Tag: BIR

Birchcliff Energy – hiding in plain sight

Sometimes an investment stares at you in the face and it is so obvious that it makes you wonder why others do not see it this way.

This is the case with Birchcliff Energy (TSX: BIR). Now that it has appreciated well beyond its Covid lows, I’ll write a little more about it in detail. I’ve been long shares of this (both common and preferred) for quite some time.

In 2022 it will produce about 79,000 boe/d equivalent (exit 2022 at approx. 82,000 boe/d), of which 80% of it is in the form of natural gas. All of this production is in the northwestern Alberta area, right up to the BC border.

Thus, the primary driver for this company is the state of the natural gas market. It has exposure to Dawn, Henry Hub and AECO.

Birchcliff is an unusual company in that they do not host quarterly conference calls. Instead, they issue information through large press releases and make it very easy to look at the assumptions. Although I have no problem sharpening my pencil and doing the leg works to do a proper pro-forma projection given various commodity price environments, Birchcliff expedites this process considerably.

There is some fine print to wade through, but the point is that BIR will generate $910 million in “excess free funds flow” (effectively cash flows after capex and projected dividend payments) with the average commodity prices as displayed in the release.

Notably, spot WTI and the spot Henry Hub price is well above their assumptions (US$114 and US$9.2 as I write this). Dawn typically tracks Henry Hub. Let’s ignore that spot is higher than modeled rates in the press release.

$910M of “excessive free funds” translates into $3.43/share.

At Wednesday’s closing price of $11.56, that is 3.4x or a yield of about 30%.

Normally companies are constrained with leverage and debt servicing. At the end of 2021, Birchcliff had $539 million in net debt (which includes BIR.PR.C) and another $50 million for the redemption of BIR.PR.A. The redemption of the preferred shares will result in a $6.8 million annualized savings on dividends (3 pennies a share, every bit counts!).

This will leave the company with a positive net cash amount of $270 million at the end of the year (the “Surplus”), unless they decide to blow some money on acquisitions and the like. Importantly, the math does not have to be adjusted for a leveraged return (indeed, it has to be corrected in the opposite direction).

The company will also be making enough money to eat through most of its tax shield ($1.9 billion at the end of 2021) and start paying income taxes in 2023, if the current price environment continues. Still, at US$88 oil, and US$5.50 Henry Hub for 2023 assumptions, the projection is for $535 million or about $2/share in free cash flow.

The stated policy on what to do with the cash surplus is to dividend it out beyond that which is to be used for strategic purposes. Management does not appear to be big on share repurchases other than to offset dilution that which has been issued from option plans (which is a real cash cost and will drag cash flows accordingly).

They will increase the dividend to $0.80/year in 2023, which is a $212 million outflow. This dividend can be maintained at price levels that are unlikely to be seen barring a great depression.

If they dividend the rest of their cash flows, when plugging in current commodity prices, they can give out far more than $0.80/year in dividends. It would be closer to around $2.80, or about $0.70 per quarter. Needless to say, if this is what they did, the market would find the yield (24%) tough to resist.

This is a very similar situation to Arch Resources (NYSE: ARCH), where the company will be giving out half of its free cash flow as a dividend and the other half to buy back shares. Considering its Q2 dividend will likely be around US$11/share, the obvious value of a share buyback is apparent. I wish Birchcliff would more actively consider it, at some cut-off threshold. For example, they can buy back shares until the price gets to a point where it is at 15% projected long-term free cash flows, a very conservative metric for a beneficial buyback. Right now that would imply that buying back below $15/share will clear that hurdle. At 12%, that number is about $19/share. There’s quite a way to go from current market prices.

None of this is a huge secret. It’s all in plain sight. It all relies on elevated commodity prices.

The last decent preferred shares left on the market

Long-time readers here should remember that I referred to a specific security as cash parking vessel. I didn’t make it much of a secret, but I was referring to DREAM Unlimited’s preferred share, which has been redeemed at the end of 2019.

There has been a lot that has happened since then and now! During the COVID crisis, there were a lot of good opportunities for fixed income investors in the form of bonds, preferred shares and income-bearing equity (in addition to others). Today, however, when scanning my fixed income lists, it is a total wasteland – generally the reasonably safe returns will give you a 5% dividend, while marching up the risk spectrum (e.g. Bombardier’s BBD.PR.B) will get you about 7.3%. It is slim pickings.

The next nearest cash-parking vessel is Birchcliff Energy’s (TSX: BIR.PR.C), which I have written about during the COVID crisis. Unfortunately, it, along with its twin cousin, (TSX: BIR.PR.A) is likely to get called out over the next 1.6 years – I am expecting the company to redeem the latter for par on the September 30, 2022 rate reset date.

It is very tempting to leverage up on “safe” preferred shares yielding 5% or so and finance it with 1.5% margin debt, but as the market instructed people 12 months ago, doing so can be very financially hazardous in the event of a collapse in asset prices.

More Misc market notes

Too much going on today, so will consolidate it into one post.

Everything that is going on is liquidity-fuelled. Central banks buy bonds. Bond yields go down. The equity to bond spread goes in conjunction with this, and hence prices rise. Doesn’t matter what the heck happens to the economy and it will drive most people crazy that do not see this relationship. Eventually they will capitulate and buy at the top, but right now there is a huge wall of worry which favours further equity upside.

* A week ago, I told you about Birchcliff preferred shares – they’re up today and as natural gas strengthens these present a good risk-reward, coupled with some income to boot. I’m sure there are better ways to play the natural gas space with equity (TOU, ARX?). The floor is pretty much in. Dollar-cost average on anything fossil-fuel related over the next couple months and a year later I’m sure it’ll work out.

* Atlantic Power’s performance (and utilities in general) has been disappointing in the COVID-19 recovery, mainly because power demand has dropped as a result of the economic slump. It doesn’t really matter for them as the price of their power generation is secured through power purchase agreements, but it doesn’t bode well for the residual value of their power plants after the agreements expire. After repurchasing 12.5 million shares of their own stock on May 1st, they will not be able to repurchase further equity until 20 business days after the offering concluded (i.e. not until June). I would expect them to resume share repurchases in June, so I suspect that the common shares will be a reasonably good bargain in May. I won’t be adding since this company is a low-medium reward and low risk entity, so it will be like watching paint dry compared to many other offerings in the stock market. But I’m pretty sure that June will see higher prices for ATP than in May.

* I watched Planet of the Humans, available on Youtube until mid-May, which puts a huge hole through the motivations of various environmental activists. Surprise surprise, it’s all about money and not the Earth! Blair King (a professional chemist which I have a very high degree of respect for) has an excellent review on the movie.

The only reason why I mention this movie is because they tear a good strip out of biomass plants as being “renewable energy”, and for a very brief moment, Atlantic Power’s Cadillac plant (the one which had a major explosion and plant fire earlier this year) was mentioned.

* Firms are going to be throwing everything under the bus for the first and second quarter, citing COVID-19. There will be write-downs of all sorts of junk on the books that have been accumulating. Firms that do not blame COVID-19 during the two quarters for various one-time write downs of financial performance are likely to be more honest than not.

* An example of this is BWX Technologies (NYSE: BWXT), which reported earnings yesterday. They have a competitive advantage in nuclear engineering services. They did not blame COVID-19 for anything, probably because nuclear engineering services are booming and they should become at least a US$65/share stock by year’s end. Yes, I own shares. The most profit to be had in the nuclear value chain is not in uranium, people!

* There is an interesting tug-of-war happening in the Yellow Pages right now, which traded more shares today than it has in a long time. Somebody at RBC is very interested in shares, while Canaccord has been on the selling side of the large blocks, mostly around the $10 range. Just announce the takeover bid already, folks!

* I find it probable that the central banks will target a stabilization of equity levels, so they will adjust the rate of their liquidity injections that go into the market. Still, the trend is for further liquidity until unemployment metrics begin to moderate. I will have a comment on unemployment/employment rates in a future post, as this is an interesting topic in itself which has market implications.

* REITs, financials, and insurance companies, in general, I think will disappoint. You can almost take anything that somebody is bullish on whatever that is posted on Reddit CanadianInvestor and just take it off your list of consideration. It is quite remarkable how useful it is, entirely for the oppositely intended reason.

Birchcliff Energy preferred shares

The market is starting to normalize again. We’re about half-way done on the up-side, and I estimate while there will be some minor panics here and there that will bring things down 3-5%, in balance you’re going to see things get back to at least where they were before the end of the year.

I’ve taken my fair share of these shares (earlier in the month), so I’ll post it to the public since there is plenty of upside. I’ve written about them before, so this is going to be somewhat redundant.

Birchcliff Energy (TSX: BIR) is a natural gas heavy producer. They are a low cost producer, refine their own gas, and they will survive. They are primarily financed by a low cost line of credit which is not in any danger of having the plug pulled. While their equity remains undervalued (and insiders also believe the same, especially those that were buying when the stock was under a dollar), the even better risk/reward are the preferred shares.

There are two series. BIR.PR.A is a standard fixed-reset perpetual preferred share, currently 8.374% coupon with a +6.83% reset rate, resetting September 2022. Even at the present Government of Canada’s 5 year bond yield of 0.41%, at current market rates it will reset at a 10.5% yield. It is conceivable that they will trade up to par again, just as they were for most of 2017 to 2019. A ‘quick’ capital gain of roughly 50%, plus you’re given a very healthy 12% eligible dividend. Even with the Bank of Canada turning our currency into toilet paper, your real return will be positive.

BIR.PR.C is a straight perpetual share with a coupon of 7%. After June 30, holders can put their preferred shares back to Birchcliff at par, which BIR has the option of paying cash, or giving stock at the 20 day VWAP or $2 minimum per share. Considering BIR is trading at $1.57/share, this works out to a discount to the current preferred share value ($17 for the preferred shares vs. $19.60 in BIR stock). I don’t know what the term is in finance, but it creates a “Mexican standoff” situation where if this continues past June 30th, I don’t think holders will be too eager to redeem, nor will Birchcliff be too eager to redeem either. In the meantime, you can collect a 10.3% yield (assuming a $17 purchase price) for waiting. The obvious price target is par, although if you get fancy you might be able to get a mild premium.

I generally believe the worst is over for oil and gas, and as a result, all of this is going to be a moot point when BIR goes higher later this year. Why not buy the equity? There are worse things you can do, but the preferred shares are pretty much a lock for appreciation on a risk/reward spectrum. For every 1% the equity goes up, the preferreds will probably get around 75% of it until they get closer to par.

Of course there aren’t any guarantees of 50% gains in a few months’ time, but this one seems feasible. The risk scenario is that the common stock meanders about and you collect an ultra-high coupon while waiting for natural gas demand to rise. In the case of BIR.PR.C you end up with 12.5 shares of BIR.