Up from depressed levels, Canadian producer Birchcliff Energy (OTCPK:BIREF), hold-rated Berry Petroleum (BRY), hold-rated Encore Acquisition (NASDAQ:EAC) and buy-recommended Cimarex Energy (NYSE:XEC) are getting some momentum going in the stock market. Birchcliff and Berry are trading above the 50-day average stock price while Encore and Cimarex are trading at narrowing discounts to the 50-day average.
A recent price trend reversal for oil and possibly for natural gas is especially welcome as each of the companies is actively developing new energy supply. Cimarex offers low financial risk and strong natural gas appreciation potential. Encore has moderate financial risk and Berry higher financial risk while both hold undervalued long-life oil reserves. Birchcliff has built an extensive inventory of undeveloped natural gas acreage in Alberta that may ultimately be attractive to a larger company.
We discuss the investment appeal of the four stocks using the framework of our weekly valuation tables. With BIR’s release on March 19, we have 2008 reserves and operating performance for each company that we use to make updated estimates of cash flow and to confirm Net Present Value (NPV).
Cimarex has Lowest Financial Risk
We use both a market sensitive measure of financial risk and our own estimate related to present Value. On the market sensitive measure, Enterprise Value (EV)/Market Cap, both Cimarex and Birchcliff have moderate leverage. On our own estimate, Debt/Present Value, the same two stocks have moderate leverage.
Normally, leverage simply magnifies the gains and setbacks. We neutralize for that effect by recommending that portfolio weights be judged by Enterprise Value rather than by Market Cap. On EV, Berry is twice the size of Birchcliff. Yet on Market Cap, Berry is half the size of Birchcliff. Since most investors readily know the Market Cap of portfolio positions, we suggest multiplying Market Cap times the ratio EV/Market Cap to get Enterprise Value.
Berry Overcomes Nonlinear Risk
When debt gets too high, a company may incur risk beyond normal leverage. That has happened for Berry as its last acquisition proved in hindsight not to be well timed. As a result, the company has recently sold other property for less than normal value in order to apply the proceeds to reduce debt. In its 100-year history, the company has survived other volatile periods only to rebound and advance to new highs on the strength of its valuable, long-life oil reserves. We are optimistic the stock can do that again.
Cimarex and Birchcliff are Natural Gas Oriented
We want to overweight natural gas on a long term basis because consumption of the clean fuel is growing faster globally than refined products from crude oil. Because our large cap buy recommendations are usually more concentrated on oil, we look for natural gas where we can find it including among income and small cap stocks. Natural gas concentration is an important reason for our buy emphasis on Cimarex. Natural gas also makes Birchcliff more unusual among Canadian stocks because Canada’s largest growth potential is in oil sands.
Cimarex has Lowest McDep Ratio
Summarizing our valuation analysis, the McDep Ratio may be the most important number in our tables. The ratios are unusually low for most of the stocks. Cimarex’s McDep Ratio of 0.46 implies unlevered appreciation, or appreciation in Enterprise Value, of 117% to a McDep Ratio of 1.0. The single most important number behind the McDep Ratio is Net Present Value (NPV). The McDep Ratio essentially converts the levered value comparison of stock price to NPV to an unlevered measure independent of the amount of debt a company may be obligated to repay. Estimated NPV normally changes only when we change our estimates of long-term oil and natural gas prices. During the turmoil in the stock market and rapidly changing near-term cash flow expectations, the steady NPV estimates help us keep perspective.
Encore and Berry have Long-Life Reserves
The ratio of Adjusted Reserves/Production credits both Encore and Berry with long, twelve year life index. Unlevered cash flow multiple, PV/Ebitda or EV/Ebitda, tends to vary with reserve life. A higher estimated PV for Berry’s long life than for Encore’s shows up in a higher unlevered multiple, PV/Ebitda. We would justify that in part to a delay in the realizing of unproven potential in Encore’s largest field as it shifts its tertiary recovery focus to carbon dioxide injection from high pressure air that did not work as well as hoped. Yet, the market unlevered multiple is nearly the same for the two stocks.
Birchcliff has Resource Upside
Birchcliff’s major unproven potential in the Montney/Doig natural gas formation contributes to the higher multiple for our estimate (PV/Ebitda) and to the higher multiple for current market (EV/Ebitda). Unproven potential accounts for about 42% of Present Value. In a bull market, uproven values can be a source of great appreciation while in a bear market unproven values may be difficult to realize as the volatility in Birchcliff stock has demonstrated.
Originally published on March 20, 2009.