OPEC expects the world oil demand to increase by 2.32 million bpd this year. Moreover, Chinese oil demand is increasing due to the relaxation of the country’s COVID-19 curbs. OPEC expects Chinese oil demand to grow by 710,000 bpd in 2023, up from last month’s forecast of 590,000 bpd.

Despite the promising growth potential of the energy sector, Reconnaissance Energy Africa Ltd. (RECAF) is lagging behind. In this article, I will explore the industry’s prospects and the possible reasons behind RECAF’s underperformance.

On April 2, 2023, OPEC+ and Saudi Arabia made a surprising announcement that they would cut oil production by roughly 1.16 million barrels per day. As per Reuters’ calculations, this brings the total volume of oil cuts made by OPEC+ to 3.66 million barrels per day, which is approximately 3.7% of the global demand.

Amrita Sen, founder and director of Energy Aspects, said, “OPEC is taking pre-emptive steps in case of any possible demand reduction.”

However, the number of U.S. oil and gas rigs fell last week, according to a Baker Hughes report, indicating that U.S. production is not expected to increase in the near term, which should support more price hikes ahead.

Furthermore, despite the economic uncertainty and geopolitical risks, the energy industry has managed to maintain a relatively positive performance. The Energy Select Sector SPDR Fund (XLE) has gained 6.9% over the past year, outperforming the broader SPDR S&P 500 ETF Trust’s (SPY) 8.9% decline over the same period.

Headquartered in Vancouver, Canada, RECAF is a junior oil and gas company that explores and develops oil and gas potential in Namibia and Botswana.

The stock has declined 76.4% over the past year to close the last trading session at $1.07. It has declined 21.3% over the past month and 69.8% over the past six months. Its 24-month beta of 1.40 indicates the stock is relatively more volatile than the overall market.

Here’s what could shape RECAF’s performance in the near term:

Weak Financials

During the fiscal year that ended December 31, 2022, RECAF’s revenue declined 15.9% year-over-year to CAD5.52 million ($4.08 million). Its general and administration expenses rose 17.1% year-over-year to CAD5.25 million ($3.88 million).

Also, net loss rose 22.1% year-over-year to CAD14.62 million ($10.82 million), while its loss per common share grew 16.7% from the prior-year quarter to CAD0.07.

Poor Profitability

RECAF’s trailing-12-month gross profit margin of 13.32% is 70.7% lower than the industry average of 45.41%. Its trailing-12-month asset turnover ratio of 0.03x is 95.2% lower than the 0.67x industry average.

Additionally, its trailing-12-month negative ROCE, ROTC, and ROTA of 57.98%, 28.73%, and 27.46% are remarkably lower than the industry averages of 21.44%, 9.91%, and 7.09%, respectively.

Stretched Valuations

RECAF’s trailing-12-month P/S multiple of 55.47x is significantly higher than the industry average of 1.17x. Its trailing-12-month EV/Sales multiple of 48.22x is also higher than the industry average of 1.67x, while its trailing-12-month Price/Book of 3.05x is 93% higher than the industry average of 1.58x.

POWR Ratings Reflect Bleak Outlook

RECAF has an overall rating of F, translating to a Strong Sell in our proprietary POWR Ratings system. The POWR Ratings are calculated considering 118 distinct factors, with each factor weighted to an optimal degree.

Our proprietary rating system also evaluates each stock based on eight distinct categories. The stock has an F grade for Value and Quality, consistent with its premium valuation and lower-than-industry profitability.

RECAF is ranked last in the 42-stock Foreign Oil & Gas industry.

Click here to access RECAF’s Growth, Momentum, Stability, and Sentiment grades.

Bottom Line

RECAF’s poor financials, weak profitability, and high valuations could be the reasons for its underperformance in the near term.

While the energy industry is poised to thrive this year, RECAF is currently trading below its 50-day and 200-day moving averages of $1.24 and $2.26, indicating a downtrend. The stock’s sustained downtrend and high beta suggests it may be a risky investment now. So, it might be ideal to avoid the stock.

Stocks to Consider Instead of Reconnaissance Energy Africa Ltd. (RECAF)

Unfortunately, the odds of RECAF outperforming in the weeks and months ahead are greatly compromised. However, there are many good stocks in the Foreign Oil and Gas industry with impressive POWR Ratings. So, consider these three A-rated (Strong Buy) stocks instead:

GeoPark Ltd. (GPRK)

Santos Limited (SSLZY)

Petroneft Resources PLC (PTR).

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RECAF shares were unchanged in premarket trading Monday. Year-to-date, RECAF has gained 12.63%, versus a 7.41% rise in the benchmark S&P 500 index during the same period.

About the Author: Kritika Sarmah

Her interest in risky instruments and passion for writing made Kritika an analyst and financial journalist. She earned her bachelor's degree in commerce and is currently pursuing the CFA program. With her fundamental approach, she aims to help investors identify untapped investment opportunities. More...

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