As spot gas prices struggle, their debt climbs higher, and the long-term consensus AECO outlook softens, we believe there’s a possibility that Birchcliff will take their dividend to zero and reorient the business from an income model, back to their core competency of organic production growth and reserve expansion. Birchcliff has the opportunity to transition into a company that offers an extremely attractive value proposition. We have closely monitored their capital efficiency progress throughout 2024, and believe the piece remaining to unlock incremental shareholder value comes from cutting the dividend and continuing to execute an asset-focused business model; segmenting their operating units to further improve capital efficiency while bringing Elmworth into the growth plan – an asset that has serious upside.

Birchcliff would be a materially different business without the dividend, with an unhedged stay-flat plantgate breakeven of ~$1.75/Mcf when we assume 2025e PDP F&D costs of $1.05/Mcf. This maps to benchmark pricing around $2.00/MMBtu AECO, US$2.35/MMBtu Dawn, and US$2.90/MMBtu Henry Hub (assuming a US$1.35/MMBtu basis differential), which the forward strip is well above across all sales points. We also think that Birchcliff can further improve PDP F&D costs by focusing dry gas maintenance at Elmworth/South Pouce, and liquids maintenance updip Gordondale. HTM spent time running through various scenarios where Birchcliff slowly dispatches Elmworth to replace Pouce Coupe dry gas production, while focusing on North Pouce Coupe to transition the asset to a rich gas play – and we think Birchcliff could move their prevailing F&D costs as low as $0.80/Mcfe, while simultaneously improving their production stream weighting (2028e 19% liquids vs. Q2 2024a 17% liquids). 

Birchcliff’s own capital efficiency improvements show how good the basin has become at producing natural gas – and considering such, how relentlessly streamlined a gas producer must be to remain competitive. To us, that means that a dry gas producer with a commitment to remain unhedged should not have a regular dividend. Without the dividend, Birchcliff has line-of-sight to be a machine of an operation – a free cashflow positive producer seeing massive improvements in capital efficiencies, with a high-impact exploration area, all with manageable leverage. We like Birchcliff because, despite their infamous policy of not entering fixed price hedge contracts; their exposure to AECO is relatively limited, with majority of their gas exposed to Dawn and Henry Hub – and we are more constructive US natural gas prices vs. WCSB benchmarks. At $5.00/Mcf AECO and US$5.00/MMBtu Henry Hub and Dawn, Birchcliff trades <3x EV/DACF, we don’t think either benchmarks will get there, but it does highlight the leverage to gas prices that Birchcliff offers. In the meantime, if Birchcliff was to cut the dividend, they would eliminate further risks caused by increasing balance sheet leverage. Even at 2024 YTD’s brutal commodity price deck, Birchcliff has managed to cover their interest, G&A, OPEX, and F&D CAPEX without adding debt. Their debt has come almost entirely from the dividend. Birchcliff has a massive asset base with a long optimization runway, and we believe they should cut the dividend, to focus on further improving the business. If they do choose this, depending on further messaging (i.e. growth outlook), we believe that Birchcliff will become incrementally much more ownable. 

At our prevailing price outlook, which sees AECO below $2.85/MMBtu, and Henry Hub at US$3.05/MMBtu, Birchcliff trades at ~5x EV/DACF, which we think is a generally fair valuation; though see Birchcliff as able to drive material value through growth projects, further delineation of their North Pouce Coupe assets (while recognizing the difficulty of doing so with CNRL as a working interest partner), and the shift of lean gas production to Elmworth. We also believe – totally overlooked by the street, that Birchcliff has >300 ultra-rich gas locations in the Upper Montney at Pouce Coupe, and at Elmworth East, where in many cases, offsetting wells with tiny completions have already produced >300,000Bbls of liquids. Early Birchcliff Montney tests at Sinclair/Elmworth show similar results to Sundown; one of the most prolific dry gas areas of the Montney, with recent Ovintiv wells in-line with the Haynesville and Marcellus, proving IP₃₀ gas rates >30MMcf/d. We have a positive outlook towards Elmworth and Sinclair, where we believe that operators will be able to replicate the Sundown/Sunrise fields in BC, which are some of the best gas assets in the WCSB. Elmworth is slightly lower pressure, though thermal maturity suggests the gas stream may be marginally richer than Sundown, which itself is quite dry. Ultimately, what we believe Birchcliff has, is an asset that can deliver 10-20Bcf EURs, with liquids recoveries ranging from almost nothing <100,000Bbls, to extremely rich gas >500,000Bbls. From an acreage standpoint, Elmworth is 100% working interest (as far as we can tell) and spans >100,000 acres supporting ~400 locations across multiple Montney benches. We believe it has the potential to replicate Advantage Glacier – right now we don’t see the market ascribing any value to the asset, and rightfully so. Assuming shallow cut recoveries using area average plant efficiencies, at Elmworth West, where Advantage has been active, our current analyst derived type curve estimate expects the functional AECO delivered breakeven (i.e. payout <3yrs and P/I_10% >20%), to be ~$1.65/MMBtu at US$75/Bbl WTI, and F&D <$0.40/Mcf. 

So, how should Birchcliff be valued? We think probabilistically; recognizing that the AECO strip is not what is going to materialize but Birchcliff can continue to operate as a going concern through multiple years of soft commodity prices to capture those few years (or months) of very strong gas prices. Valuing Birchcliff using flat spot prices would ignore the fact they have well delineated assets with minimal exploration risk and remain unhedged to capture upside price movement. Like the EQT model; we believe Birchcliff should relentlessly work on improving their unlevered AECO breakeven, with their equity benefitting from the short periods when North American gas prices strengthen. We ran a random walk experiment; taking Birchcliff in 2024, cutting the dividend, keeping leverage flat (debt priced at forward LIBOR), then randomizing AECO, Henry Hub and WTI prices monthly for the next 25 years, with AECO between $1.00-5.00/MMBtu, Henry Hub between US$1.25-$4.50/MMBtu, and WTI between US$50-100/Bbl. We then fed this through our model 1,000,000 times; with annual free cashflow sweeping towards growing production (and subsequent years in the experiment benefitting from the higher production, via OPEX reductions, and higher revenues), though free cashflow was allowed to be negative when necessary to keep production flat. We did not consider infrastructure constraints in this experiment though inflated CAPEX and OPEX by 3% annually, and added random CAPEX spend between $10-50MM annually to represent full-cycle CAPEX. While it’s not perfect, we believe it’s miles ahead of any other valuation method for an unhedged gas producer. Annual FCFPS figures (undiscounted) ranged from -$1.15/sh to $4.61/sh; both the massive down and up years are not reflected in any traditional valuation method. While we recognize Birchcliff will never be priced like this, we believe it’s a useful exercise to calibrate what value is with volatility reflected. Focusing on the business, with extreme confidence we can say that Birchcliff is pricing in a bottom-decile long-term outcome, which is statistically very unlikely. As sentiment shifts (as it always has, and always will), we’d expect Birchcliff’s equity will move towards a price closer to the center of the range-of-outcomes bell curve.