Tag Archives: management

Go For Birchcliff’s Preferred Shares Instead Of The Common Stock

Summary Birchcliff enjoys an ultra-low production cost for its natural gas, thanks in part to processing the majority at its own processing plant. I’m curious to see Birchcliff’s plan for 2016 as, despite the $120M price tag, it would make sense to expand the gas processing plant. The IRR is positive and will be 22% at a 10% higher gas price, so technically and theoretically Birchcliff should be going ahead with the expansion plans. But everything will depend on the company’s plans to achieve production growth, and I think Birchcliff will have to choose between the gas plant and a higher gross production rate. It’s pretty obvious the vast majority of the oil and gas producers are bleeding in the current price environment. That’s particularly true for Birchcliff Energy ( OTCPK:BIREF ) where the majority of the annual production consists of natural gas, which has been hit pretty hard. In fact, the gas price in North America has even dropped to less than $2. BIR data by YCharts Birchcliff is a Canadian company and I think it would be a better idea to trade the shares through the facilities of the Toronto Stock Exchange, where Birchchliff is listed on the main board with BIR as its ticker symbol . The average daily volume is much better in Canada as approximately 660,000 shares are changing hands on a daily basis for a daily dollar volume of $2M. El Nino Is Hurting the Company’s Top and Bottom Lines Let’s start with the good news: Birchcliff Energy was able to keep its production rate stable at a total of 38,400 barrels of oil-equivalent per day. As I said, the vast majority of this comes from natural gas sales and the revenue from natural gas was approximately 3.25 times higher than the revenue generated from selling the attributable oil output. As the average production rate in the same quarter of last year was just over 34,000 boe/day and as the average in the first nine months of the current financial year was approximately 38,400 barrels per day, Birchcliff has done a pretty good job at keeping its production rates pretty consistent despite the worsening climate on the oil and gas front. (click to enlarge) Source: Financial statements. The total revenue in the third quarter of the financial year was almost C$79M ($57M) , which is more than 25% lower compared to the same quarter last year, so the higher output didn’t compensate for the lower oil and gas prices. The operating costs also increased a bit, due to increased marketing and transportation expenses. Nonetheless, Birchcliff was able to write black numbers on its bottom line, and the company generated a net profit of C$4.8M ($3.65M) in the third quarter of 2015. Keep in mind that Birchcliff hasn’t hedged any of its gas and oil production, so “what you see is what you get.” The revenue has not been boosted by one-time events, such as the gain on derivative instruments. Source: Financial statements. The operating cash flow on an adjusted basis was C$44.3M ($32M), which is pretty good considering the circumstances and the shortfall to cover the capital expenditures. The investing part of the working capital position was limited to just C$20M ($14.5M). This could be better, but it could also have been a lot worse. This is where Birchcliff’s low-cost gas production at Montney comes in handy. Will Birchcliff Generate a Sufficient Amount of Cash Flow to Cover Its 2016 Capital Expenditures? My main test for Birchcliff will be in seeing what the company is planning to do next year. The original plan called for another 10%-12% production increase to 42,000-45,000 barrels of oil-equivalent per day, but I can imagine the company is currently developing a revised capital plan that will forego any production expansion while waiting for a higher gas price. This might probably be the smartest decision because even though the production costs at Montney are quite low, it might not be sufficient to cover the additional capital expenditures to indeed break even on the cash flow front. Source: Company presentation. It’s encouraging to see that even in the current gas price environment, the annualized operating cash flow will be roughly C$160M ($116M) and Birchcliff will have to try to keep the capital expenditures limited to approximately this level. Fortunately, the Canadian Dollar continued to weaken. This basically means that the lower natural gas price expressed in USD is partly compensated by the weaker CAD, which is also the currency Birchcliff is reporting its financial statements in. (click to enlarge) Fortunately, Birchcliff Energy still has ample access to liquidity as its bank has confirmed and increased an existing credit facility. Birchcliff can still draw approximately US$120M from this credit facility, and that should be sufficient to cover the capital shortfalls for the next two to three years. The Preferred Shares Could Be a Solution to Raise More Cash No company likes to issue new shares at the bottom of a cycle, but Birchcliff has an attractive Plan B. Birchcliff has two series of preferred shares in the market, and both the A-series and C-series have 2 million outstanding shares. The A-shares have a fixed 8% yield (payable quarterly) and are currently trading at 70% of par (and can be reset in 2017 based on the five-year yield on Canadian government bonds with a mark-up of 6.83%). The C-series have a fixed 7% yield . Both preferred share issues are perpetual, so Birchcliff can decide whether or not it wants to retire these preferred shares in the future. Should Birchcliff double the preferred share issue, it could raise C$70M ($50M) in a heartbeat, further reducing the pressure on its balance sheet. This could cover almost two years of capex funding shortfall. The additional cost of raising this C$70M? Just C$7.5M ($5.5M) per year. That’s not cheap, but it would provide an easy way to fund the ongoing activities. Once Birchcliff’s cash flows increase, the company can easily repurchase the preferred shares. Investment Thesis Birchcliff Energy is definitely hoping for a harsh winter to see a boost in the average gas price. The cash flow situation remains under control, but I think I would prefer the additional layer of safety and purchase the preferred shares. Yes, the upside is a bit more limited, but the series-C preferred share now yields almost 9%. That excludes any potential capital gains if Birchcliff decides to repurchase the preferred shares at par value sometime in the future. It will be very interesting to see what kind of capital investment plan Birchcliff has been preparing for 2016, and what it will do with the PCS gas plant, which was expected to see its throughput increase by 30% by the end of 2016. I think holding off on the expansion is the wisest decision, considering the IRR is just 22% at an AECO gas price of $2.5/GJ (currently at $2.25) and the initial capex is budgeted at US$120M. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

Will Falling Silver Production Start To Impact SLV?

Summary The price of SLV lost 9% of its value during 2015. Silver production may drop in 2015 — for the first time in over a decade. As the deficit in silver keeps rising, this could eventually start affecting the price of SLV. The silver market didn’t have a good year as the price of the iShares Silver Trust ETF (NYSEARCA: SLV ) shed over 9% off its value. The direction of silver will continue to be dictated by the direction of long term interest rates and U.S. dollar (among other things that silver investors look for when investing in the precious metal). But what about the changes in the physical demand and supply for silver? After all, the ongoing low silver prices contributed to the decline in silver production this year – perhaps 2015 will be the first year since in well over a decade, in which production won’t rise. Will this be enough to drive up the price of SLV? I have already addressed the recent rate hike by the Fed and its impact on SLV. Currently, the market isn’t convinced the Fed will raise rates by another 1 percentage point as its members estimated in the last FOMC meeting. The implied probabilities , as collected by Fed-watch, suggest the market projects only two hikes of 0.25 basis points in 2016. If the Fed wind up raising by only 0.25bp or not raise at all, this could bring back down long term interest rates and perhaps even depreciate the U.S. dollar – two shifts that could behoove the price of SLV. What about the changes in production? According to the Silver Institute the balance between supply and demand was in deficit (i.e. the demand was higher than the supply). And this has been the case for the past 12 consecutive years . This year’s deficit is expected to settle at 21.3 million oz – the lowest deficit in a decade. This decline in deficit is mostly due to net outflows from ETFs holdings and derivatives exchange inventories. Basically, as the demand for silver as investment diminishes, it helps ease the physical deficit. But there is also the matter of falling production that could increase this deficit. Up to 2014, production has been rising. This year, however, it seems production hasn’t picked up and perhaps even slightly declined. Among the top leading countries the produce silver: Mexico, Peru, China, Australia and Chile, according to one outlet , total production in these countries is slightly down for the year (up to August) – by less than 1%. So it’s still unclear how the year will end for the silver balance. But even if this year the deficit expands again, it doesn’t mean this trend will be enough to push up the price of silver. The high deficit in recent years including 2013 and 2014 hasn’t helped rally the price of silver. But perhaps this could also be a matter of timing. Eventually the deficit in supply-demand balance will matter enough to pull up the price of silver, especially as silver loses its shine as investment. When will this happen? That’s unclear. Therefore, for the near term it still seems that the direction of SLV will be govern firstly by the changes in the demand for silver as an investment tool and only secondly by the changes in supply and demand for physical silver. This means the direction of the U.S. dollar, other precious metals – most notably gold – and long term interest rates will set the pace for SLV. In the coming months, I won’t be surprised if the Fed takes a more dovish tone than it took in its recent statement, which could actually slightly pull up SLV. Finally, in the medium term, the growing deficit in silver – mostly driven by falling production and rising physical demand – may take a bigger role in moving the price of silver. For more please see: What’s Up Ahead for Silver in 2016?

VFORX: How A Target Date Fund Should Be Built

Summary The Vanguard Target Retirement 2040 Fund has a simple construction and a low expense ratio. Despite being a very simple portfolio, they have covered exposure to most of the important asset classes to reach the efficient frontier. The fund is mostly in equity but has materially underperformed the S&P 500 over because of a strong allocation to international equity. Lately I have been doing some research on target date retirement funds. Despite the concept of a target date retirement fund being fairly simple, the investment options appear to vary quite dramatically in quality. Some of the funds have dramatically more complex holdings consisting with a high volume of various funds while others use only a few funds and yet achieve excellent diversification. My goal is help investors recognize which funds are the most useful tools for planning for retirement. In this article I’m focusing on the Vanguard Target Retirement 2040 Fund Inv (MUTF: VFORX ). What do funds like VFORX do? They establish a portfolio based on a hypothetical start to retirement period. The portfolios are generally going to be designed under Modern Portfolio Theory so the goal is to maximize the expected return relative to the amount of risk the portfolio takes on. As investors are approaching retirement it is assumed that their risk tolerance will be decreasing and thus the holdings of the fund should become more conservative over time. That won’t be the case for every investor, but it is a reasonable starting place for creating a retirement option when each investor cannot be surveyed about their own unique risk tolerances. Therefore, the holdings of VFORX should be more aggressive now than they would be 3 years from now, but at all points we would expect the fund to be more conservative than a fund designed for investors that are expected to retire 5 years later. What Must Investors Know? The most important things to know about the funds are the expenses and either the individual holdings or the volatility of the portfolio as a whole. Regardless of the planned retirement date, high expense ratios are a problem. Depending on the individual, they may wish to modify their portfolio to be more or less aggressive than the holdings of VFORX. Expense Ratio The expense ratio of Vanguard Target Retirement 2040 Fund is .18%. That is higher than some of the underlying funds, but overall this is a very reasonable expense ratio for a fund that is creating an exceptionally efficient portfolio for investors and rebalancing it over time to reflect a reduced risk tolerance as investors get closer to retirement. In short, this is a very solid value for investors that don’t want to be constantly actively management their portfolio. Composition The fund is running almost 89% stocks to about 11% bonds, but over time the portfolio shifts to sell off stocks and hold more bonds as Vanguard assumes that investors nearing retirement will have a reduced risk tolerance. This portfolio strategy is the embodiment of what financial advisors seek to do for clients. Unfortunately Vanguard does not know the unique circumstances of every client, but for a .18% expense ratio they are doing a great job. Holdings The following chart demonstrates the holdings of the Vanguard Target Retirement 2040 Fund: (click to enlarge) This is a fairly simple portfolio. Only four total funds are included so the fund can gradually be shifted to more conservative allocations by making small decreases in equity weightings and increases in bond weightings. The funds included are the kind of funds you would expect from Vanguard. They are all solid funds with strong internal diversification in the holdings and low expense ratios. The Vanguard Total Stock Market Index Fund is also available as an ETF. The ETF version is the Vanguard Total Stock Market ETF (NYSEARCA: VTI ). To be fair, Vanguard has a great reputation for running funds but not for coming up with creative names. I have a significant position in VTI because it carries an extremely low expense ratio and offers excellent diversification across the U.S. economy. Volatility An investor may choose to use VFORX in an employer sponsored account (if their employer has it on the approved list) while creating their own portfolio in separate accounts. Since I can’t predict what investors will choose to combine with the fund, I analyze it as being an entire portfolio. Since the fund includes domestic and international exposure to both equity and bonds, that seems like a fair way to analyze it. (click to enlarge) When we look at the volatility on VFORX, it is only slightly lower than the volatility on SPY. Despite similar levels of volatility, it has underperformed SPY. Generally investors will expect a target date fund to hold up better in a bear market and to fall behind in a bull market. For a portfolio with a target date as distant as 2040, investors have to expect strong equity positions will result in similar returns to the market. The real weakness demonstrated here was largely a function of the international equity markets underperforming the domestic equity markets. A Suggested Modification Even though this portfolio is designed for investors that are 25 years away from retirement, for the sake of lower annualized volatility I would like to see a slightly larger allocation to very long term treasury bonds. Since Vanguard is regularly rebalancing the fund it should be able to benefit from the strong negative correlation between the domestic equity market and the long term treasuries. To be fair, international markets have also been showing a negative correlation with long term treasury returns, so it really should be able to dramatically reduce the volatility without creating a very large drag on earnings. The benefit of the negative correlation with frequent rebalancing allows investors to be regularly buying low and selling high. Compared to most active investment strategies, a simple rebalancing plan that combines long term treasuries with domestic equities has been a very solid and remarkably simple strategy. Conclusion VFORX is a great mutual fund for investors looking for a simple “set it and forget it” option for their employer sponsored retirement accounts. It is ideally designed for investors planning to retire around 2040, but can also be used by younger employees with lower risk tolerances or older workers with higher risk tolerances.