Birchcliff envy of oil and gas mid-caps as it makes plans to rejoin TSX index
Producer’s shares up 179% over last year
CALGARY • After two years in exile, Birchcliff Energy Ltd. could be poised for a lucrative boost as it is on the verge of rejoining the TSX Composite Index — making it the envy of mid-sized oil and gas companies in Calgary.
“Over the past two years, companies have had to be resilient, they’ve had to adjust their business plans and it’s been survival mode,” said Chris Carlsen, vice-president of engineering at Calgary-based Birchcliff, adding the natural gas producer has been “watching every dollar and focused on every aspect of the business.”
Index provider S&P Global Inc. booted Birchcliff and seven other mid-sized oil and gas industry companies from the composite index in September 2019 after an investor exodus led to a collapse in their share prices. At that time, Birchcliff and Canada’s largest drilling companies like Precision Drilling Corp. and Ensign Energy Services Ltd., shrank to the point of being too small for inclusion in the key index. Getting punted from the index in turn caused index-linked funds to drop the stocks.
Demand for low-cost, exchange traded funds (ETFS) and passive investment funds has led to huge growth in funds that follow major indexes in both Canada and the U.S., where the passive fund management has grown to encapsulate half of the public stock markets. The dynamic has made inclusion on key indexes a lucrative prize for publicly traded companies.
“All of a sudden, you’ve got many different funds out there that are following it and you’ll have all these firms buying it up algorithmically, and you do see that effect. And on the downside, when they’re excluded, you’ll see that too,” said Ari Pandes, associate finance professor at the University of Calgary.
At Birchcliff, Carlsen said he’s confident the company’s addition to the index will lead to an influx of new investors.
The natural gas producer’s shares are up 179 per cent over the last year, rising $2.97 each to $4.63 per share on Aug. 20 following a jump in gas commodity prices and the company’s focus on repaying debt.
Billed as “the headline index for the Canadian equity market,” S&P Global uses a “float-adjusted, market cap-weighted” calculation four times per year to determine which companies should be included on the composite index.
A company’s average market capitalization over the course of the last 10 trading days of the quarter must be equal to 0.04 per cent of the total index value. That value changes over time as the value of the 230 companies on the index change, but analysts expect the threshold for inclusion on Sept. 24 will be between $1.3 billion and $1.4 billion.
But Birchcliff could be the only energy-sector company re-added to the composite index in the fall rebalancing, which will take place before markets open Sept. 20. Analysts believe five mid-sized oil-and-gas sector companies will narrowly miss this rebalancing due to either a recent retreat in their share prices or because insiders control a large percentage of the stock so they don’t enjoy enough trading liquidity.
Peyto Exploration and Development Corp., Paramount Resources Ltd., Freehold Royalties Ltd., Topaz Energy Corp. and waste water-handling company Secure Energy Services Inc. could be left off the index despite an impressive run-up in their share prices over the past 12 months. Meanwhile, Precision and Ensign have not rebounded to the point where they are eligible for re-inclusion in the index.
“There was a point when it was looking like there was a massive inclusion coming,” said Rafi Tahmazian, director and senior portfolio manager with Canoe Financial. Over the summer months, however, energy stocks have retreated to the point where “it doesn’t look good today.”
“How can this industry have such an impact on the GDP of the country and the Canadian dollar and yet the representation of the sector on the index is misaligned?” Tahmazian said, adding that believes valuations oil and gas sector is undervalued. “There’s such a misalignment with how people are investing and the realities of the world.”
In May, the last month for which TMX Market Intelligence Group data is available, oil and gas stocks represented just five per cent of the total market capitalization on the Toronto Stock Exchange and the TSX Venture exchange, down from 18 per cent 10 years ago.
Mining and oil-and-gas extraction contributed eight per cent of Canada’ gross domestic product in May of this year, the last month for which data is available. The sector’s contribution has risen and fallen over time, generally aligned with swings in commodity prices.
But the number of publicly listed oil and gas companies on Canadian exchanges has shrunk dramatically in the last 10 years, from 405 companies in 2011 to 139 issuers at the end of May.
However, thanks to the presence of large-cap energy sector companies like Canadian Natural Resources Ltd. and Suncor Energy Inc., the energy sector is the second-largest component of the composite index with 12 per cent.
Canoe Financial’s Tahmazian said his funds are invested in Birchcliff but cautioned against picking stocks based on a company’s potential inclusion in an index.
“I don’t think playing indexes works in the moment. You have a high risk of being wrong,” he said. “I don’t typically invest playing that game. I try to do it saying that’s one of my data points.”
Indeed, experts say inclusion in major stock indexes is important for companies that want access to a larger pool of potential investors, but inclusion does not, on its own, drive companies’ share prices higher.
“Near term, there is something to be said about share prices doing well leading up to these announcements for the names. Post announcement, it’s hard to say,” said Jeremy Mccrea, director of oil and gas equity research at Raymond James. “The reason why this makes a difference is the institutional investors that we talk to will only have the names on the composite in their coverage universe — smaller names aren’t even on their radar screen.”
Mccrea said that even though it is unlikely that more than a few oil and gas companies will be included in the fall index rebalancing, the number of companies on the bubble could help increase the profile of midsized exploration and production companies among investors.
“The fact that there are so many names looking to re-join the composite index is going to force some portfolio managers to start looking back into oil and gas,” he said.