Birchcliff Energy: For The Long Term – Birchcliff Energy Ltd. (OTCMKTS:BIREF)


Despite the lowest production volume since Q3 2017, Birchcliff Energy (OTCPK:BIREF) reported a record high adjusted funds flow during Q1 2019. The performance is due to one-time events and higher liquids production.

Besides the short-term results, the increasing liquids production will support strong netbacks. Also, management confirmed the guidance and the free cash potential above C$100 million in 2019.

But, in this article, I describe why investing in Birchcliff isn’t about its free cash flow potential over the short term. In the current Canadian oil and gas environment, the market offers much better free cash flow yield opportunities. Due to its important assets, the company is rather an interesting investment case in the scope of long-term improvement in oil and gas prices.

Birchcliff Energy production map

Image source: Birchcliff Energy

Note: All the numbers in the article are in Canadian dollars unless otherwise noted.

Drivers for higher realized prices

During Q1, Birchcliff reported its lowest production volume since Q3 2017 with 74,887 boe/d. The 2% production decline year over year is due to the timing of the capital program. Management’s goal is still to hold production flat for the full year.

Birchcliff Energy Q1 earnings: production

Source: Q1 2019 MD&A

But, thanks to higher realized gas prices and increased liquids production, adjusted funds flow reached an all-time high at C$116.6 million.

Liquids represented 21% of the total production against 17% the year before. The company is focusing on liquid-rich areas due to the higher netback potential.

Birchcliff Energy Q1 earnings: liquids and gas portions

Source: Q1 2019 MD&A

Yet, as gas production still represents 79% of the total production, gas prices are still an important revenue driver for the company. And the strong result this quarter is due to higher realized gas prices.

Birchcliff Energy Q1 earnings: realized prices

Source: Q1 2019 MD&A

As shown in the table above, the increase in realized prices contrasts with the drop in liquids prices compared to last year. And, despite the lower per-unit revenue from liquids, the total average per-unit revenue increased, thanks to the 31% increase in gas prices.

Marketing diversification to the Dawn hub, with an average realized price of C$5.06/mcfe, was a strong contributor to the higher total realized gas prices.

Birchcliff Energy Q1 earnings: gas prices

Source: Q1 2019 MD&A

But the realized gas prices don’t reflect the benchmark prices. As shown below, benchmark prices at the Dawn hub were US$2.91/MMBtu (equivalent to approximately C$3.77/mcfe) during Q1.

Birchcliff Energy Q1 earnings: benchmark prices

Source: Q1 2019 MD&A

The higher realized prices at the Dawn hub were due to a physical delivery sales contract for 50,000 MMBtu/d at an average contract price of US$5.05/MMBtu (equivalent to C$6.55/mcf). This boost was temporary as the company doesn’t have such a contract beyond Q1.

Also, a realized gain on financial instruments contributed to the higher revenue. The company has an original hedging strategy compared to its peers.

Birchcliff hedges its exposure to U.S. gas prices with long-term AECO/NYMEX differential contracts. The table below lists the contracts the company owned during Q1.

Birchcliff Energy Q1 earnings: hedges

Source: Q1 2019 MD&A

Management continues with this strategy as it entered the following contracts after the end of Q1:

Birchcliff Energy Q1 earnings: hedges after Q1

Source: Q1 2019 MD&A

Trading some of these contracts provided a nice revenue boost during this quarter. But I’m not a big fan of trading hedging contracts. For a Canadian producer exposed to volatile oil and gas prices, hedges are better used to protect cash flow over the long term via an automatic hedging program.

In any case, with the marketing diversification and hedges, 87% of the total expected revenue in 2019 is exposed to non-AECO benchmark prices.

Over the medium term and beyond, higher realized prices will come from the increase in liquids production as a percentage of the total production. Management is taking initiatives to increase condensate production:

“Due to increased condensate volumes from Pouce Coupe, Birchcliff has committed to the construction of a 20,000 bbls/d inlet liquids-handling facility at its Pouce Coupe Gas Plant which will give Birchcliff the ability to grow its condensate production in Pouce Coupe from 3,000 to 10,000 bbls/d. During Q1 2019, Birchcliff completed the frontend engineering for this facility and it is anticipated that it will be brought online in Q3 2020. Birchcliff plans on spending approximately $9.5 million on the associated engineering and long-lead equipment for this facility in 2019.” – Source: Q1 2019 MD&A

Investment with a long-term perspective

As management plans to hold production flat, valuing the company based on free cash flow generated while sustaining the production is convenient.

Based on reasonable price assumptions listed below, management expects to generate C$330 million of adjusted funds flow in 2019.

Birchcliff Energy 2019 guidance: price assumptionsSource: Q1 2019 MD&A

In my previous article, I provided the details of my sustaining capex estimate of C$225 million.

Thus, I expect the company to generate about C$105 million of free cash flow in 2019 while holding production flat.

With a share price at C$3.87, the corresponding free cash flow yield is 9.4%. The valuation is attractive, but the market offers better opportunities in the Canadian oil and gas industry. For instance, Crescent Point’s (CPG) and Peyto’s (OTCPK:OTCPK:PEYUF) valuations correspond to a 20% free cash flow yield (I wrote about their respective valuations here and here).

Despite the interesting free cash flow yield, Birchcliff isn’t the most attractive investment proposition in the Canadian oil and gas industry.

Let’s now compare Birchcliff Energy to Arc Resources (OTCPK:OTCPK:AETUF) and Tourmaline (OTCPK:OTCPK:TRMLF). These three producers operate a similar production mix.

Birchcliff Energy Q1: production mix compared with Tourmaline and Arc Resources

Source: Author, based on company reports

The table below shows that Tourmaline generated higher netbacks before hedges during Q1. Due to its scale and its lower debt ratios, Tourmaline operates at lower costs.

Birchcliff Energy Q1 earnings: costs and netbacks

Source: Author, based on company reports

Yet, based on the midpoint of the forecasted 2019 production, flowing barrel valuations for Birchcliff and Tourmaline are similar.

Birchcliff Energy Q1 earnings: flowing barrel valuation compared with Tourmaline and Arc Resources

Source: Author, based on company reports

Also, Birchcliff Energy is less flexible due to its higher level of debt. While Tourmaline keeps on growing its production, Birchcliff stopped growing its production to wait for better oil and gas prices.

Also, with a net debt to TTM funds flow ratio close to 1x, Tourmaline and Arc Resources have the extra option of acquiring cheap assets in a depressed environment.

Birchcliff Energy Q1 earnings: debt ratios compared to Arc Resources and Tourmaline

Source: Author, based on company reports

Birchcliff owns vast assets, though. Based on the 2018 reserves report and the midpoint of the 2019 estimated production, 2P reserves represent more than 35 years of production.

Birchcliff Energy: reserves ratios compared to Arc Resources and Tourmaline

Source: Author, based on company reports

But, by pausing production growth, management delayed the realization of the value of the assets with the perspective of higher oil and gas prices.

Thus, investing in Birchcliff isn’t about the current free cash flow yield potential. Due to its important reserves, investing in the company is a bet on the long-term improvement of the Canadian oil and gas prices. In the meantime, the company can sustain its production and generate free cash flow for many years.

Conclusion

With its Q1 results, Birchcliff Energy confirmed its strong free cash flow potential. Besides the boost from one-time events during Q1 and the increase of liquids production will support higher netbacks.

Also, management confirmed the goal of exceeding C$100 million of free cash flow while holding production flat.

Yet, the 9.4% free cash flow yield isn’t as attractive as the 20% yield the market is offering with some other Canadian producers.

But the company owns vast assets and has the potential to generate free cash flow over many years at current prices. Thus, investing in the company is an interesting proposition in the perspective of higher Canadian oil and gas prices over the long term.

Note: If you enjoyed this article and wish to receive updates on my latest research, click “Follow” next to my name at the top of this article.

Disclosure: I am/we are long CPG, PEYUF. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.





Source link