PRMRF - Paramount Resources: Back To Growth

2023-10-05 03:35:21 ET

Summary

• Paramount Resources is a family-owned company with a conservative management approach.
• The company is effectively debt-free and has strong cash flow to support growth and reward shareholders.
• The forecast for the current year has been adjusted due to wildfires, but production is expected to jump in the next fiscal year.
• The old strategy of borrowing to develop leases and then sell them has now changed to using cash flow to develop leases and then sell them.
• The company has significant investments in other companies.

Paramount Resources (PRMRF) is a family-owned company that took an unusual way to get where it is today. Now that the company has "arrived" the cash flow is such that management is highly unlikely to repeat the past. Still the past follows the stock in the eyes of Mr. Market until there is a sufficient record in the future of the way things are now. This provides investors with lower risk than usual to wait for the market to properly value this conservatively run company.

(Note: This is a Canadian company reporting in Canadian dollars unless otherwise noted.)

As shown above , the family controls enough stock to effectively run the company for the foreseeable future. The company is effectively debt free from a net debt standpoint. The cash flow provides enough money to grow production while rewarding shareholders at a rather generous pace.

The forecast for the current year has been adjusted for the effects of the wildfires that have been an issue in Canada for a significant part of the fiscal year. That production has not been lost. But it has been delayed. The wildfires also slowed development activity as well. The sizable jump in projected production assumes no similar event in the next fiscal year.

Business Strategy

This company has long taken a lease position where no one else is (meaning they generally grab raw acreage) at the moment and developed that position for sale at a certain point. Management also owns positions in other companies, both public and private, that the company may acquire or sell the position as market conditions dictate. In some ways, this company functions more like an upstream mutual fund.

The industry in general may be "in the area". But this company rarely purchases anything that is developed. Management did buy Apache Canada some years back and that has given the management a lot of work to turn that purchase around. It would appear that work is about to pay off big time.

Probably the difference this time around is that there are several projects generating a lot of cash flow and free cash flow. Before, management would develop a project and then sell that project. The proceeds were used to develop the next project. Generally, the company always retained some production. But the retained production levels were nothing close to the total production before the sale.

This business strategy was acceptable prior to 2015 when a lot of companies were doing the same thing. However, management had to change direction and fortunately, was able to get the company to a debt free situation with a lot of production. Going forward, any sales that take place will likely not entail all the production (unless management sells the whole company). Therefore, there will be some cash flow to support future developments as well as the cash received from the sale.

The most significant change in business strategy over the years has been a transition from a dry gas producer to a rich gas producer. The liquids have added an important profitability contributor to the revenue stream. Recent well payback periods have largely remained under one year. That is extremely good in the upstream world.

Canada has an important cost advantage over the United States in that acreage in Canada is often dirt cheap in prime areas when compared to United States prices. As a result, the location cost of a well in Canada is often insignificant compared to cost in the United States for similar acreage.

These wells are profitable enough that there is plenty of room for the hostile environment of a cyclical downturn. The company has emphasized the production of condensate which often sells for a premium to light oil in Canada. Not only are the payback periods unusually short, but the profitability of the wells happens under a wide variety of industry conditions. This is a company that typically reports profits well into a cyclical downturn and is one of the first to "bounce back" during a recovery.

The short payback period allows for a dividend payment, an occasional variable payment, share repurchases from time to time, and production growth. Very few companies can do all that at one time.

The priority for the foreseeable future will be low debt (or no debt at all) and production growth. That should support the base dividend to a greater extent than is the case with much of the industry that cannot grow while the balance sheet is repaired.

Other Company Investments

This company has a significant investment in both wholly owned subsidiaries, private and public companies.

As the notes to the slide make clear, investors wanting the full details of all the investments made need to look at the quarterly report. What is shown above is intended to be a significant summary of what is important to management at the current time.

Management will either acquire some of these companies or will sell positions as market conditions dictate. Wholly owned investments are actively managed, and some are closely coordinated with company activities.

Oftentimes, this is the place where investors can look for potential future projects if something gets sold. The company has long not kept higher cost production. When project profitability hits the peak area, the project is often marketed so that management can reinvest in a new project. Therefore, it seldom has to deal with significant plugging and abandonment issues.

The Future

Investors can expect that unlike the past, debt is likely to remain low (or not at all) in the future. Production has now reached the point where major projects can be sold and new projects developed without the need to borrow money.

Sometimes the market does not like this cycle because production will decline with the periodic sale of major projects. But now cash flow and receipt of proceeds from the sale should enable a quick production recovery without financial leverage. As the company grows, those periodic sales will become less significant. That should enable smoother, more reliable growth that the market favors.

The base dividend has been growing rapidly. That is likely to continue with the growth of production. This unusually profitable company can grow production and the dividend at the same time. That means that while growth of production has a high priority, investors can expect an overall base dividend that rapidly increases in the future as long as the growth story remains intact.

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