated that its revenues are not enough to regularly fund the exploration activities. In my opinion, this is the biggest risk to which ReconAfrica is currently exposed and any investor should be aware that the Company will have to find some other funding source, either with the issuance of new shares, loans from banks or by creating a JV with a partner.

Valuation

Providing a realistic target price or valuation forecast for a company like ReconAfrica is definitely not an easy game. Considering that almost all of its share value is based on market expectations of potential hydrocarbon discoveries, I believe that a DCF model would not be suitable. Rather, I think it might be more helpful to compare some KPI with ReconAfrica's peers. Particularly, I have chosen companies whose main business is the exploration of oil/gas and that have zero or limited production. Then, I looked at the EV/Sales multiple which is one of the few multiples that can be used for this type of companies since they almost all have negative net income and cash flows.

The result is that ReconAfrica has an EV/Sales that is almost twice the mean and median values for the selected peers. However, if we compare ReconAfrica with Touchstone Exploration, which has a similar market cap, the EV/Sales is more in line.

The difference between ReconAfrica and the other companies is that ReconAfrica is carrying out exploration activities in the Namibia/Botswana onshore area which no other company ever explored before. In addition, the first rumors and results seem to go in the direction of large hydrocarbon quantities available, thus making the stock more expensive than peers.

Operations update and catalysts

• Seismic : so far, ReconAfrica has carried out three different seismic operations (from 2021 to 2023). The first two seismic data programs were helpful in identifying some leads and in expanding ReconAfrica’s portfolio. The third one was needed to confirm the extension of the Karoo Rift Basin and to delineate a new play, the Damara Fold Belt. In order to have a better understanding of this play, ReconAfrica decided to carry out an Enhanced Full Tensor Gravity (eFTG) survey.
• eFTG : as anticipated in my previous article, ReconAfrica carried out two eFTG programs, covering respectively areas of 2,184 and 2,814 square kilometers. The second program was concluded in May 2023 and ReconAfrica is now interpreting the eFTG results that, together with the 2D seismic data, are expected to provide the company with a better understanding of the subsurface.
• Drilling : in the previous months, ReconAfrica has built an access road and drilling pad to drill the Wisdom 5-1 well that was supposed to be spud in December 2022. However, considering the liquidity constraint, the company took the decision to postpone the drilling operations until the results of the eFTG survey. The purpose is obviously to minimize the risk associated with the well drilling and to find the best location to drill the next well, likely in the Damara Fold Belt.
• Drilling permits : on July 4 ^th , 2023, ReconAfrica received the authorization to drill an additional 12 exploration wells from the Ministry of Environment, Forestry and Tourism.

Damara Fold Belt Reserve Report

On June 26 ^th , 2023, ReconAfrica released a reserve report focused on the Damara Fold Belt gas play that shows – as of March 31 ^st , 2023 - a net unrisked best estimate of natural gas reserves of 12,439 Bcf, decreasing to 1,172 Bcf if risked (risk factor ca 10%). The best estimate – carried out by Netherland, Sewell & Associates – shows quite a significant amount of gas that could potentially be recovered by ReconAfrica. At this point, it becomes clearer why the Company postponed the 5-2 Well that was supposed to be spud in December 2022: my guess is that ReconAfrica will shift its focus on the gas reserves of the Damara Fold Belt.

New CEO appointment

On August 1 ^st , 2023, ReconAfrica appointed Brian Reinsborough as the new CEO . With more than 35 years of experience in the oil and gas industry, Reinsborough worked for Mobil One, Warburg Pincus, Nexen and Venari Resources and was involved in significant oil discoveries in the US Gulf of Mexico such as Shenandoah and Appomattox.

The new CEO was also given ReconAfrica’s shares for a total value of $1 M.

Conclusion

Overall, I believe that ReconAfrica is going in the right direction and could be a BUY opportunity for risk-prone investors. Indeed, any possible upside in the stock price is clearly given by future potential hydrocarbon discoveries and, as mentioned at the beginning, the stock is, and will be, subject to strong volatility. The new drilling permits, the appointment of a new CEO and the Damara reserve report make me think that ReconAfrica will be able to overcome the potential liquidity constraint and carry out successful explorations.

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