Birchcliff: Another Insanely Cheap Canadian Energy Company

In a depressed market with a whack of opportunities, I find myself drawn to Canadian energy stocks more and more. I just can’t help it. The energy space is insanely cheap, barring a big decrease in oil.

That’s the 64,000 pound gorilla or elephant or whatever in the room, of course. Nobody can accurately predict the path of oil prices in the short-term, never mind the long-term. It’s a complex market that can be turned on a dime by the whims of some prince in Saudi Arabia. And even if the overall trend is still up — or flat — the sector’s daily gyrations are more than enough to scare off most conservative investors.

Add in other factors like a possible recession squashing demand, a peaceful resolution to the Russia/Ukraine situation, and a multitude of cheap stocks that aren’t linked to a volatile commodity, and it’s easy to see why most investors are still nervous about the sector. In fact, it’ll likely take years of sustained high prices to entice many investors back into the sector.

These all combine to create a pretty compelling opportunity. At least in this analyst’s mind.

So fresh after looking at three other dirt-cheap energy stocks last week, let’s take a closer look at another — natural gas producer Birchcliff Energy (TSX:BIR).

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A little about Birchcliff

Birchcliff is primarily a natural gas producer with assets located in Northwest Alberta’s Montney region — a gas-rich area located around Grande Prairie and Peace River.

As it stands today, Birchcliff produces approximately 80,000 barrels of energy equivalent per day. Natural gas accounts for approximately 80% of total production, with various grades of oil making up the other 20%.

Reserves are relatively strong, with more than 1 billion BOE equivalent in the ground, waiting to be extracted. Based on current production — which is about 29 million BOE per day — Birchcliff has enough in reserves to sustain the next 34 years of production, give or take. Granted, the company will have to invest in capex to bring those reserves out of the ground, but at least it eliminates exploration risk.

The company has been paying off debt aggressively over the last couple years, using improved funds flow to improve its balance sheet. At the end of 2020, long-term debt stood at more than $700M. Birchcliff has just announced it’ll likely pay off all of its debt by the end of 2022.

Guidance for the year is strong, and is based on somewhat conservative assumptions. The company projects it’ll generate approximately $1.2B in funds flow for 2022. Subtract between $240M and $260M in capex, and we have a hair over $900 million in free cash flow this year.

To put the valuation in perspective, Birchcliff has a market cap of $2.2B. That puts shares at approximately 2.5x free cash flow.

It’s a good time to address the commodity price issue. Birchcliff’s assumptions for the year is for natural gas to stay in the $6.50 per GJ range. That looked quite conservative when the commodity spiked. But it has sold off lately, meaning today’s price is right around where guidance is. The company needs prices to stay the same or improve to hit their guidance numbers, although having nearly six months worth of production at higher prices in the bank is a good start.

A few thoughts on natural gas

The natural gas market is a little different than oil, despite the two commodities often being treated as largely the same. Natural gas has traditionally been a winter commodity, something that nobody cares about until the latest cold snap puts us into a -30 deep freeze. It then spikes for a little while, everyone freaks out, and then promptly improves like three weeks later.

Things are a little different these days. So many coal-fired power plants have converted to natural gas. Alberta’s oil sands producers use tons of natural gas to extract thick tar-like crude. And much of the commodity is liquefied and exported these days, loaded onto tankers and taken to Europe or Asia. Russia’s invasion of Ukraine just accelerated an already obvious trend.

This bullish sentiment sent the benchmark price of natural gas skyrocketing, peaking at just over $8 per GJ. After a quick selloff, the benchmark price today is approximately $6.50 per GJ.

This analyst has no idea where natural gas prices are going, and would advise you to not listen to anyone who thinks they have sort of individual insight that can make you money. All I know is there’s certainly a compelling bull case for natural gas and, more importantly, Birchcliff has multiple ways for the investment to work out.

Back to Birchcliff — The Opportunity

What I like about Birchcliff is even if natural gas doesn’t really cooperate, there’s a potential consolation prize.

Management’s plan once the debt is paid off — which is projected to be before the end of the year — is simple. They’re going to take excess free cash flow and use it to pay an extremely generous dividend.

The initial projection is an annual dividend of $0.80 per share. That works out to a 9.4% yield.

This payout would be sustainable, too. Birchcliff has told investors it can afford the dividend at $3 per GJ for natural gas and $70 per barrel of oil, prices that are more than 50% and 30% lower than current commodity prices, respectively.

The company will also have between $250 and $300 million in net cash by the end of the year, which is enough to fund the dividend for an entire year. That’s a nice buffer.

Birchcliff is also projecting free cash flow falls a fair bit next year, although as far as I can tell that’s from more conservative guidance. Free cash flow is expected to be $535M, or a hair over $2 per share. That’s still cheap based on today’s share price of $8.49. Production is expected to largely be the same in 2023 as it is today, suggesting the company is being more conservative on longer-term outlooks.

The bottom line

The whole point of this site is to uncover dividend stocks that might be under your radar, usually the kinds of names that are trading at extremely low valuations. The reasoning for this is two-fold. One, I’m a long-suffering value investor and no matter what I do, I can’t get away from that mindset. And two, these are the kinds of stocks that offer sustainable 5%+ payouts, the kind of companies that will allow me to retire all the sooner.

Birchcliff checks off both boxes. You’ll have to wait approximately 6-9 months, but the company should start paying a very generous dividend early in 2023. We’re talking a 9%+ yield based on today’s prices.

Combine that with a stock that trades at just 2.5x 2022’s projected free cash flow, a company with a rapidly improving balance sheet, and management who have a pretty good history of capital allocation, and I like the opportunity here. I’d like it a little better if they looked at hedging some of their production, but I think I’m asking for a little much.

Disclosure: no position as of today’s writing, but will likely buy some on Monday.

Thanks to Sean for putting a bug in my ear about Birchcliff.