PRMRF - Paramount Resources: Oil Exposure No Debt 5% Dividend And Trading At 4x FCF

Summary

• Paramount is one of the most attractive pure play oil securities exposure.
• It delivers significant FCF at current prices.
• The 5% dividend is well covered.
• The risk/reward profile is attractive.
• I am buying the dips in oil prices but will consider selling some at US$100/Bbl.

My philosophy as an investor is focused on building a diversified portfolio of securities that generates attractive and uncorrelated cashflows. Some of my investments do well in an inflationary or high rates environment (e.g. certain banks) whereas others work better if and when lower rates eventually prevail (REITs).

I generally look for a margin of safety and am quite particular about doing my best in avoiding a permanent loss of capital. Naturally, I much prefer to be paid (i.e. a nice dividend) whilst I wait for the thesis to play out.

Why Oil?

There are several reasons why exposure to oil is beneficial in a well-diversified portfolio.

In my view, the push for decarbonization and the inevitable transition to renewable energy is restraining capital investments in a new supply of oil and gas fields (e.g. predominantly due to the higher cost of capital). This, in an already tight market, could give rise to a major demand-supply imbalance in the medium term and lead to higher energy prices for longer or otherwise known in investment circles as "the revenge of the old carbon energy".

Secondly, I also see oil exposure as a good hedge against major geopolitical risks - for example, a conflict in the Middle East involving Iran, Israel, and the United States.

Finally, there are also cyclical forces that may play in favor of higher oil prices such as the reopening of China and stronger-than-expected and resilient performance from the U.S. and EU economies.

Whilst I do not have a crystal ball, it seems to me that a moderate allocation to energy plays in the portfolio (~5% to 10%) may still be warranted at this stage of the cycle.

My preferred name (amongst several others) is Paramount Resources (PRMRF) ( POU:CA ).

Paramount is a Calgary-based oil and natural gas exploration and production company operating primarily in Western Canada. Paramount has significant land positions in the most liquids-rich areas of the prolific Montney and Duvernay resource plays.

(All dollar amounts in this article are expressed in Canadian dollars unless otherwise noted).

Elevator Pitch

The key reasons I like POU are:

1. Trades at a very cheap valuation of 4x FCF of (adjusted) market cap.
2. It is practically debt free
3. It pays a sustainable monthly dividend of 5% annualized complemented with additional special dividends and share buybacks.
4. It forecasts to grow its production strongly in the next several years (self-funded)
5. It has very high insider ownership (~47%)

Valuation

The current market value of the stock is $4.2 billion but excluding other investments in securities, its adjusted market cap is ~$3.75 billion.

For 2023 and 2024, the company provides the following forecast for FCF:

The midcap of CapEx guidance also includes $317 million of growth CapEx and therefore for the purposes of this calculation, I will exclude this from the adjusted FCF calculation. As such, the adjusted FCF (excluding growth CapEx) is $947 million, so, therefore, the company trades at ~3.8x adjusted 2023 FCF to market cap.

Even if you choose to include growth CapEx in FCF, the company is projected to generate FCF in excess of its adjusted market cap in the next 5 years:

The Dividends

Investors are being paid handsomely whilst waiting for the oil thesis to play out.

Currently, the dividend yield is 5% and has grown massively in recent years as the company de-levered and production levels grew. Following the sale of its Kaybob Smoky and Kaybob South Duvernay properties in the Kaybob Region, it also paid a special dividend of $1.00.

The current projections by the company indicate that the regular dividend is fully covered by WTI Crude price at US$56/Bbl (currently US$75/Bbl).

As can be seen above, POU is a pure play on WTI price and its FCF will increase strongly at US$100/Bbl. On the flip side, there is considerable downside protection for the dividend coverage (WTI needs to fall to US$56/Bbl for the dividend not to be fully covered) and POU will still remain cashflow positive at much lower oil prices.

Final Thoughts

I like the risk/reward profile in the investment thesis in POU. If oil price rise strongly due to supply constraints or geopolitical factors, the FCF will materially increase. In such a scenario, I expect additional regular and special dividends as well as continued share buyback activities.

On the flip side, there is also significant downside protection. The dividend is well-covered until a much lower oil price and the company has no outstanding debt either to worry about. It should generate positive FCF under most scenarios for the foreseeable future.

At less than 4x adjusted FCF, I find the valuation extremely attractive and I like the 5% dividend as well. In such a cyclical industry, I believe a dividend is an important consideration.

All in all, this investment is a good diversifier for my portfolio especially as it has less correlation to many other traditional growth and value securities.

I remain very bullish and buy on dips. I will probably consider selling some when/if WTI oil crosses US$100/Bbl.

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