Birchcliff Energy Is Taking Advantage Of The Multi-Year High Gas Price

Summary

• Birchcliff is a natural gas producer in Canada and is taking advantage of the strong gas price to rapidly reduce its net debt.
• The company remains on track to generate about C$1.5/share in free cash flow in 2022 based on the official guidance.
• Even if the realized gas price would be 20% lower, Birchcliff Energy would still be attractively priced.
• I only own the preferred shares for now, but if the outlook for natural gas remains strong, I should also go long the common shares.
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Introduction

Birchcliff Energy (OTCPK:BIREF) is one of my favorite Canadian natural gas producers. In an article published in April, I commented the company appeared to be trading at just 4 times the free funds flow for 2023, and just a few months later, when the natural gas price in Canada had indeed increased, the cash flow started to pour in, allowing Birchcliff to reduce its net debt much faster than it had anticipated.

Data by YCharts

Birchcliff has its primary listing in Canada where it's trading with BIR as its ticker symbol. The average daily volume on the Toronto Stock Exchange is approximately 1.6 million shares per day, so the TSX clearly is the most liquid trading venue. I will use the Canadian Dollar as base currency in this article as Birchcliff also reports its financial results in Canadian Dollar.

The debt is decreasing much faster than anticipated

Just two years ago, Birchcliff was struggling a bit as the low natural gas price and the relatively high net debt position on the balance sheet meant there wasn't a whole lot of money available for shareholder rewards. 2021 was the turning point as - especially in the second half of the year - the average natural gas price was excellent. In the third quarter of the year, Birchcliff recorded an average realized sales price of C$4.46 per Mcf which was almost twice as high compared to the price generated in Q3 2020.

This means the company was able to continuously update its full-year guidance while it's exceeding its debt reduction schedule.

Source: company presentation

During the third quarter, the company produced an average of just under 85,000 barrels of oil-equivalent per day with about 80% of the total oil-equivalent production actually consisting of natural gas. As mentioned before, that gas was sold at a rather high average price, resulting in a total revenue of just over C$260M (that being said, although about 80% of the oil-equivalent output was natural gas, the revenue from gas sales represented less than 65% of the oil and gas sales).

Source: financial results

As you can see in the image above, the total reported revenue was C$321M, but this included an unrealized gain of about C$70M so we'll have to filter that out in the cash flow results to actually figure out the normalized underlying cash flows.

The total operating expenses were less than C$140M resulting in a pre-tax income of C$181M and a net income of just under C$140M representing an EPS of C$0.52. Again, this includes about C$68M of net gains on derivative instruments so the 'normalized' EPS would likely have come in about 30% lower. Which obviously still would have been a good result.

So those derivatives clearly have a major impact on the company's net income and that's another reason why I think we should also focus on the company's cash flow statement as the unrealized gains are filtered out of the equation there.

As you can see on the image below, the reported operating cash flow was C$155.6M but this includes about C$12.3M in investments in the working capital position while we should also deduct the C$0.6M in lease payments. This would result in an adjusted operating cash flow of approximately C$167M during the third quarter.

Source: financial results

We see the total capex was less than C$20M and that's obviously rather 'abnormal'. The third quarter was capex-light as Birchcliff has spent multiples of that amount in the first half of the year. So while the adjusted free cash flow was just under C$150M, let's be clear that's not what the 'normalized' situation would look like.

Birchcliff is guiding for a full-year capex of about C$225-230M which means the company will likely spend about C$30M in the final quarter of the year. More importantly, this allows us to calculate the average capex per quarter at about C$60M. So if we would deduct the normalized quarterly capex from the Q3 adjusted operating cash flow, the free cash flow would have been approximately C$107M or C$0.40/share. And that free cash flow was used to rapidly reduce the net debt as Birchcliff repaid about C$73M of its credit facility.

The initial outlook for 2022 looks strong

And it looks like Birchcliff anticipates 2022 to be even stronger than 2021. Based on the strip prices in November, the company was expecting to generate about C$650M in adjusted funds flow in 2022. As Birchcliff was guiding for a total capex of C$240-260M, the free cash flow in 2022 was anticipated to be approximately C$400M or roughly $1.5/share.

Birchcliff continues to focus on its balance sheet and the C$250M capex budget for 2022 does not include any efforts towards growth. Instead, BIR plans to keep the production level at 78-80,000 barrels of oil-equivalent per day. Of course, gas prices are changing on a daily basis and Birchcliff promised to provide a more detailed guidance on January 19th. I'll be looking forward to that update to see if Birchcliff is perhaps considering increasing its capex spending, and to see what the average gas price is the company will use in its base case scenario.

Source: company presentation

Investment thesis

Birchcliff Energy is taking advantage of the high gas price, and although the AECO gas price in Canada is currently trading just under C$4 which is lower than the average price received during Q3, I'm convinced Birchcliff will perform very well in 2022 at the current gas price. The free cash flow result will likely come in at around C$350M (I'm a bit more conservative than the company as I'm applying a discount to the strip prices) which would help to slash the net debt by about 60% compared to the level I'm expecting at the end of FY 2021.

I don't own the common shares of Birchcliff Resources, but I have a decent-sized position in the company's preferred shares A (OTCPK:BCHFP) which are paying about C$0.523 per share per quarter until September 2022 (I discussed both series of preferred shares in this article). My main fear is now that those preferred shares will be called by the company as it would only cost Birchcliff about C$50M to retire the A-series of the preferred shares. Considering that's just a fraction of the anticipated free cash flow to be generated in 2022, it would be a small effort for Birchcliff to retire the preferred shares.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of BCHFP either through stock ownership, options, or other derivatives. 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.