2023-10-17 10:30:00 ET
Summary
- Oil royalty companies offer low-risk exposure to the oil price and attractive income plays through dividends.
- PrairieSky Royalty reported a total revenue from oil and gas sales of C$108M in Q2.
- I am not prepared to pay 15 times the FFO for PrairieSky and currently have no position in the company.
Introduction
I like oil royalty companies as they offer relatively low-risk exposure to the oil price. While you can't rule out all risks (after all, if the owner of the wells you own a royalty on is shutting down the production during low oil prices, the royalty company will feel the pain as well), it is an easy way to capture the momentum in the oil market. Additionally, most oil royalty companies use a substantial amount of their free cash flow to pay dividends, making some of the oil royalty companies attractive income plays. I have discussed Freehold Royalties ( FRU:CA ) (FRHLF) multiple times here on Seeking Alpha and the total return on that call I made in March 2021 is now in excess of 110%.
While I am a satisfied shareholder of Freehold Royalties, there are other royalty companies out there and I have also discussed PrairieSky Royalty ( PSK:CA ) (PREKF) here on Seeking Alpha and although the stock was priced at an attractive level in the summer of last year, and the total return since that call was approximately 36% which isn't bad given the oil price evolution in the past fifteen months. PrairieSky Royalty is reporting on its Q3 results next week and I already wanted to check if I should keep close tabs on the stock or if it already is fully valued.
Royalty companies generate strong cash flows
During the second quarter of the year, the total royalty interests of PrairieSky resulted in a total attributable production of just over 23,500 barrels of oil-equivalent per day , and as you can see below, about half of the equivalent production is actually oil with NGLs taking up about 8% of the output. This indeed means the royalty company has a significant exposure to natural gas and the natural gas prices.
While the total oil-equivalent production rate was slightly disappointing, keep in mind PrairieSky estimated the impact of the wildfires on its attributable production at about 750 boe/day, so we should definitely see a higher normalized production rate.
As you can see above, the company reported an average realized oil price of C$78 per barrel while the natural gas price was just C$2.23 per Mcf.
PrairieSky reported a total revenue of C$117M which consisted of a total revenue from oil and gas sales of C$108M while there was an 'other' revenue of C$9M. The latter includes the lease rental income and bonus payments by the lessors.
The G&A expenses remain relatively high at C$13M and this, in combination with the almost C$34M in depreciation and depletion expenses, resulted in an EBIT of C$68M which ultimately allowed the company to book a net profit of C$48M or C$0.20 per share. That is lower than in the first quarter of the year but that's not unexpected as prices and output were higher in Q1.
As the capex of a royalty company is zero, the free cash flow result tends to be quite a bit higher than the reported net income, so I wanted to compare the cash flow statement with the income statement.
As you can see below, the company reported a total funds from operations of C$91.3M and almost exactly C$91M after also taking the lease payments into consideration. The capex was actually zero, although you may want to deduct the acquisitions from the operating cash flow.
If you would do that, the underlying free cash flow was still approximately C$76M or C$0.32 per share. Excluding those acquisitions, the net FFO per share (still adjusted for lease payments) was C$0.38.
Of course, the realized oil price will be higher in the third quarter of the year. If I would assume an average realized oil price of C$88/barrel (13% higher than in the second quarter), the net after-tax cash flow would increase by C$9M per quarter, or C$0.035/share. Using a natural gas price of C$4/Mcf would add an additional C$6M or C$0.025 per share per quarter to the FFO.
For the third quarter, I am expecting the FFO/share to increase to C$0.43-0.45 per share on the back of higher oil prices and a higher production rate. The natural gas price was still weak, so I am not expecting a substantial improvement there.
Investment thesis
While I acknowledge PrairieSky Royalty has a very substantial land package in Canada which will likely secure its cash flows for years to come, I'm not prepared to pay 15 times the FFO at this point and PrairieSky is a 'hold' at best. I currently have no position in PrairieSky but I do have a long position in its peer/competitor Freehold Royalties.
I will keep an eye on PrairieSky's upcoming Q3 results but I am not holding my breath. I am on the sidelines for now.
For further details see:
PrairieSky Royalty: Well-Managed But I Am On The Sidelines