Description

BIRCHCLIFF ENERGY (BIREF):  THE FULL MONTNEY

(Denoted in Canadian $ Unless Otherwise Noted)

(As of 6-30-2016)

COMPANY OVERVIEW

Birchcliff Energy is a low cost natural gas producer in Canada.  The company’s two resource plays–the Montney/Doig and Charles Lake–are located in the Peace River Arch of the Western Canadian Sedimentary Basin. Formed in 2005, the company has primarily focused on the development of its extensive drilling inventory of natural gas wells in the lower and upper Montney/Doig and invested in a significant amount of infrastructure to lower its cost structure.  Production grew 15.5% YoY in 2015 to 38,950 boe/d, while production per share has grown at a ~20% CAGR over the past 5 years.  Billionaire investor Seymour Schulich also owns a 28% stake in the company.  Below is a financial summary of the company’s profit margin over the past six years.  Surprisingly, the company’s cost cutting helped it to report a profit last year despite the plunge in natural gas and oil prices.     

Source:  Birchcliff Energy 2015 Annual Report

The company has grown PDP reserves and 2P reserves at 16% and 27% CAGRs, respectively, since 2005.  2P reserves grew ~23% YoY in 2015 to ~573M boe, while proved reserves grew ~24% despite the substantial drop in oil and gas prices.  Managing to grow reserves at 20%+ in a year where oil and gas prices fell 50% or more is a testament to the strength of the company’s reserves.         

Thesis:

Birchcliff Energy holds one of the largest 2P natural gas reserves in Canada and has managed to cut operating and F&D costs over the past 5 years by focusing on its productive Montney resource play, continuing to implement operational efficiencies, and investing in strategic infrastructure to process its gas at low costs.  The company’s low cost position, large resource base, secured transportation capacity, flexible credit facility, and recent Gordondale acquisition allow investors to benefit from improving oil and gas Strip prices.  Birchcliff Energy trades at 5.8x 2018E EBITDA, which includes the recent Gordondale acquisition and assumes the current 2018 Strip.  Discounting the current 2016-2018 Strip and $3.00/GJ AECO and USD$55/bbl WTI thereafter, Birchcliff Energy should be worth $9.35/share, or 7.6x 2018E EBITDA (~$40,500 boe/d), by 2018.  This represents 36% upside from the current share price.  My sum of the parts valuation consists of:

1. $7.18/share based on 2018E NAV, excluding Gordondale assets  

2. $3.78/share for Gordondale assets based on 6.5x 2018E EBITDA     

3. $1.61/share of Net Debt for 2018                

Current Market Perception

Birchcliff Energy is considered a low cost Canadian natural gas producer with one of the largest 2P natural gas reserves.  Shares currently trade at 15.7x 2016E EBITDA (~$48,900 boe/d), which includes both EBITDA and production contributions from the Gordondale acquisition that is expected to close on July 28, 2016.  Assuming investors are valuing Birchcliff Energy at ~8.5x 2017 EBITDA, the current share price discounts ~$2.50/GJ for AECO gas and ~USD$50/bbl for WTI for 2017.  Since $2.50/GJ AECO gas is below the current futures curve, investors could be reluctant to discount any further upside in oil and gas prices at least until North America storage numbers begin to decline, or unless Birchcliff begins hedging more of its production at current Strip prices.  Investors may also still be skeptical about the 60% equity dilution to fund the $625M Gordondale acquisition.                            

GORDONDALE ACQUISITION

Birchcliff Energy paid Encana $625M for the Gordondale assets by raising $653M (104.5M shares) in gross proceeds via a bought-deal equity financing and an $18.75M private placement subscribed for by Seymour Schulich.  Based on the 26,000 boe/d of average production for 1H 2016 and annual 20% base decline rate, Birchcliff Energy paid ~$30,000 boe/d and $3.27/boe on a 2P reserves basis.  For reference, Enerplus Corporation divested ~$193M of non-core Alberta Deep Basin natural gas properties for ~$35,700 boe/d earlier this year.   The Gordondale acquisition will allow the company to de-lever its balance sheet, sustain its borrowing base with increased PDP reserves, and further consolidate acreage in its core Montney/Pouce Coupe play at a fairly attractive valuation.  Drilling buffers that border Birchcliff lands will also be eliminated, allowing for optimized well development planning.  The acquisition also comes with firm transportation capacity on Pembina’s pipeline system and an inventory of more liquids rich wells that provide the company with more flexibility to invest in liquids rich or gassier wells depending on oil and gas prices.  

Assuming current Strip prices, the Gordondale assets should generate ~$151M in EBITDA and ~$63M in free cash flow for 2017.  This also assumes capex spend of $37M for the remainder of 2016 and $87.9M in 2017 to increase production to ~28,200 boe/d.  Applying a 6.5x EBITDA multiple yields a ~$1B enterprise value, or $3.78/share, for 2018.  This implies a valuation of ~$36,000 boe/d, which is in-line with recent asset divestitures.  If AECO gas and WTI oil prices rose to $3.25/GJ and USD$60/bbl, respectively, for 2017-2018, then the value attributed to the Gordondale assets would climb to ~$4.50/share.           

Gordondale Pro-Forma Projections

COMPETITIVE POSITION

PCS (Pouce Coupe South) Gas Plant Supports Low-Cost Production Growth

Birchcliff Energy’s PCS gas plant can currently process 180,000 mcf/d of natural gas.  Owning a processing plant provides Birchcliff with a lower cost structure since the company can adjust its development plans depending on commodity prices and generates ~$1.00/mcf in operating cost savings compared to using third party gas processing facilities.  It cost $0.31/mcf ($1.90/boe) to process natural gas through the PCS gas plant in 2015.  Low operating costs allow Birchcliff to remain profitable even when many other competitors are generating losses at current natural gas prices.  The company has ramped up natural gas production only when it brought on additional processing capacity at its PCS gas plant.  Preparation for construction of Phase V expansion is already underway and will increase the PCS processing capacity to 260,000 mcf/d by late 2017 for a total cost of $90M ($57M capital spend remaining for 2016-2017).  Following the Phase V completion, management expects to spend an additional ~$46M over 2018-2019 on the Phase VI expansion, which will increase the PCS gas plant processing capacity by another 80,000 mcf/d to 340,000 mcf/d by the end of 2019.                            

Montney/Doig Offers Attractive Well Economics

Birchcliff Energy has an extensive, repeatable drilling inventory of wells within its stacked Montney/Doig resource play.  The company has drilled 187.9 net wells as of December 31, 2015 and has focused its drilling to mainly two intervals:  the Upper Montney (D5) and Lower Montney (D1) intervals.  The Montney D4 interval provides additional upside optionality if the company succeeds in adding substantial reserves from its development program.  

Source:  Birchcliff Energy Investor Presentation (May 2016)

Management estimates there are 3,611 net potential well locations based on the company’s resource development to date.  This works out to ~3.1 net wells per section.  For modeling purposes, I assume there are 2.4 net wells per section since the company is likely drilling longer laterals to increase EURs per well.                         

Birchcliff Energy is also achieving better well performance from its current drilling program.  The company increased proved plus probable natural gas reserves from its Montney/Doig resource play by over 600 Bcf in 2015.  Positive technical revisions accounted for ~200 Bcf of the increase due to Deloitte’s (independent qualified reserves evaluator) assignment of a new Montney/Doig type curve to future well locations by Deloitte.  All wells are choked initially and have an average IP365 rate of ~2,850 mcfe/d based on Deloitte’s Tier 0 and Tier 1 type curves.    Choked wells lead to higher ultimate recovery and better reservoir management, which leads to lower decline rates and subsequently lower maintenance capital expenditures.  Birchcliff estimates an overall base production decline rate of ~20% for 2016.  Birchcliff typically recovers 8.5-11.5 bbls per MMcf of liquids from its Montney/Doig wells, and nearly all of these liquids are high value oil and condensate.