Birchcliff or Peyto?

A lot depends on your investment horizon and risk tolerance

To frame this discussion, I will first provide a Black Scholes valuation of each company’s reserves. Here is Peyto’s which puts a value of $15.18 on the stock.

Both Peyto and Birchcliff operate in the Deep Basin area, but Birchcliff has a slightly higher mix of liquids versus dry gas which explains why the same inputs for commodity price produce a different blended price, which is what is used in the valuation. Here’s the Birchcliff valuation.

These rivals have differing approaches to strategy. Peyto prefers to hedge commodity prices on a rolling basis (a bit like dollar cost averaging for stock prices in theory) and pay out regular dividends while increasing output. Birchcliff prefers to offer investors an unhedged exposure to commodity prices and curb output growth when prices are low.

Based on the Black Scholes approach, both companies shares are undervalued, Peyto’s shares by 13% and Birchcliff shares by 41%. Most analysts prefer Peyto to Birchcliff since they focus on short term price appreciation potential and value each company using primarily multiples of cash flow.

For the purpose of the Black Scholes analysis, I used a price of CDN$3.00 a gigajoule since it comprises more or less the weighted average breakeven price for Canadian producers (the chart below is U.S. funds and converts to ~CDN$3.00 for Canada). The presumption is that producers will not direct more capital to production when it is not profitable.

Readers may find it interesting to compare the results of the company’s if natural gas prices rise from the relatively low prices of today. Both companies experience rapid rsies in cash flow per share from higher natural gas prices, but Birchcliff cash flow per share has substantially greater leverage to higher gas prices owing to Peyto’s practice of hedging.

Many readers will argue that the odds of natural gas prices averaging $10 a gigajoule in 2025 are low. Maybe, but history shows that is within the bounds of reasonable possiblities and in 2025 there will be a combination of LNG exports from Canada’s West Coast, an expected La Nina bringing colder temperatures, and the possibility of tighter natural gas markets in Canada as a result. For reference, here is a chart of natural gas prices for the 20 year period ending 2018 to show the volatility and potential for higher prices, if history has any lessons for us.

Birchcliff’s CEO was on BNN yesterday and confirmed that the company is committed to providing investors with unhedged exposure to natural gas prices. I think that is the strategy I see as having the most value over time so I have a major long position in BIR and a somewhat smaller long position in PEY.