Birchcliff Energy - What's Not To Like About Cheap Gas And A 9% Yield?

| About: Birchcliff Energy (BIREF)

Summary

Birchcliff Energy was almost profitable in 2015, despite not having a hedge book.

The operating cash flow remained pretty strong, and Birchcliff should be able to break even after reducing its capex once again.

I would recommend the company's preferred shares, which are yielding 9.15% right now.

Introduction

Back in 2015, I was already convinced about Birchcliff Energy's (OTCPK:BIREF) potential to survive the current situation on the oil and gas markets. Fortunately the company can benefit tremendously from its low-cost gas production.

BIR Chart

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Birchcliff has a more liquid listing in Canada where it's trading with BIR as its ticker symbol. The average daily volume is approximately 750,000 shares per day.

The operating cash flow in 2015 was very strong

The company produced an average of 39,000 barrels of oil-equivalent per day in 2015 but ended the year on a very strong note as Birchcliff said its year-end production rate was approximately 42,000 boe/day (with an average production of 40,500 boe/day in Q4 2015).

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Source: company presentation

Thanks to this excellent achievement, Birchcliff was able to keep the revenue loss acceptable at just 30% as the total revenue fell to almost C$306M ($230M). What's interesting is the fact Birchcliff didn't deem it necessary to record an impairment charge on the value of its assets, despite the low price for natural gas. That might be a bit surprising considering the vast majority of its competitors are using the Q4 2015 financial statements to clean up the balance sheet and to re-establish the value of the producing properties. Birchcliff didn't do so and whilst I can understand this move (the assets generated in excess of US$100M in operating cash flow in 2015), this doesn't mean an impairment charge can be excluded in the future.

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Source: financial statements

Quite surprisingly, Birchcliff was able to post a pre-tax profit but due to a higher tax bill, the bottom line was still showing a net loss of C$12.2M ($9M) or approximately US$0.085 per share. That's not bad, but I was also very interested in the company's cash flow statements to see how Birchcliff was able to cope with the lower gas price environment.

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Source: financial statements

Unfortunately the company didn't have any substantial hedges in place, but this results in 'pure' cash flows without any one-time benefits from reducing the hedge book. And I can't really be unhappy with what I saw on the CF statements. Yes, the Operating cash flow nosedived from C$299M ($222M) to C$160M (-47%) ($120M), but despite the horrible situation on the gas market, Birchcliff's ability to generate a triple digit operating cash flow is a very good achievement.

The 2016 capex has been cut once again, providing additional flexibility

Birchcliff's main (and only) priority is to bring its incoming and outgoing cash flow in balance, and even though the company previously guided to spend C$140M ($105M) on capital expenditures on its properties, it has now revealed an updated capital plan. According to the new numbers, Birchcliff thinks it can keep the production rate stable by spending just C$128M ($99M) on capital expenditures which is an additional cost saving of US$9M.

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Source: company presentation

That's an excellent achievement and this actually puts the company on track to aim for a break-even situation on the cash flow front, considering Birchcliff generated US$120M in operating cash flow last year. Of course, the gas price will remain decisive, but I do like the company's ability to cut the capital expenditures without seeing the total production rate slide (in fact, the official guidance is calling for a 3-5% increase in the company's gas production). This increased efficiency is caused by the fact the previously drilled wells seem to have a lower decline profile than originally expected:

'It is noteworthy that wells drilled in previous years continue to show lower than expected declines which bolsters our average production rates, but also gives us the ability to drill less wells and spend less capital to meet our previous guidance of modest growth.'

I argued in some previous articles the decline rates will very likely be decisive in which companies will remain standing in 12 or 24 months if the recovery of the oil and gas price is taking longer than originally expected.

In my previous article, I also hoped the company would call off the expansion plans at the PCS gas plant:

It will be very interesting to see what kind of capital investment plan Birchcliff has been preparing for 2016, and what it will do with the PCS gas plant, which was expected to see its throughput increase by 30% by the end of 2016. I think holding off on the expansion is the wisest decision, considering the IRR is just 22% at an AECO gas price of $2.5/GJ

As part of the reduced capital investment plan, Birchcliff has now effectively slowed down its expansion plans for the PCS plant:

Completion of the Phase V expansion of the PCS Gas Plant will be deferred and timed to the drilling of additional Montney/Doig horizontal natural gas wells beyond those contemplated by the 2016 Capital Program, which will be subject to future commodity prices.

Investment thesis

The excellent results also increase the appeal of the company's preferred stock, and even though I have no position in Birchcliff's common shares, I did buy some C-series of the company's preferred shares. Those preferred shares are currently trading at just 76.5% of the par value which increases the yield on investment to 9.15% and I think that's a very attractive investment proposal considering it does tick the 'acceptable risk/reward' box.

Should the natgas price recover slightly, Birchcliff should even be in a position to reduce its net debt, thereby strengthening its balance sheet. Throw in the total reserve life of almost 39 years (!!) on a proved plus probable basis (and 7 years on a proved developed producing basis), and I think Birchcliff might actually be an interesting acquisition target as well.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.

Additional disclosure: I have no position in Birchcliff's common shares, but have a long position in its preferred shares series C, and am considering taking a position in the preferred shares Series A.

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