2023-04-25 08:00:00 ET
Summary
- PrairieSky has a solid, repeatable business model that essentially just, "collects rents," or royalties on other companies' risk.
- It has big acreage positions in two of the hottest low cost, low decline plays in Canada.
- "The worm may turn" on the WCS spread in the second half of the year and give a boost to shares of PREKF.
- Investors looking for growth and small, but increasing income should review the company to see if it fits in their risk profile.
- We rate PREKF stock a hold at current prices, but would see them as being attractive at a slightly lower price.
Introduction
It's been a wee-bit since we last took at looked at PrairieSky Royalty, (PREKF), about 8 months to narrow it down. In that time the company has rallied ~20% from the mid-$14's where we suggested a hold , and then gave up a good bit of those gains as oil prices have waffled about.
PrairieSky Royalty price chart (Seeking Alpha)
What we find though as we look at the one year chart on the company is a fair amount of relative stability, certainly in relation to some of the U.S. shale names we cover. I don't know about you, but I am a little shell-shocked after the last six months, and stability doesn't sound all that bad.
In this article we will review the Q-1 report for clues about where we think the company might go in the year to come. Analysts have a median price target for PREKF of $24.50 , which is a pretty solid upside from here.
We will now dive in the conference call and press release to form our own opinion.
A quick reminder on the thesis for PREKF
The company owns the land and mineral rights to the leases many Canadian companies we cover drill upon. They escape the big capex and logistics headwinds that operating companies fall prey to, but ultimately their revenue is derived from these companies and the old "rising tide/falling tide adage is relevant to their success. What interests us most about PREKF are the low cost, low decline plays in Viking, and Clearwater. These areas stand to be the beneficiaries of commodity price driven capital allocations that shun the higher cost wells. As such, PREKF should see less fluctuation in revenues and growth in their 3.5% yielding dividend. Let's see what the company tells us.
PREKF top revenue sources (PREKF)
The company's top 25 lessee's read like a bibliography of many articles we have published over the last couple of years on Canadian E&P companies.
There is also the point about PREKF's massive acreage position, 9.7 mm acres of which are held in Fee Simple title. A legal construct dating from original Hudson Bay company land grants from King Charles II. It means PREKF has absolute ownership of mineral rights on these lands in perpetuity.
PREKF investment thesis (PREKF)
Q-1 CC and press release info
The company experienced liquids royalty volumes increases in 2022. These drove 80% of royalty revenue, and remained at record levels after experiencing 18% organic growth in 2022. This was the strongest on record for PrairieSky. The company expects oil royalty volumes to grow again in 2023. Leasing was also strong in the quarter, with another record quarter of land leasing in Q1. A total of 67 new leases with 57 different counterparties resulted. Area of strength included the Western Canadian heavy oil fairway. Notably, Viking leasing has also recently picked up with light oil around CAD$100 per barrel and superior payouts for operators on the shallow resource play.
CEO Andrew Phillips commented about their acreage vs. U.S. shale-
Economic inventory for oil directed drilling has been a growing concern for North American operators. With our large undeveloped land base, we are a natural beneficiary of operators looking to expand existing plays or develop new ones. This is evident in the volume of land leasing arrangements we have entered into. With decades of economic Clearwater inventory remaining and numerous new discoveries in the heavy oil region of Alberta, our owners get the benefit of strong cash flows today with a long duration attached to the shares of the business they own.
There were 214 wells spud in Q1, which were 87% oil with an average royalty rate of 8.2%. This was an increase of 20 wells over Q1 2022 and an increase of 2.1% in the average royalty rate for new wells on PREKF land. The Viking light oil play was the most active play with 68 wells spud followed by the Mannville heavy and light oil play with 42 wells spud and the Clearwater with 25 wells spud.
There were also 28 natural gas wells spud, including 18 in the Montney which the company anticipates will be TIL'd late in the year. PREKF saw 98% operating margins, with no liabilities or maintenance CapEx. They expect organic growth through land leasing in these plays.
PrairieSky generated funds from operations of $86.3 million or $0.36 per common share for the quarter. Key drivers here were royalty production revenue of $116.8 million earned on total royalty production of 24,809 BOE per day as well as $9.3 million of other revenues.
In Q-1, 2023 PrairieSky’s oil royalty production totaled 12,212 barrels per day in the quarter, which was up 9% over Q1 2022 and flat with Q4. Operational downtime at one of the thermal heavy oil projects negatively impacted the quarter by approximately 75 barrels per day and a decline in benchmark oil prices negatively impacted sliding scale royalty volumes, which were down by 67 barrels per day.
Oil royalty revenue totaled $83.8 million, which was down from prior quarters due to lower benchmark WTI pricing as well as the lighter heavy oil differential. PrairieSky’s oil price realization was 77% of light oil versus their usual 80% to 85% range. With heavy oil differentials now in the mid-teens, price realizations are expected to return to the 80% plus range.
Natural gas royalty volumes averaged 59.6 mcf/d a day, flat with Q1 and down 10% from Q4. Q1 included 0.7 million a day of prior period adjustments as compared to Q4, which included 5 million a day of PPAs.
Natural gas revenue totaled $21.8 million. The decrease from the prior quarter was primarily due to lower AECO benchmark pricing. PrairieSky’s quarterly realized price of $4.05 per Mcf was positively impacted as certain BC royalty production volumes were sold at few mass pricing in January.
NGL royalty volumes averaged 2,664 barrels per day, which was flat with both Q1 and Q4. NGL royalty volumes generated $11.2 million of royalty revenue at a realized price of $46.71 per barrel.
Cash administrative expense totaled $17.2 million in Q1 and included annual long-term incentive payments, which were higher than the prior year due to strong share price and corporate performance. PrairieSky recorded a current tax expense of $16.5 million and PrairieSky has $1.55 billion of tax pool to offset future taxable income. So, for the year the first $155 million of cash flow before tax is tax free, with remainder tax at the statutory tax rate of approximately 23.5%.
During the quarter, PrairieSky declared dividends of $0.24 per share with the resulting payout ratio of 66%. Excess funds from operations above the dividends were used primarily to repay bank debt, which totaled $292.4 million at March 31st. PREKF plans to apply to the TSX to renew the NCIB at the end of May.
Discussion
Many of the companies we have discussed are active in the key areas mentioned by PREKF in the call. Headwater Exploration (CDDRF) was formed to develop Clearwater resources. ( We have reviewed Headwater a couple of times in the past, and those articles are worth a read if you'd like to know more about the Clearwater.) With the key activity in the Clearwater in Marten Hills and Nipisi fields, PREKF has over 1.3 mm acres throughout the Clearwater Trend. An article put out by fellow SA author , Laurentian Research discusses the Clearwater in even more detail. When you think of the Clearwater, think-long life, low decline, and cheap to drill. It adds up to magic over time.
PrairieSky Clearwater acreage (PrairieSky Royalty)
This slide from Baytex Energy's ( BTE ) latest deck shows the economics the Viking light oil play. This is frac country so the wells are more expensive than Clearwater, but at $80 WTI operators like BTE are seeing 12 month payouts.
BTE Viking Netback chart (Baytex Energy)
A possible catalyst for PREKF (and other Canadian E&P Cos)
You can pretty well chart the decline of many Canadian E&P's over the last year with the advent of the massive releases from the U.S. SPR. Overnight the WCS discount went from the $14's to over $20, where it remains today. Some of that is due to the Canadian dollar losing ground to the Greenback, thanks to Fed tightening that began about this time last year, but the majority is SPR related.
WCS/WTI differential chart (MacroMicro)
If you want to get really wonky about it this article from Reuters charts the WCS differential landscape fairly well. It lists some transitory takeaway issues and the burgeoning supply of Canadian crude among others.
The good news is the SPR releases have come to an end ( not that those fun loving pranksters in the White House couldn't order more, mind you... ), and that creates inflection potential later in the year, when expectations are for inventories to be lower and production targets to be lowered, if the Good Sheikhs and their Russian comrades are to be believed. The IEA notes in their forecast for the year a sharp increase of Chinese demand as we exit 2023-
Global demand is set to surge by 3.2 mb/d from 1Q23 to 4Q23, taking average growth for the year to 2 mb/d. Matching that increase would be a challenge even if Russia were able to maintain production at pre-war levels.
Your takeaway
The bright promise of $130 oil and $10 gas turned into a fizzle in 2022, with multi-year lows following the highs seen in Q-1, 2022. The reasons are well known and I won't belabor them here. What we do know for certain is the crude price action since November of last year has degraded the market's appetite for risk in the upstream energy markets. There are now signs that we have passed the peak of pessimism, thanks to the OPEC+ cut scheduled for mid-year.
In that scenario we could see companies like PrairieSky get a bid toward the higher end of analysts' projections. PREKF is trading at about 8X EV/EBITDA, a little on the high side for current conditions, to be honest. If the company's optimism about the second half of the year is justified, and IEA projections come to pass, that multiple could swell quickly as the coffers swell from lower WCS differentials and prices that move back into the $90's.
With those caveats, investors looking for growth and income-it should be noted that PREKF just doubled their dividend, may find the company a worthwhile bet near current levels. COO, Cam Proctor comments on the outlook for 2023 -
A lot of the operators have told us they plan to be in growth mode, specifically with the narrower differentials we are seeing now and the stronger WTI pricing. We expect activity to pick up year-upon-year based on the conversations with the operators, primarily privates.
The company will have an investor day May 17th . I plan to register and suggest interested readers might do the same. Until then we will put PREKF on our watch list for weakness.
For further details see:
PrairieSky Royalty: The Sky Could Be The Limit