Cheap Leveraged Upside on Potential Major Oil Discovery

On December 3, Reconnaissance Energy Africa Ltd. (RECO.V) (RECAF) shot up 38% from $0.48 to $0.66 in Canada upon the announcement of results on its Kavango West 1X well in Namibia. According to the press release: "Extensive wireline logging indicates ~85 metres (~280 feet) of net reservoir with 64 metres (210 feet) of net hydrocarbon pay across a gross interval of ~400 metres (~1,300 feet) containing multiple limestone reservoir units." 

The stock gained further momentum on Monday on excitement over the production test that is to come in Q1. It rose 11% to close at a day high of $0.72. We think RECO could head over $1.00 in anticipation of that test, which leads to a lucrative opportunity for traders. 

RECO has publicly traded warrants under the symbol RECO.WT.A that can be exercised for one share at $0.60 until June 17, 2027. These warrants closed on Monday at $0.21, leaving just $0.09 of time value on them for 1.5 years of leveraged upside. From here on in, the warrants are going to move up essentially penny-for-penny with the stock. If the stock was to move up another 39% to $1.00, these warrants would intrinsically be worth $0.40 and likely be a double from here with a couple more cents in time value remaining. 

Options on a similar type of oil stock typically have an implied volatility of around 90%. Applying the same implied volatility to RECO.WT.A results in a fair value of $0.35 for the warrants. This is reflected in the leveraging opportunity of the warrants. Should RECO reach the $4.40 target as outlined by Research Capital by June 2027, a six times upside on the stock, the warrants would be worth $3.80, nearly 20 times upside from today's price.

To drive home how undervalued these warrants are, RECO has another set of warrants under the symbol RECO.WT.B that expire on September 29, 2027 with a strike price of $0.72. Those warrants closed at $0.20, despite having a strike price that is $0.12 higher. Considering that the expiries are 18 and 21 months away, respectively, we don't think that offsets the $0.12 higher strike price. RECO.WT.A should be several cents higher than RECO.WT.B.

RECO has a third set of warrants under the symbol RECO.WT that closed at $0.08 on Monday. These warrants have much poorer terms with an expiry at the end of July 2026 at a $1.75 strike price. Those warrants actually appear to be correctly priced as the implied volatility on them is 110%. People are buying at $0.08 with a Hail Mary shot that RECO will triple or more in the next several months. That is a reasonable gamble, although not one that we would take. Compare this to RECO.WT.A. RECO could double in the next several months and RECO.WT would be worthless. But RECO.WT.A would be worth $0.84. That's the kind of bet that makes sense in our eyes. 

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Disclosure: We are long RECO.WT.A