"PrairieSky Announces First Quarter 2024 Results, Record Oil Royalty Production"

[Previously: Earnings Notes (Q4 2023), PrairieSky Announces 2023 Third Quarter Results, Canadian Oil Earnings, PrairieSky Royalty Ltd. Reports Q2 2022 Earnings, and PrairieSky Royalty Ltd. Reports Q1 2022 Earnings.]

The market capitalization of PrairieSky (at US$20 per share for the U.S. ADR) is $4.8 billion and the enterprise value (with $152 million of net debt) is $4.9 billion.

The company reported net earnings of $35 million for the first quarter of 2024 (compared with $41 million the prior year) and earnings plus DD&A were $62 million (compared with $66 million the prior year). That's a "cash generation" yield of 5% (annualized) on the current enterprise value. The company paid $44 million of dividends and reduced net debt by $10 million, for a total shareholder yield of 4.5% on the market cap.

Crude oil production was up 8% over the prior year and total BOE royalty production was up 5%. The crude oil realized price was only $56 per barrel, which was up 1.2% from the prior year.

The company generated $58 million of cash from operations and spent $6.4 million on acquisition of new properties, $10 million on debt repayment, and $42 million on dividends.

Slide 9 of the investor presentation talks about PrairieSky's reserves replacement. Since 2016, the share count has increased by only 4.8%, while the proved and probable (2P) liquids reserves have increased by 64% and the production (in MBOE) has increased by 6%. (The total 2P reserves in MBOE went from 5.6 years to 7.2 years.)

• Q1 2024 management discussion & analysis
• Q1 2024 financial statements
• April 2024 investor presentation
  

Works in Progress Links

• What if, Jackling asked himself, you could extract copper not just out of those high-grade chunks (copper content of over five per cent) but also out of the other stuff too? In many mines around the world there were vast volumes of ores which looked to the untrained eye like normal rocks but contained a few percentage points of copper. They were set aside because it was simply too expensive to justify refining them. But, wondered Jackling, might there be some way of changing the calculus? In 1904 at Bingham Canyon, just outside Salt Lake City, Utah, he answered that question in dramatic fashion. Vast quantities of explosives were deployed to blast massive chunks of low-grade ore out of the ground. Steam shovels and steam crushers were brought in to ferry and grind the ores. What was once a mountain was turned into a kind of dust, which was then mechanically and chemically processed in what became known as ‘flotation separation’: the ore dust was mixed with an oily compound and then sloshed and shaken inside large tanks, allowing copper particles to float to the surface before being smelted into solid metal. What might sound like an arcane set of process changes turned out to be utterly revolutionary. Jackling’s ‘non-selective techniques’, as they are sometimes called, meant you could extract copper from even low-grade ores in large quantities. All of a sudden, the metal was no longer in short supply; it was plentiful. Better still, new electrolytic refining methods meant that the quality of copper being turned out by these new mega-mines was even better than the kind previously produced by older reverberatory furnaces, which roasted processed copper ores and dominated the business back in the nineteenth century, when the UK refined most of the world’s metals. [Works in Progress]
  
• Few materials fell from grace like asbestos. Once cherished as an almost-magical material, it is now the archetypal carcinogen. We spent over a century integrating it into buildings, wiring, pipes, brake pads, and more, and we now spend billions of dollars a year removing it. But the standard story of asbestos as a mistake – or even a crime – of massive proportions does not do justice to the real benefits it brought. Asbestos was central to mitigating urban fires, which cost thousands of lives each year as modern cities grew larger, denser, and more flammable. But as we learned to control urban fires without it, asbestos’s health costs seemed less and less worth bearing. Asbestos is in its final days and soon the material will almost disappear entirely. [Works in Progress]
• Crack the nut of geothermal power and it will feed us for billions of years: the Sun will engulf us long before the Earth’s core stops providing us with heat. In the here and now, a successful geothermal industry would mean a neat repurposing of oil and gas infrastructure and expertise; little prospect of Putin-style energy blackmail; and, most importantly, abundant clean energy, available 24/7, regardless of geography. Perhaps equally thrillingly, we would have drilling that would make the Soviets’ Arctic Circle record breaker look like a hobbit hole. [Works in Progress]
• Among other things, that meant bringing back American rye whiskey – the base ingredient for cocktails like the Manhattan. Rye whiskey ruled American bars before Prohibition, but during the second half of the twentieth century, it all but disappeared from the market. In the 1980s and 1990s, only a few US whiskey brands still produced rye whiskey at all, and production was in some cases limited to a single day a year. But as with crème de violette, rye came back in large part because of bartender demand. In Michael Ruhlman’s The Book of Cocktail Ratios, Audrey Saunders, a New York cocktail bar entrepreneur and important figure in the cocktail renaissance, describes becoming obsessed with Rittenhouse rye in the early 2000s after having been served a Rittenhouse rye Manhattan at Crobar in London, which she describes as a ‘hole-in-the-wall heavy metal bar’. [Works in Progress]
• Making cocktails at home means seeking out bottles that are good values and can be used in a lot of drinks. And there just aren’t many ryes that can meaningfully compete with Rittenhouse. In an era of demand-driven whiskey shortages, it’s widely available. At $28 or so a bottle, it’s reasonably affordable. And it is often not only a good choice for standard versions of classic cocktails, but the very best choice, particularly for drinks in the Manhattan family. [Cocktails With Suderman]
• A key advance was the growth of triangulation. The diagram below illustrates the basic idea: if you have the points A and B and measure the angles ɑ and β to C, this uniquely pins down the position of C. Further, if the length between A and B is known, the method also delivers the distances from A and B to C. Triangulation was attractive because it replaced expensive measurement of distances with cheap measurement of angles. After the mathematician Gemma Frisius explained how triangulation could be used for mapmaking in 1533, the method spread rapidly across Europe. In 1578, the astronomer Tycho Brahe used triangulation to map the island of Hven where his observatory was located, and the method is described in many textbooks published before the end of the century. [Works in Progress]
• Very few people understand how difficult it was to build state capacity in the past. Others conclude that things like property rights, state capacity, and development happened easily, quickly, and automatically, and they can’t figure out why developing countries are having so much trouble. Peruvian economist Hernando de Soto spent 13 years visiting land registries in rich countries, asking the experts that worked there how their respective countries created functional systems of property rights. None of them knew; they all admitted to never having thought of the question. While De Soto was focused on property rights, in this piece we will examine the development of state capacity in Mexico. There are lots of definitions of state capacity, but here I mean the ability of the Mexican government to enforce the laws in all of its territories, to be able to tax its people, and to formulate and enact policies. [Works in Progress]
• Some scientific papers receive very little attention after their publication – some, indeed, receive no attention whatsoever. Others, though, can languish with few citations for years or decades, but are eventually rediscovered and become highly cited. These are the so-called ‘sleeping beauties’ of science. The reasons for their hibernation vary. Sometimes it is because contemporaneous scientists lack the tools or practical technology to test the idea. Other times, the scientific community does not understand or appreciate what has been discovered, perhaps because of a lack of theory. Yet other times it’s a more sublunary reason: the paper is simply published somewhere obscure and it never makes its way to the right readers. [Works in Progress]
• Another important takeaway is that not only may Europe have had close to the ‘Goldilocks’ amount of competition between states, but it also benefited enormously from the ability of states to copy the successful innovations of others through means other than through annexation, and a relatively unified collective intellectual culture. Waves of institutional innovations brought about by newcomers forced other states to adapt and learn if they wanted to survive, just as with useful and technological innovations. The introduction of parliaments, the rise of fiscal capacity, and later on executive constraints and the rule of law went hand in hand with enhanced military might, leading to a virtuous cycle of better governance coupled with larger shares in the market of governance. [Works in Progress]
  

Looking at the Magnificent 7

The "Magnificent 7" companies have replaced the "FAANG" stocks, which means that Netflix has been dropped from the growthy-tech investor zeitgeist and Microsoft, Nvidia, and Tesla have been added. The combined market capitalization of the Mag 7 is $14 trillion, which is equal to one-third of the total market capitalization of the S&P 500 companies ($43 trillion). 

That is a very high level of concentration in the top index picks, which means that the returns for the float adjusted, market capitalization weighted index that most index investors buy (SPY) will likely be meaningfully different than the returns on the equally weighted index (e.g. RSP). (The equal weight RSP is trading for 19x earnings versus 21.5x for the SPY.)

Since we are generalists at CBS, it is "our business to know" what is going on with everything, even the frothy Magnificent 7. I thought that we should take a look at the cash generation power of these businesses. What do you get for $14 trillion? How are the free cash flow conversion margins - are these actually good businesses - and what is the valuation (FCF/EV)?

Before I did that, I wrote down my subjective view of business quality or moat for each, on a one to five scale. I am a customer of five of the seven (i.e. all of them except Nvidia and Tesla). How hard would it be for me to fire them? How hard do I think it would be for a team of well-funded 10x engineers to disrupt them? 

Based on that framework, I think that Tesla is 1/5; clearly the worst. (It now has the smallest market capitalization by a significant margin, while it was once larger than Facebook.) I think that Apple is clearly the best, 5/5. I gave Nvidia 4/5 although I am not very familiar with the company or its products. I think that Microsoft, Amazon, and Google are 3s and Facebook is a 2. (Without Instagram, Facebook would be a 1.)

How did my subjective view line up with the numbers? Surprisingly well. Click the table below to enlarge:

Some observations that stand out:

Microsoft blew an entire quarter's revenue, $65 billion, on the acquisition of Activision. But even adding that back, Apple generated almost as much free cash flow ($34.5 billion) as the other six companies combined ($46 billion).

Apple has the second highest free cash flow margin (29% of revenue) of the Mag 7. Nvidia's was 46%, a tobacco-like margin. We know that Amazon is a low margin retail business, Tesla is a joke of course, but Microsoft and Google have very lackluster free cash flow conversion.

Google's stock based compensation (SBC) in the most recent quarter was equal to 30% of cash from operations, and capital expenditures were equal to 58% of cash from operations. (Or 6% of revenue and 9% of revenue, respectively, if you want to look at it that way.)

Apple spent only 8% of cash from operations on SBC in the most recent quarter (3% of revenue), and only 6% of CFO on capital expenditure (2% of revenue), leaving much more free cash flow.

We know that Google is an inferior business to Apple because Google pays a gigantic tithe to Apple. But notice that Apple's most recent quarter cash flow was running at a 5% yield on the enterprise value. That is much more attractive than the other companies in the Mag 7 (which otherwise seem quite expensive).

Apple seems to have the best combination of moat and valuation. If you had to own one of the Mag 7, Apple would be our choice, hands-down, based on business quality and valuation. (Maybe you do have to own one. How far from the S&P 500 index and its performance are you allowed to stray?)

Berkshire has $156 billion of Apple stock, just over a quarter of its own market capitalization. We do not like Buffett's energy pick, but we do like his tech pick.

Books - Q1 2024

• The Past is a Future Country: The Coming Conservative Demographic Revolution (4/5) See full Tom File review. Most important takeaway from book: "One way to look at the Sexual Revolution is as a powerful poison designed to eradicate human beings like bacteria in a petri dish by interrupting their natural reproductive ecology. Like an antibiotic, if the dose is insufficient to uniformly kill the entire population, any surviving members become resistant. Dutton then simply identifies the two populations who have successfully resisted the poison: highly religious, intentionally fertile families who reject the Sexual Revolution explicitly, and those who lack the self-control or conscientiousness to make use of its technologies to prevent unintentional pregnancies." Of the Big Five personality factors (which are heritable), he thinks that agreeableness is being selected for and neuroticism is being selected against, and points out that religious people (except converts!) are agreeable and low in neuroticism. Something else useful is that Dutton gives a good discussion of the moral foundations framework. Liberals are high in individualizing foundations and low in group-binding foundations. "As a result, [liberals] will tend to hijack the culture and push it leftwards, because conservatives can empathize with liberals while liberals cannot empathize with conservatives." Big point: "among those who have relatively high intelligence, religiousness and conservatism are crucial predictors of fertility... conservatism 'protects' IQ - it protects a large female brain from sterilizing her womb with leftist ideology."  Predicts that the world is going to have an over-population crisis of the vert stupid and very antisocial, and that the smart fraction will escape to civilizational bastions during a winter of civilization. (Is this why Musk wants to go to Mars? Another option might be to escape to El Salvador?) He doesn't think that what we are experiencing now is the result of anyone's 100 year plan. "Dogmatic conspiracy theorists tend to be of low socio-economic status, giving them a sense of powerlessness which is assuaged by the feeling that they have some gnosis about the nature of the world." "We would expect people, due to decreasing intelligence (and thus decreasing logical abilities) and increasing schizophrenia (due to higher mutational load) to be arguing that there was a Satanic elite that was going to succeed in enslaving us all." Points out something that I think explains Richard Spencer: "a portion of those on the 'far right' today may simply be contrarians... Being 'alt-right' is predicted, in part, by psychopathic personality traits, an element of which involves being attracted to and enjoying danger and simply taking pleasure in upsetting people." He says the biggest single predictor of supporting very left wing policy is "malicious envy".
  
• Simplicity Parenting: Using the Extraordinary Power of Less to Raise Calmer, Happier, and More Secure Kids (3/5) Without realizing it, this author actually gives a very similar message as Bryan Caplan in Selfish Reasons to Have More Kids (see CBS note). He is a Waldorf educator and one of the funny issues that he confronts is leftist parents who make their kids (and themselves) anxious and unhappy with things like CNN/MSNBC propaganda and climate alarmism. The type of people who say they are "raising a citizen of the world." This book builds on the previous Dutton book in a funny way because that is the perfect example of a neurotic leftist behavior that is being selected against and will go extinct. He discusses four levels (really, areas) of simplification of family life: the environment, rhythm, schedules, and filtering out the adult world. Regarding toys, he asks, "is this a toy my child can pour their imagination into, or is it too 'fixed'?" It is a bit alarming to see what has happened with LEGO toys but it is still possible to just buy the blocks and leave room for creativity. Here's agreement with Simon Sarris: "Children love to be busy, and useful... A wonderful counterbalance to 'entertaining' children is to involve them in a task, in the 'work' of family life." "Infants thrive on closeness; they're most soothed and happy in some form of warm embrace. Toddlers want to play - even if they're playing alone - where they can see and be near others. You've noticed their preference for right under your feet. Sometimes rooms in the house need to be shifted for the early childhood years, so that a play space is made near the kitchen or the heart of the house." "Children who've had a role in preparing a meal assume ownership of it." "Schedules can be simplified tremendously just by emphasizing free play over organized sports..." Naturally he's not a fan of screens (see Tom File on screens), but suggest that it applies to the parents as well. "Everyone is distracted when one member of the family is distracted. Even if the kids don't have their own cellphones, they understand when they have someone's attention and when they don't." (Waldorf is very strong on smartphones.)
  
• Wind Energy Comes of Age (3/5) This was written in 1995 by wind energy advocate Paul Gipe to make the argument that wind power was ready for prime time. It has some good sections on the physics of wind and especially some of the physics based tradeoffs that go into designing a wind farm and picking the right turbines to use. Gipe thought that medium sized (e.g. half-megawatt) turbines were going to win out. There was a physics-based argument for this: the square-cube tradeoff. The energy captured by the rotor (blades) is proportional to the square of the length (since it's based on area), but the volume of the blades and other parts (like the turbine) are proportional to the cube. So the cost of the blades, turbine, and tower increases faster than the value of the energy produced as the blade length and rotor area gets longer. What has ended up happening, though, is that manufacturers have gotten better at building the different parts and systems (learning curves), and so the optimal blade length and rotor area has trended up. So a 40 meter modern blade might weigh the same about as a 30 meter older blade, which allows the optimal size rotor area and turbine to be bigger. This is another instance of the tension between physics-based pessimism about natural resources and economics-based optimism (cornucopianism). Speaking of wind energy, there is an Oddball Stock called Aztec Land & Cattle Co., Ltd. (AZLCZ) that owns about a quarter-million acres in northern Arizona. There is going to be at least one wind farm on their property, starting with a 500 MW project that is being built by AES called the West Camp Wind Farm. The turbines are going to be Vestas V150 (each 4.5 megawatt) which have 74 meter long blades. The area of the circle swept by them is 190,000 square feet -- 4.4 acres! So in some ways, Gipe underestimated the progress that wind energy was going to make. These turbines are an order of magnitude larger than what he thought would be optimal. On the other hand, you still don't see wind power happening without subsidies. The production tax credit of 2.6 cents/kWh was recently extended. There are also manufacturing tax credits for U.S. manufactured wind energy components such as blades, nacelles, and towers. As the landowner, Aztec will get a royalty on the electricity sold by the WCWF, so it is agnostic about the ultimate economics (subsidized or unsubsidized) of the project. (In fact, if renewable energy boondoggles cause the wholesale price of electricity to rise it will benefit Aztec.)
  
• From Bauhaus To Our House (5/5) There's a theory that Tom Wolfe is one of the writers (perhaps, THE writer) of our simulation. How else could he have been so prescient and why else would our universe now be striving for the most ironic outcomes? Wolfe does not say this explicitly, but modern architecture (e.g. Walter Gropius and his Bauhaus school in Weimar) was Marxist. The goal of this architecture was to be "nonbourgeois," which like everything else in Marxism was an attack on normal people. Also, and again this is a consistent theme of Marxism and communism, the buildings didn't work. Example: "It had been decided, in the battle of the theories, that pitched roofs and cornices represented the 'crowns' of the old nobility, which the bourgeoisie spent most of its time imitating. Therefore, henceforth, there would be only flat roofs; flat roofs making clean right angles with the building facades. No cornices. No overhanging eaves. These young architects were working and building in cities like Berlin, Weimar, Rotterdam, Amsterdam, at about the Fifty-second Parallel... At this swath of the globe, with enough snow and rain to stop an army, as history has shown more than once, there was no such thing as a functional flat roof and a functional facade with no overhang. In fact, it is difficult to imagine where such a building might be considered functional outside of the Painted Desert. Nevertheless, there was no turning back from the flat roof and the sheer facade. It had become the very symbol of non-bourgeois architecture. No eaves; so that very quickly one of the hallmarks of compound work, never referred to in the manifestos, became the permanently streaked and stained white beige or stucco exterior wall." Also: "The brutal fact of life was that it was difficult for [modernist] architects to get work unless there was a government - usually socialist - that had decided, in effect: We need a new look around here, and you fellows have one." So, ugly architecture is not the free market outcome in many cases! The further capital is from having a responsible owner, the more likely it is to build hideous modernist structures. Is Bauhaus where minimalism came from?: "They had open floor plans, ending the old individualistic, bourgeois obsession with privacy. There was no wallpaper, no drapes... no more 'luxurious' rugs and carpets. Gray or black linoleum was the ticket." So minimalism is an expression of Communist poverty, and the observation flooring reminds us of the current, bleak, grey "luxury" vinyl flooring that pervades all new home construction and renovations now.
  
• What I Learned About Investing from Darwin (3/5) Thought this would be interesting since I have been interested in the intersection of evolutionary theory and investing, but it was underwhelming. A few things that stuck with me - not saying I agree with them unequivocally but food for thought. "Not having high leverage probably makes sense to everyone. But the following may not: I am an advocate of no leverage. More than 90 percent of our portfolio companies have - and have always had - excess cash." He points out that a few years ago we had a bubble in electric vehicle startups, counting seven new companies that IPOd. "I don't know if the IPOs of these companies increased the interest level in the search term or whether the increased searches of 'electric vehicles' were a leading indicator of public listings. Maybe they just fed each other in a positive feedback loop. Whatever the case may be, as you can see, there is a strong correlation between the theme of electric vehicles and the IPOs..." Discussion of reasons for fund manager under-performance - he thinks a big reason is low active share. Important quote from Darwin that's worth repeating: "Every being, which during its natural lifetime produces several eggs or seeds, must suffer destruction during some period of its life, and during some season or occasional year; otherwise, on the principle of geometric increase, its numbers would quickly become so inordinately great that no country could support the product. Hence, as more individuals are produced than can survive, there must in every case be a struggle for existence. Either one individual with another of the same species, or with the individuals of distinct species, or with the physical conditions of life." His investment approach is to search for companies with high return on capital employed (ROCE). So - even though he doesn't mention this - he is betting against mean reversion. His basic view: "[G]reat businesses maintained their greatness over a very long period. Stasis was the default for them. Once we own such a business, selling would border on being sinful."
• Birdseye: The Adventures of a Curious Man (3/5) This is by Mark Kurlansky, a prolific author of such books as Salt and Cod. Birdseye invented a good process for freezing food and then sold his company to Marjorie Merriweather Post, who had inherited her father's Postum Cereal Company. (She spent $7 million in the mid-1920s building Mar-a-Lago in Palm Beach.) Kurlansky says that he says he decided to write about Birdseye because he turned up in his Salt and Cod books as well as his history of Gloucester. Key point: "Birdseye greatly contributed to the development of industrial-scale agriculture. He even worked with farmers to make their products more suitable for industry. But unlike people today who have grown distrustful of big business, for Birdseye, a product of the zenith of the Industrial Revolution, 'industry' was always a good word, without negative connotations. Today's locavore movement - the movement to shun food from afar and eat what is produced locally - would have perplexed him. Why, Birdseye would have wondered, would you want to be limited by local production when the food of the world is available." "It would have made little sense to Birdseye to prefer small artisanal farms with low and inconsistent yields to the miracles of agribusiness." Another Birdseye concept - he "developed a pet theory that the subconscious resembled an electronic calculating machine. 'If you feed the right information into it, it will quietly go to work in mysterious ways of its own and, by-and-by, produce the answer to your problem.'"
• The Coming Boom: Economic, Political and Social (3/5) Edward Dutton (author of The Past is a Future Country, above) does not believe what we are experiencing now is the result of anyone's 100 year plan. But there is some kind of permanent deep state, and we know some of the people who helped to form its ideas in the past. An example is Herman Kahn, a futurist who worked for the RAND Corporation and helped formulate the strategy of nuclear deterrence. He wrote this book predicting a boom in 1982, which was early in Ronald Reagan's first term and absolutely prescient timing to predict a boom. The yield on the ten year treasury had just hit its all time high of 15.8% in September 1981, and 1982 was the beginning of a generational bull market in stocks and bonds that has lasted for more than 40 years. This paragraph gives a good sense of how Kahn thought: "At present, almost all schools in the advanced capitalist nations teach that the world is running out of resources, that our grandchildren will not live as well as we do because of the reckless use of nonrenewable resources for frivolous purposes, that the environment is being polluted beyond repair and the ecology being destroyed, and that industry is increasingly producing products that give consumers and workers cancer. All of the above are either completely or largely false. One might well ask what kind of a price these countries will have to pay for teaching this kind of insidious and invidious nonsense to the younger generation." Kahn is thus really interesting because he was a physicist but his beliefs were economist-cornucopian. He thought that problems that were less than existential could likely be solved through ingenuity or substitution, and the real meta-problems were pessimism and attitudes of anti-prosperity. In the same way that the election of Reagan sparked a boom by changing the attitude from Democrat malaise (Democrat presidents from 1933 until 1981 interrupted only by Eisenhower and Nixon/Ford, and Nixon had a Democrat congress his entire presidency), if Trump is put back in office we could experience another boom.
  

Wednesday Night Links

• During wartime the British would suspend the convertibility of bank notes with the promise to restore convertibility at the previous parity after the war. This allowed the Bank of England to help finance the war with note issuance without the fear of a wave of redemptions at the Bank and a drain of its gold reserves. In addition, the commitment to restore the previous parity was equivalent to a promise to offset any inflation created during the war from note issuance with a corresponding deflation after the war. Many people, including many economists, have criticized this practice since the policy-induced deflations were particularly costly. They argue that after the war it might be best to let bygones be bygones and simply devalue the unit of account to avoid the costly deflation. However, if one recognizes the state’s desire for emergency financing, it is obvious that this commitment to restore the previous parity is necessary for long-term emergency financing. Without that commitment, money demand would decline over time in anticipation that the currency would be permanently devalued in an emergency and this would make it difficult for the state to use the same tool of emergency finance in the future. [Economic Forces]
  
• Ferran Adrià, the legendary chef of El Bulli, once said that Mao was the most consequential figure in the history of cooking because: “[Spain, France, Italy and California] are only competing for the top spot because Mao destroyed the pre-eminence of Chinese cooking by sending China’s chefs to work in the fields and factories. If he hadn’t done this, all the other countries and all the other chefs, myself included, would still be chasing the Chinese dragon.” [Mr. and Mrs. Psmith’s Bookshelf]
• Take, for example, the 15-minute city, which is a radical proposal that people should be able to get pretty much anywhere they need to go within fifteen minutes and ideally without needing a car. It’s a lovely idea, and the parts of residential America that are like that — most of them former suburbs — are insanely desirable and therefore insanely expensive. If it were easy to make more of them, you’d think the market would have figured out how! And if I had any confidence whatsoever that anyone involved in municipal planning could produce more neighborhoods like that — leafy green places full of parks, libraries, schools, and shops — or even that they wanted to have safe, clean, and reliable transit options, I’d be all for it. But these are the same people who are gutting public safety in the cities while failing to maintain or enforce order on existing transit. These are the same people who imposed draconian Covid mitigation policies like Zoom kindergarten, padlocked churches, and old people dying alone with nothing but a glove full of warm water to mimic human touch, all of which were meant to buy time for…something (human challenge trials? nationalized N95 production?) that never happened. It’s easy to ban things; it’s hard to do things. So you’ll excuse my doubts about their ability to build a 15-minute city that looks like Jane Jacobs’s ideal mixed-use development, with safe, orderly streets and a neighborhood feel. One rather suspects they would find it far more within their wheelhouse to simply abolish single-family zoning or imposing restrictions on who can go where, when. [Mr. and Mrs. Psmith’s Bookshelf]
• Charles Town (later Charleston), South Carolina, modeled on the capital of Barbados, was filled with theaters, taverns, brothels, cockfighting rings, private clubs, and shops stocked with goods imported from London. Life in the city was a constant churn of social engagements, signalling, and status competition: in 1773, a pseudonymous correspondent wrote in the South Carolina Gazette that “if we observe the Behavior of the polite Part of this Country, we shall see, that their whole Lives are one continued Race; in which everyone is endeavouring to distance all behind him, and to overtake or pass by, all before him; everyone is flying from his Inferiors in Pursuit of his Superiors, who fly from him with equal Alacrity…” [Mr. and Mrs. Psmith’s Bookshelf]
• To a certain way of thinking, after all, cities are where you get culture, like live theater and fusion cuisine and $20 cocktails; they’re where you get cool parties and bodega cats and the other essential elements of twenty-first century self-actualization. Children interrupt all that: they’re a weird time-consuming hobby, like building model railroads or running ultramarathons, so the suburbs, which are full of children, are a sort of ticky-tacky storeroom for humanity either larval or on hold. Suburbs are where interesting people go once they have kids and cease to be interesting. But if you regard children as not just a lifestyle choice but part of becoming a human being, if you believe that creating a home for your family is not drudgery but a valuable undertaking, then you begin to see the point of even an exurban subdivision. (Though I still like sidewalks.) [Mr. and Mrs. Psmith’s Bookshelf]
•  My startup Terraform Industries looks to apply solar to produce synthetic fuel, consuming substantial amounts of land (though less than agriculture) in the process. Something like 2 billion acres, or 7% of Earth’s land surface area, would be sufficient to provide every man, woman, and child on Earth with US levels of oil and gas abundance and commensurate prosperity. It’s possible to imagine a future where people consume even more than that – widespread personal supersonic transport, for example – but ongoing conversion of land use away from intensive industrial agriculture toward inherently more productive solar synthetics is a clear net win for the environment. [Casey Handmer]
• The “Yale or Jail” mentality that shuffles moderately intelligent people who would make excellent craftsmen into low-earning degrees at noncompetitive colleges7 gives unearned status to many of those who work at computers in air conditioning. Status is a substitute for cash in human economies, leading to an oversupply of white collar workers, and the cultural rot is continually reducing the number of working-class people who are employable. I predict that wages for people doing physical work will increase substantially in the coming decade, and ironically it may be these workers who have the most leverage to improve their working conditions. [The Tom File]
  
• So why is strong government less appealing these days? Well, COVID happened. And our governments were pretty damn strong in dealing with it. They made strong laws and enforced them. And what did they do with their power? Absolutely retarded shit. They destroyed the world economy and made 95% of people completely miserable for 18 months. Up to 3 long years in some places. Again, as an Orient enjoyer I was very sympathetic of strong, effective government. My life has been pretty cozy thanks to it for the past decades. But after seeing boomers, hypocondriacs and neurotic menopausal women take the reins and use it against healthy people, I'm fucking done with strong effective government. [Spandrell]
• Battery demand is growing exponentially, driven by a domino effect of adoption that cascades from country to country and from sector to sector. This battery domino effect is set to enable the rapid phaseout of half of global fossil fuel demand and be instrumental in abating transport and power emissions. This is the conclusion of RMI’s recently published report X-Change: Batteries. In this article, we highlight six of the key messages from the report. [RMI]
• All we have managed to do halfway through the intended grand global energy transition is a small relative decline in the share of fossil fuel in the world’s primary energy consumption—from nearly 86 percent in 1997 to about 82 percent in 2022. But this marginal relative retreat has been accompanied by a massive absolute increase in fossil fuel combustion: in 2022 the world consumed nearly 55 percent more energy locked in fossil carbon than it did in 1997. [JP Morgan]
• Let’s do a first principles-based bottoms up cost estimate. What is the Platonic ideal of a solar array? An array needs a 50 um thick layer of silicon to be fully opaque, and perhaps 100 um of necessarily flexible plastic “backing” material to provide mechanical support. Throwing in power cabling and installation rigs, I expect the installed cost of solar arrays to fall to $30,000/MW within 15 years, again with no miracles required. This is roughly 10x cheaper than the current cheapest costs. If we’re prepared to consider the implications of materials science wizardry – essentially expanding the class of known manufacturing techniques to include arbitrary configurations of known elements, a solar array could be made that’s even thinner, lighter, and cheaper, or even self-assembling. But even without such science fiction, existing manufacturing techniques will be extended to give us at least another decade of steeply falling costs, along with commensurate additional installations. The market will demand it and industry will provide. [Casey Handmer]
• Your particular contribution is to pluck a worthy idea from the infinite sea of possibility, to determine how it must take form in the physical world, and to contrive a way to connect it to the engine of capitalism so it can generate self-sustaining wealth and value for its users. [Casey Handmer]
  

Earnings Notes V (Q4 2023)

[Previous earnings notes for Q4 2023: I, II, III, and IV.]

Franco-Nevada Corporation (FNV)
As you may recall from our notes last year on Rise of the Mining Royalty Companies, Franco-Nevada was the original mining royalty company, and is the largest, with a $20 billion market capitalization. Newmont acquired Franco-Nevada in 2002 and spun it back out in 2007.

FNC gets 64% of revenue from gold, 17% from oil and gas, 10% from silver, 5% from "other mining," and 3% from PGM metals. The revenue mix is 32% Canada and U.S., 30% South America, and 26% Central America and Mexico. Unfortunately, their biggest asset, the Cobre Panama mine in Panama which is operated by First Quantum Minerals, is currently on preservation and safe maintenance because of a political dispute.

FNV has net cash on the balance sheet, so the enterprise value is $18.5 billion. For 2023, revenue was $1.2 billion and cash from operations was $985 million. (So the OCF/EV yield is 5.3% and the OCF margin is 82% of revenue.) They spent $520 million on acquisitions of new interests and paid $233 million of dividends. (A 1.2% dividend yield.) General and administrative expense is only 2% of revenue.

Note that FNV's average selling price for gold in the fourth quarter was just under $2,000/oz and it comprised 66% of their revenue, but the price of gold just hit $2,200/oz.

Costco Wholesale Corporation (COST)
Look at a chart of Costco - it's like a meme stock. Even after a post-earnings (fiscal Q2 2024 release) selloff, it is still up 50% (not including dividends) over the past year. The market capitalization is now $324 billion. 

Total revenue was up 5.7% year-over-year, and comp sales in the U.S. (adjusted for gasoline price changes) were up 4.8%. Operating income for the quarter was up 8.4%, to $2.1 billion. (Note that membership fees for the quarter of $1.1 billion are equal to 54% of operating income.) Operating cash flow for the first half of fiscal 2024 has been $5.4 billion. The company spent $2.1 billion on capex (new stores) and paid shareholders $8 billion of dividends.

So the shares are pricey, but growth is good.

OTC Markets Group Inc. (OTCM)
This is an idea for a royalty-like business that is not as expensive as a business of similar quality (e.g. Intercontinental Exchange) because it is smaller. In the fourth quarter, OTCM had an operating income margin of 35% of its revenue less transaction based expenses. The market capitalization is currently $670 million and the enterprise value $638 million.

Free cash flow for 2023 was $31.5 million, a 4.9% yield on the enterprise value. (If you subtract stock based compensation, the FCF is only $25.6 million, a 4% yield on the EV.) Last year, the company returned $26.5 million to shareholders via dividends and $3.4 million via repurchases, which is a shareholder yield of 4.5%.

One concern is that growth has not been great recently for how expensive the stock is. The free cash flow has been lower each of the past two years. However, if you look back five years (to 2018), net revenue then was $56 million (vs $101 million last year), free cash flow (excluding SBC) was $20 million (vs $26 million last year) and shareholder returns were $15 million. So free cash flow was only up 30% in five years, not nearly as good as Enterprise Products Partners (for example).

Petróleo Brasileiro S.A. (PBR)
Our guest writer @pdxsag first wrote about Petrobras for us last June when it was trading for $12.25 per share, an $85 billion market capitalization and an enterprise value of $118 billion. At the time, their recent quarter's free cash flow was $7.9B for a FCF/EV yield of 27%. The market capitalization (at $15 per share) is now $97 billion and the enterprise value is $124 billion. Last year (see results), Petrobras generated cash from operations of $43 billion and had $12 billion of capex, for free cash flow of $31 billion. They paid $19.7 billion in dividends and repaid $10 billion of debt. (A FCF/EV yield of 26% and a shareholder yield of 20%.)

Petrobras shares were down 10% on March 8th after some alarming comments from the company about reducing dividends to invest in an energy transition. Is it worth investing in a country where you would not want to drink the water just to get a bit higher free cash flow yield than you can get on Canadian oil sands?

Natural Resource Partners L.P. (NRP)
Let's start with the highlights from NRP's Q4 2023 conference call:

*Years of hard work and persistence are paying off. The business is generating robust levels of free cash flow, the capital structure is solid and our financial outlook is much improved. As of today, our total remaining obligations, which include debt, preferred equity and warrants, stand at approximately $270 million, a 40% decrease from just 1 year ago. I would like to express my sincere thanks for the support of our employees, external stakeholders and Board of Directors, without which none of these results would have been possible. We retired $178 million of preferred equity at par in 2023 and settled 1.5 million warrants, both with cash. And early this year, we settled an additional 1.2 million warrants utilizing cash and common units. There are two factors we consider when deciding whether to settle warrants with cash or common units: First, do we have ample liquidity, which we define quite conservatively, I might add; and second, is the market value of the common units less than our estimate of intrinsic value? If the answer to both of those questions is yes, we settle with cash. While we will not comment specifically directly on our view of intrinsic value, I will say that it was our inability to answer yes to the liquidity question that caused us to issue units to settle a portion of the warrant exercises early this year. We continue to add additional bank revolver capacity that will provide financial flexibility to settle warrants with cash and accelerate redemptions of preferreds.

*We received $81 million in cash distributions from Sisecam Wyoming in 2023, which is the highest annual amount of regular distributions we've ever received. This result was driven by record high sales prices, both domestic and export during the first half of the year. Unfortunately, global soda ash export prices fell significantly in the back half of the year as new low-cost soda ash supply came online in China, Turkey and the United States. We expect 2024 to be a challenging year as global soda ash markets absorb significant new production volumes, a process that we believe will take several years to complete. Cash distributions to NRP will adjust accordingly as profit margins compress due to the combination of lower sales prices and inflation-driven cost increases. Despite the current headwinds facing the soda ash industry, our long-term view of our investment in Sisecam Wyoming has not changed. We are one of the world's lowest-cost producers of a product that has favorable long-term fundamentals, driven by urbanization, the megatrends for renewable energy and the electrification of the global auto free fleet.

*You are right in what you summarized initially that at our current run rate that it's not too long before we get to the point where we're obligation free. But I don't want to speculate now on what we would do in 1.5 years, 2 years from now if we had excess cash. I can tell you at this point in time, we don't see opportunities in the market. If we were in that theoretical situation where we had excess cash today, they are not on the horizon overly attractive opportunities to deploy capital. That being said, I will point out that we are focused on the task at hand right now, and we're not out beating the bushes for places to deploy capital. I think you can rest assured that we are going to be quite thoughtful about anything we do with respect to deploying capital in any manner other than distributing it out to unit holders. 

At the current unit price of $92, the market capitalization is $1.2 billion (using the February 2024 unit count and not the year-end). They have spent $55.7 million repurchasing warrants in Q1 2024 and have hopefully earned about the same amount from two months of cash flow. If that is the case, the enterprise value is currently around $1.4 billion. Last year's free cash flow of $313 million represents a 22% yield on the enterprise value.

Canadian Natural Resources Limited - 2023 Earnings ($CNQ)

[Previously regarding Canadian Natural Resources Limited (CNQ).] 

An outstanding year from the titan of the Canadian energy industry. Some key highlights from the results (dollar figures in USD):

• CNQ achieved its target net debt level of $7.4 billion in Q4 2023 (slightly earlier than their forecast of Q1 2024). This means that they will target 100% return of free cash flow to shareholders via dividends and buybacks.
• Capital expenditures were 4.7% lower in 2023 than in 2022, yet production of liquids was up 4.3% and total production (including natural gas) was up 4%. They averaged 974k bbl/d for the full year and 1.05 million bbl/d in Q4.
  
• Out of $9.1 billion of cash from operations, $5.6 billion of capital was returned via share repurchases, dividends, and debt repayment, and $3.6 billion was spent on capex. The share count was 2.8% lower year-over year.

The current market capitalization of CNQ (at a $75 share price) is $75 billion, and the enterprise value is $82.5 billion. Cash from operations for the fourth quarter was $3.6 billion and the company spent $722 million on capital expenditures. The remaining free cash flow for the quarter was $2.9 billion, of which $450 million was used for debt repayment, $1.15 billion was used for share repurchases, and $725 million was used for share repurchases. The free cash flow yield on the enterprise value was 14% and the shareholder yield was 12% (both based on the quarter's results annualized).

This was during a quarter with an average WTI price of $78. In its latest investor presentation, CNQ says that free cash flow per share would be 40% higher at $95 WTI than at $80 WTI. Notice also on slide 8 of the presentation, CNQ management points out that oil sands mining and upgrading requires much less capital expenditure to maintain production than shale. They call this the "long life no decline advantage".

The net present value of future net revenues, before income tax, discounted at 10%, is $78 billion for proved developed producing reserves and $138 billion for total proved plus probable reserves.

This is very speculative, but if WTI did go back to $95, that implies that the shareholder yield would be 16.8%. If that happened and investors decided to value CNQ, with a 40+ year reserve life, more like a "quality compounder" (such as Marriott or Visa) at a 4.2% shareholder yield, shares would quadruple. (We have observed in the past that investors double count: low multiples when things are bad, high multiples when things are good.)