We initiate a buy recommendation of Canadian small cap producer Birchcliff Energy Ltd. (OTCPK:BIREF) for rapidly growing natural gas production in the Montney/Doig unconventional shale gas/tight gas formation in northwest Alberta. Anticipating production from probable reserves in addition to proven quantities, we see unlevered appreciation potential of 41% in Birchcliff stock to a McDep Ratio of 1.0 where stock price would equal Net Present Value of US$14 a share, up from US$11. Seeing a month of successful operation in the first phase of expansion of a processing plant completed at the end of the first quarter, we estimate unlevered cash flow for the next twelve months of US$127 million (C$129 million), up 25% from three months ago. The estimate includes a further 24% volume gain in the first quarter of 2011 from a second phase of processing expansion. At the same time, we change our estimate of adjusted reserve life index to include probable reserves as estimated by an independent engineer. Higher initial cash flow and longer life with its required additional investment support NPV.
Strategic advantages include high working interests, operating control and contiguous lands in a concentrated geographic area. Volatility in stock price warns of higher risk in Birchcliff stock. Yet, we are attracted to the opportunity as we see new investor interest in small cap oil and gas stocks. Contributing factors may include higher spill risk in deep water oil, a possible turn in natural gas pricing ahead, the decline of the euro and weakening confidence in currency-denominated savings.
Originally published on May 13, 2010.