BIR - Seize the momenthttps://michaela34.substack.com/p/energy-investors-are-crying-the-blues?utm_source=profile&utm_medium=reader2
The sharp decline in fossil fuel prices this week had energy investors running for the exit doors, anticipating the trend to continue (as is likely as the economy slows in Europe, China and North America). My largest holding is Birchcliff Energy (BIR.TO) and I have to admit my original purchases were less than CDN$1.00 per share but I have added more all the way up to CDN$10 and today at less than CDN$7.00. At today’s commodity prices with 5% cost inflation and no changes in price, Birchcliff at 4 x EBITDA is barely worth the ~CDN$7.00 per share it is trading at. Here is my model of the company, a bit simplified but adequate. Based on a steady $280 million capital budget and the assumed 24% decline rate and CDN$12,000 per boe capital efficiency, the company can slowly increase output while paying its dividend and chipping way at the debt level which I think will be about CDN$ 290 million by year end. If commodity prices fall further, I expect to see both dividend and capital outlays fall.
So why buy a stock at CDN$7.00 more or less when traders are addicted to seeing prices soar and reaping capital gains? Because I don’t trade and I am happy to see dividend of about 10% as a more or less steady stream of income for other uses.
About a year ago, natural gas prices made it to the CDN$10 level for a few months. I don’t expect that to happen this winter, or at any particular time for that matter, but do think the start of LNG Canada, the expansion of LNG in United States, and the desperate need to keep houses heated during the next cold winter (whenever it comes, if every) have the potential to push natural gas prices higher and I like it that Birchcliff has no fixed price hedges. The above 5-year model is not proof of anything, it is more like a sensitivity analysis. But suppose natural gas prices in Canada do rise the CDN$10 level and stay there for a few years. Here is what Birchcliff would look like if that happened tomorrow (it won’t, and I don’t suggest it will). Again, sensitivity anlaysis. In that (albeit unlikely) scenario, Birchcliff would generate enough cash flow to pay its capital budget, fund its current dividend and accumulate CDN$4 billion in cash in five years, and at a 4 x EBITDA multiples have a trading value in the high $30’s. I kept every other assumption constant, which of course they are not and cannot be. Again, sensitivity analysis.
If natural gas prices fall below today’s levels and stay down for more than a few months, Birchcliff is likely to (and should) cut is dividend. A prolonged period of natural gas prices at $CDN2.25 a gigajoule and Birchcliff could fund its capital with a zero dividend and have a modest cash flow surplus. That is equivalent to a Henry Hub natural gas price of US$1.70 a gigajoule. Below that, capital spending would need to fall to keep from adding debt.
For what its is worth, management has budgeted for cash flow of $500 million next year, more than enough to pay the $0.80 per share dividend, fund capital expenditures and reduce debt. E&P company managers seem always to be bullish on commodity prices so I take management’s expectations with a grain of salt.
This article points out the obvious. Low cost producers like Birchcliff with little debt can ride out a prolonged stint of low commodity prices and generate substantial cash flows when prices are firm. In my opinion, the risk reward trade offs favour an investment in Birchcliff and for that reason I hold 150,000 shares.
I muse and often smile about the legion of energy investors who were promoting stock buybacks for the past two years. Maybe they will work out but so far it looks like those who sold into the buybacks were on the right side of the trade.