Friday, April 29, 2022

PrairieSky Royalty Ltd. Reports Q1 2022 Earnings ($PREKF)

Prairie Sky Royalty (PREKF, PSK.TO) is a pure-play royalty company, generating royalty revenues as petroleum and natural gas are produced from their 18.2 million acres of royalty properties spanning Western Canada from Northeast British Columbia to Western Manitoba. They have the largest independently owned portfolio of fee simple mineral title and oil and gas royalty interests in Canada.

The land that they own came from Canadian Pacific Railways, which was given a checkerboard pattern of land along its railway right-of-way from Winnipeg to British Columbia. They were granted 25 million acres of land, including mineral rights, in exchange for building the road. Later, the railway created Canadian Pacific Oil and Gas Limited, which became PanCanadian Petroleum Limited through a merger with Central Del Rio Oils Limited, and then Encana when PanCanadian merged with Alberta Energy Company. In 2014, Encana divested Prairie Sky Royalty, which grew even further in 2015 when it acquired a substantial portion of Canadian Natural's royalty assets.

The IPO price of Prairie Sky was $28, and it now trades at $14 (figures in USD), having paid $5.85 of dividends to shareholders along the way. However, management has made repurchases, with the result that acreage per share has grown since the IPO. This is a metric that management includes in its investor presentations, and it has grown from 0.04 acre/share at IPO to about 0.07 acre/share today, an 80% increase in acreage per share. That means that an investor is paying about $200 per mineral acre. Here is how the company describes its reserves replacement since the IPO:

The investor presentations of Prairie Sky are high-class, exactly what you would want to know as a shareholder. They actually include a chart showing their FCF multiple compared to Texas Pacific Land over time. And here is another stunning slide:

Their projection in February 2022 (above) was that if they can get 23,000 BOE/d of production at $75 WTI over the next decade, they would be able to reduce their share count by 90% over the next ten years if the share price remained at $13.50 (near the current level).

The market capitalization of Prairie Sky (at $14 per share for the U.S. ADR) is $3.3 billion. During Q4 2021, the company had funds from operations of $102 million. That was with an average WTI price of $77 per barrel and a $14.64 discount to WTI for Western Candian Select crude oil. The president Andrew Philips had this to say about the 2021 annual results:

Strong commodity pricing drove increased third-party operator activity on PrairieSky’s Royalty Properties in the second half of 2021, with 193 wells spud in Q3 2021 and 166 wells spud in Q4 2021. The increase in activity on our lands is starting to be reflected in PrairieSky’s Q4 2021 royalty production volumes which increased to 20,340 BOE per day, with oil royalty production volumes increasing to 8,311 barrels per day, a 10% increase over Q3 2021. Royalty production growth coupled with strong benchmark pricing for both oil and natural gas generated record funds from operations of $101.8 million in Q4 2021, a 148% increase over Q4 2020 and a 54% increase over Q3 2021.

PrairieSky added approximately 3.0 million acres of incremental royalty lands and associated production in 2021, including closing the acquisition of 1.9 million acres of royalty lands and complementary seismic from Heritage Royalty for cash consideration of $728 million (the “Heritage Acquisition“). The Heritage Acquisition was effective December 31, 2021 and therefore the production and revenue information for Q4 2021 and annual 2021 only includes one day of contribution from the acquired assets. At the time of announcement of the Heritage Acquisition on November 29, 2021, PrairieSky estimated current royalty production of 2,700 BOE per day (92% liquids), from which PrairieSky expected to generate approximately $65 million of royalty revenue in 2022 (assuming a West Texas Intermediate (“WTI“) price of US$68 per barrel compared to current prices of over US$80 per barrel). Since closing of the Heritage Acquisition, PrairieSky has been actively leasing undeveloped land in multiple oil weighted plays. While the full benefit of the incremental production volumes, associated revenues and any other revenues from the Heritage Acquisition will first be included in the Q1 2022 results, PrairieSky’s 2021 annual current income tax expense was reduced through the use of the acquired income tax pool deductions resulting in a current income tax recovery of $12.4 million in Q4 2021.

Our Q4 2021 and 2021 annual results demonstrate the benefits of our high margin business model. We anticipate 2022 will be an active year in Canadian energy including drilling on PrairieSky’s Royalty Properties. We expect to benefit from this activity through strong royalty production volumes without any incremental capital investment. Effective for the March 31, 2022 record date, PrairieSky will pay an annualized dividend of $0.48 per common share ($0.12 per common share per quarter), an increase of 33% from the current dividend. Under strip commodity price assumptions, PrairieSky expects to accelerate debt repayment including retiring all of the debt used for the Heritage Acquisition over the next 24 months.

Prairie Sky just reported results for Q1 2022. Some highlights:

  • "Royalty production averaged 23,892 BOE per day, representing a 17% increase over Q4 2021 and a 23% increase over Q1 2021."
  • "Achieved record quarterly funds from operations of $105.0 million ($0.44 per common share basic and diluted), a 3% increase over Q4 2021 and a 115% increase over Q1 2021 driven by a combination of royalty production growth, 2021 acquisitions and strong commodity pricing."
  • "Declared a first quarter dividend of $28.7 million ($0.12 per common share), representing a payout ratio of 27%, with remaining cash flow allocated to $6.3 million of royalty acquisitions and the balance to retiring bank debt."
  • "The differentiation of our business model is evident in an accelerating capital environment as we lease our vast underdeveloped land base to qualified, well-capitalized industry partners. PrairieSky believes leasing is a leading indicator of future third-party drilling activity on our lands and organic per share growth in royalty production. During Q1 2022, PrairieSky generated $3.5 million in bonus consideration by entering into 52 distinct leasing arrangements with 43 different counterparties. Following a busy second half of 2021 when 359 wells were spud on PrairieSky’s royalty properties, Q1 2022 was another active quarter with 194 wells spud, including 168 oil wells and 26 natural gas wells, almost double the 100 wells spud in Q1 2021."
  • "Our record Q1 2022 funds from operations of $105.0 million reflects the benefits of our high margin business as PrairieSky remains insulated from direct cost inflation in the upstream sector. Our unhedged royalty production received strong netbacks including $4.20 per MMcf for natural gas, $97.99 per barrel for crude oil and $55.66 per barrel for natural gas liquids ("NGL") which drove record quarterly royalty production revenue of $134.7 million."
  • "Cash administrative expenses totaled $10.3 million or $4.79 per BOE and included the annual cash payment of long-term incentives for staff and executives of $5.0 million (2021 annual LTI payment - $0.7 million for staff and $nil for executives as performance share units expired unvested due to share price performance). PrairieSky expects cash administrative expense per BOE to be below $3.00 per BOE for 2022."

Prairie Sky has net debt of $450 million, so the market capitalization (at $14 per share for the U.S. ADR) is $3.3 billion and the enterprise value is $3.75 billion. The earnings yield, based on Q1 2022 income annualized, is 7.7%

Earnings include a big charge for depletion. More interesting is to look at funds from operations of $105 million, which adds that back, and gives an 11.2% FFO/EV yield

It is quite impressive, considering how much of Prairie Sky's acreage is still undeveloped, and how good the capital allocation and corporate governance is. 

Prairie Sky has 18.3 million acres of mineral rights in Western Canada, which means an enterprise value of $200 per acre. Acres per share have grown to almost 0.08. The latest investor presentation has a good chart of production per share:


Proved and probable reserves leapt by 37% over year-end 2020 because of more acreage and higher commodity prices. 

Since the current earnings and FFO/EV yield are attractive enough to justify the current price, you are getting quite a lot of future production "for free". Stacking barrels.

It seems like the big question for the "dying industry" value strategy right now is: how much of the tobacco stocks (i.e. Altria and Philip Morris) are optimal to given the higher valuations than the oil and gas investments? 

It probably depends on how confident you are that oil will be $100/bbl, not $50 or $75, over the coming years. The tobacco companies may be a good portfolio diversifier as well, in that lower oil prices would increase consumers' discretionary spending ability, and probably help sales.


Anonymous said...

Q1 conference call:

Combined with an almost double-digit free cash flow yield in some of the strongest growth rates in the industry, PrairieSky provides a strong total return proposition at a very low risk.

Two new major oil discoveries were announced subsequent to quarter end on our undeveloped Clearwater acreage. These include Utikuma Lake and McLeod Lake. This further highlights the optionality associated with large undeveloped land basis that is a differentiating factor when owning PrairieSky shares.

In 2022, we will have exploration wells drilled for both helium and lithium carbonate, both opportunities are on PrairieSky fee title lands. Our large-scale CCUS project in Meadowbrook received initial approval from the Alberta government and we look forward to continuing to advance this opportunity with our project partners.

Anonymous said...

Harshit Gupta
Good morning, everyone. Congrats on another strong quarter. I just wanted to first ask about the hedging strategy. Do you guys still want to go and hedge looking at the commodity prices where they are? Or you are looking at some strategy over there to hedge some of the production in the coming quarters?

Andrew Phillips
Yes. Thanks for the question, Harshit. I think the -- we're very consistent with hedging. We've never hedged since our IPO and we're not protecting capital programs because there are 0 and our debt is coming down at a very quick pace. And ultimately, we view it as speculating with investors' capital. And I think longer term, we are one of the few companies that give pure exposure to unhedged, unlevered oil and gas in Western Canada with no operational leverage. So we'll plan to keep it that way.

viennacapitalist said...

Thanx for the write up, I might swith my TPL position for this one on valuation grounds.
This things looks cheap on an absolute return level and is the perfect long term holding.
However the following thought crossed my mind:
We are used to think of royalty companies as superior (in terms of risk) relative to upstream producers.
However, is this still true when you look at the oil sands and assume disciplined managment and no need for growth capex, given the long reserve life?
What's the difference in risk between an upstream business with minimal growth capex and a pure royalty play? Probalby not much (or I am overlooking something)
The FCF YIELD of PREKF @ 75 USD oil is around 9 percent p.a. according to managment
There are junior Canandian oil sand producers that (, that have FCF Yields north of 20 percent at WTI 75.
This is a much higher reward for what it seems not much higher risk (provided managements stay disciplined)
Is there really that much more risk in the later, or are they still the better

CP said...

It's a good question.

An "upstream business with minimal growth capex [versus] a pure royalty play" - this is why I have said that the oil sands are "royalty like":

Oil sands are almost royalty-like, in the sense that (a) the capital costs are front loaded, unlike drilling wells, so they should benefit more from inflation than an E&P and (b) they have decades of sands to mine, so you avoid the forced reinvestment at inopportune times.

A royalty is basically a business with zero cost of goods sold. So the higher the gross margin goes, the more royalty-like a business is. A toll bridge is also royalty-like for the same reason.

It may be prudent to diversify, though. The oil sands are all in Canada, for one thing. (Of course, so is Prairie Sky.) Owning royalty-type interests in the U.S. reduces the geographical concentration.

Viannacapitalist said...

True, I remember now that you mentioned the similarity to royalty companies.
Agree on the diversification part. Have you looked at some LATAM plays for that purpose? You get an EM Discount in additon to the valuation discount and the ESG risk is certainly lower there. Look at Geo Park limited, a position of mine.

Now that we have established that these things are dirt cheap, the most important question remains: how much of one's net net worth should one put into these things?
Given that I (wrongly) see very limited donwside, I am constantly tempted to go "all-in", but I hesitate since I would like to understand the downside better, but am strugling with the analysis.
I it better to diversfy across the spectrum (integrated, up stream, etc) and a larger exposure, or is it better to have somewhat less exposure and take more risky junior upstream pure plays?
I am strugling with answers to these questions...

Viennacapitalist said...

Something went wrong with my comment, so I try again.

True, now I remember how you mentioned the similarties between royalties and Canadian Oil sands - very good insight.
As for the diversification: have you looked at LATAM juniors? I have fond intereting things like Geopark Ressources - very good managment presentations and fundamentals.
Here is my problem: I am struggling with how much of my net worth to put into this. Since I see (wrongly for sure) very limited downside, I am tempted to go all-in. However, I am hesitating since I do not feel the downside, i.e. I am struggling to imagine how it might look like. I mean, with current deleveraging cash generation, must comps could survive a Covid style global lockdown and remain in good condition. Have you ever seen a better opportunity in that many stocks?

CP said...

Personally, I would never invest outside the U.S., Canada, western Europe, and Japan.