Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the PrairieSky Ltd. First Quarter 2020 Financial Results Call. [Operator Instructions] Please be advised, today's call is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker, Andrew Phillips. Please go ahead.

[Andrew M. Phillips, President, CEO & Non]

Thank you, Sydney. Good morning, and thank you for dialing into the PrairieSky Royalty Q1 2020 Conference Call. On the call from PSK are Cam Proctor, COO; Pam Kazeil, CFO; and myself, Andrew Phillips. Before I begin, I would like to take a moment to address our staff, our industry, business and community partners as well as our investors. This has been a challenging time for industry, but more importantly, our communities and families. Our thoughts are with all of you, and I would like to personally wish all of you the best and hope you stay safe and healthy while we look towards more prosperous times ahead. At PrairieSky, we had 60 dedicated team members -- have 60 dedicated team members, all of whom have been working from home since early to mid-March. The executive team is very appreciative of all your efforts and ingenuity during our work from home protocol. We have continued to seamlessly execute on our business plan, and it is during times like this that I'm reminded what a great culture and team we have at PrairieSky. Following our usual path, I will provide an operational update and then turn the call over to Pam to walk through the financials. First quarter royalty production totaled 22,160 BOE per day versus 22,007 BOE per day in Q1 2019. Stable production was achieved without acquiring any producing assets over the past year. Free cash flow of $46.5 million was primarily allocated to the Q1 dividends of $45.4 million. Another $5 million was spent canceling shares with the buyback being accelerated in mid-March following a significant decline in oil prices. PrairieSky exited the quarter with no debt. Our strategy from the outset has been to build cash on top of the stable dividends in periods of strength for the industry and deploy that cash from the opportunities to improve the business per share present themselves. In 2017, we generated over $100 million on top of the $175 million dividend and carried approximately $100 million on our balance sheet. Quality opportunities presented themselves, and we were able to deploy this capital to acquire premier royalty assets that improved the per share value of the business. Today, the business continues to be debt free, which is an optimal capital structure in this volatile environment. On capital allocation, we have adjusted the dividend to allow the company to deploy the excess cash flow towards acquisitions and/or buybacks. PrairieSky currently trades at just over $100 per acre, has a long-duration, low-decline, high-margin cash flow stream and lands on the best parts of the cost curve in the basin. As a result, the hurdle rates for acquisitions are high. Fortunately, we can continue to buy more of this high-quality business through our issuer bid, while we work on opportunities that we create or which present themselves. On cash G&A, management proactively took a significant total compensation reduction in December 2019 prior to the recent oil price decline. This reduction represents over $1 million annually, and was shared amongst the 3 executives. In addition, our compensation program is heavily weighted towards share price performance, which has resulted in management realizing a fraction, approximately 1/3 of the target compensation as long-term incentive Boards past. This business is managed by 3 senior executives down from 5 3 years ago, with all of us investing the majority of our net worth in PrairieSky shares. We are shareholders first, and we continue to focus on ways to improve the per share value as well as G&A efficiencies across the organization. The compliance group was and continues to be busy and collected $1.8 million over the first quarter. Shut-in volumes have been close to 10% so far, but are expected to increase substantially in May, as most companies had their nominations in for April prior to the collapse in oil. We are supportive of these decisions and are working collaboratively with our industry partners as the oil will be stored in a reservoir until better pricing can be achieved. The challenges arising from the recent price collapse will create opportunities for PrairieSky, and we are in a strong position to execute on them. Thank you to our shareholders for their continued support, to our employees who continue to deliver results from their home-office work environment. I will now turn the call to Pam to discuss the financials.

[Pamela P. Kazeil, VP of Finance & CFO]

Thank you, Andrew. Good morning, everyone. Before I get started, I will be including certain forward-looking information in my remarks today. As such, I would refer all participants on this call to please reference the forward-looking information section of our MD&A at March 31 as well as the press release issued on April 20, 2020. During the first quarter, PrairieSky generated funds from operations of $46.5 million or $0.20 per share. Cash flow was generated primarily from royalty production revenue of $49.1 million, on average production volumes of 22,160 BOE per day. Production volumes were consistent with Q1 2019 when production averaged 22,007 BOE per day and Q4 2019 when production volumes averaged 22,203 BOE per day. Production was comprised of oil volumes of 8,582 barrels per day, NGL volumes of 2,945 barrels per day and natural gas volumes of 63.8 million per day. Oil volumes were down from Q4 2019, primarily as a result of lower sliding scale volumes due to the decline in oil prices in March and fewer compliance volumes. Given the current oil price environment, there will be production volume shut-ins on our lands. Currently, we estimate that approximately 10% of Q1 2020 oil production will be shut in for April, growing to approximately 20% in May. The situation has continued to evolve, and we are working with producers on our properties to make the appropriate long-term business decisions, which could result in additional shut-ins. NGL and natural gas volumes both increased from Q4 2019 as a result of the Montney wells that came on in the back half of 2019. These wells generate significant plant condensate, which boosted NGL price realizations in the quarter. Although drilling activity on our natural gas properties has remained modest, natural gas makes up close to half of our production volumes, and we have royalty properties on plays across Western Canada, providing significant exposure to natural gas. PrairieSky's production volumes in the quarter included 1,686 BOE per day of prior period adjustments, which were 56% liquids and included 165 BOE a day from compliance activities and an additional 1,522 BOE per day of other prior period adjustments related to new wells on stream and better well performance. The compliance group continues to recover missed and incorrect royalties through forensic accounting, collecting $1.8 million in the quarter. There were 170 wells spud in the quarter, primarily in January and February. There were 168 oil wells spud, which included 86 Viking wells, 22 Mannville heavy oil wells, 16 Bakken wells and 12 Clearwater wells. There were also 2 Mannville natural gas wells spud. Of the 22 Mannville heavy oil wells, 15 were from our 2 thermal oil projects at Lindbergh and Onion Lake. The average royalty rate of wells spud in the quarter was 8.5%. Other revenue totaled $3.6 million, including $0.7 million in lease rentals, $0.5 million in other income and $2.4 million in bonus consideration on entering into 26 leasing arrangements with 23 different counterparties. Given the impact of COVID-19 on the global economy and on the energy industry, we are reducing our outlook for other revenue from $25 million in 2020 to $15 million to $17 million, primarily as a result of lower anticipated leasing activity. This includes our estimate for compliance revenues. Cash administrative expenses totaled $7 million or $3.47 per BOE and included the annual long-term incentive payment of $1.7 million for all staff and executives. As Andrew mentioned, our staff has been working remotely since March when we implemented our business continuity plan. Early on at PrairieSky, we invested in digitizing all of our records, including our land files. This investment has enhanced our ability to analyze information over the years and has enabled a smooth transition to working from home. Due to the impact of lower WTI pricing and higher light and heavy oil differentials on revenue, we recorded a cash tax recovery in the quarter of $2.5 million. During Q1, PrairieSky paid $45.6 million in dividends and repurchased 0.5 million common shares. PrairieSky's working capital deficiency was $5.2 million at March 31, and PrairieSky has no long-term debt. Since IPO, PrairieSky has generated approximately $1.3 billion in funds from operations and returned $1.2 billion to shareholders through approximately $1.1 billion in dividends and the repurchase of 5.7 million common shares. We will now turn it over to the moderator to proceed with the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Aaron Bilkoski with TD Securities.

[Aaron Bilkoski, Equity Analyst]

I was just curious how comfortable you would be using debt to make acquisitions if we enter a very target-rich environment. And when I think about your use of debt, is there a maximum amount of leverage you'd look on the balance sheet if you were to use it?

[Andrew M. Phillips, President, CEO & Non]

Yes. Thanks for the question, Aaron. I think part of the reason we have the $200 million bank line with a $50 million accordion is to give us that flexibility. And what we're able to do today is if we put cash on the bank on top of the dividend, we get 0.5% interest, when we can get up to 6% free cash flow yield by buying back the stock. So we can continue with the repurchasing. And if we're successful executing an acquisition, we can use leverage at that point and then pay it down in a short period of time with the excess cash flow by slowing down the buyback. So that kind of gives us the levers to be flexible when we see good opportunities arise that exceed our cost of capital and enhance our asset base. So -- and in terms of the total quantum of leverage, to answer the second part of your question, it really depends on the opportunity, and I hate to give you an exact number. But again, if it's something we're comfortable, makes our business significantly better per share over the short, medium and long term, we'd find ways to do it.

[Aaron Bilkoski, Equity Analyst]

If I can ask a follow-up question on the shut-ins. From a mechanical perspective, how far in advance of a shut-in are you notified that a producer intends to shut-in a particular well?

[Andrew M. Phillips, President, CEO & Non]

That's a -- it's a good question. And we actually have the ability under our contracts to not allow shut-ins without force majeure. One of the things we recognize is that, although we do have our 98% operating margins, it's better for the producer and it's better for us to get more value for our crude. So we've allowed 30-day shut-ins. And then at the end of the 30-day period, we can then reevaluate it. So one example is there's a private producer that came to us, wanted to shut-in all of their volumes for April, which we supported, but we had already -- we took the production in kind, so we had already nominated it. But we found a way to actually make money with Shell by getting out of that contract. So there was a way for us to actually incrementally make money and shut in the volumes and preserve the value there. So again, we're -- we work collaboratively with all the producers. And we have 325 of them, so we've been extremely busy in conversations with both the marketers on the one side and then those producers on the other. But we definitely want to work with them and want to see them do well.

[Aaron Bilkoski, Equity Analyst]

Okay. Pam mentioned that you can see shut-ins of up to 20% come May. Is that based on shut-in requests that you've seen? Or is that based on just broader industry trends?

[Andrew M. Phillips, President, CEO & Non]

Yes. So the 10% is the actual number that we've seen. 20% is what we've been told by industry. My view, and this is my view only, is that it's going to be significantly higher than that in May. But time will tell. But again, that's what we've been given as guidance, Aaron, and that's kind of what we have to go off of. But my view is that it should be higher than that in May.

[Aaron Bilkoski, Equity Analyst]

You kind of bookmark that bench...

[Andrew M. Phillips, President, CEO & Non]

I do not. I wouldn't -- I'd be speculating. And the market is so volatile that -- and it really depends on a lot of the contracts that producers have in place as well. So again, there are some -- and there's obviously the issues with -- there are some heavy oil wells that if you shut-in, the wormholes can collapse, those sorts of things. So again, you do have to be cautious and do it pragmatically if you're a producer. But again, setting those aside, the economic decision would be to shut-in a far higher amount than that 20%. So that's just where the number comes from, that it's going to be higher. I just hate to take a stab at it.

[Aaron Bilkoski, Equity Analyst]

All right. And just one more question for me. I'll go one more time. If a producer opts to shut-in a well or a field, from your past experience, how long should we expect those wells to stay shut-in for? How quickly can they be returned if pricing does improve?

[Andrew M. Phillips, President, CEO & Non]

It all depends on the type of production. A SAGD can take longer in water floods or polymer floods. And in a lot of cases, they can continue to inject the polymer water to maintain pressure, maybe even increase pressure while the balance of the field shut in. But typically, it's very quickly. You can get wells on very quickly after -- when you make that decision to put them back on production, it can be within days.

[Operator]

And our next question comes from the line of Mike Dunn with Stifel FirstEnergy.

[Michael Paul Dunn, Director of Institutional Research]

Andrew, I'm going to ask you to speculate on a potential Board decision. And I know in the past, you've looked at your dividend sort of annually. But with the prospects for, I guess, very low pricing in Q2, combined with significantly lower volumes, at least temporarily, we think, if we're coming out of this, I guess, 3 months later with curtailments largely behind us or an outlook to that, but with weak pricing in Q2, would you speculate on whether the Board would look for another temporary adjustment to the dividend? Or would -- do you think they would be comfortable with funding any shortfall via your credit lines here at least temporarily?

[Andrew M. Phillips, President, CEO & Non]

Yes. I mean we've always said we wouldn't use debt long term to pay the dividends, Mike. And thanks for the question. But I guess, with 98% operating margins, 50% of our production natural gas, it's -- given where the dividend sits today at $0.24 a year, $0.06 per quarter, it looks well funded. And I think if you -- again, if there was a shortfall, it'd be in the order of $1 million on a $2 billion company, so it'd be very, very modest. So I don't think we'd make any decisions based on 2 weeks of being unsustainable because all your oil gets shut-in or something like that. Did that help to answer your question?

[Operator]

[Operator Instructions] And our next question comes from James Kubik with CIBC.

[James Kubik, Research Analyst]

Quick question for you. Given the strain on operators and balance sheets in this environment, can you talk about how you're monitoring counterparty risks? And have you seen anything on that side that is concerning at this point? Any light you can shed on that would be great.

[Pamela P. Kazeil, VP of Finance & CFO]

Yes. Thanks for the question, Jamie. Counterparty risk is something that we're always monitoring. We have very robust processes in place. Some of the things that we can do is, obviously, the leases are under our control. And if that producer is behind in royalty payments, we can take that lease back. So that's always a very powerful message to send to someone who might be behind in royalties. We also have the ability to take our production in kind. We currently take about 10% of our production volumes that way, which eliminates that counterparty risk. And we have a few letters of credit in place with certain producers. So it's something that we continue to monitor very closely, trying to work with producers, as Andrew mentioned, on shut-ins, but royalties are our priority and keeping our leases in good standing.

[Andrew M. Phillips, President, CEO & Non]

And Jamie, if I could add one thing. Again, it's a good reminder. When you own the piece of the land, you actually own the resource. So you're super secured and you're ahead of the banks, and you always have that option of kicking people off your lands if they're noncompliant. That's why we typically, if there is a bankruptcy process, which we've seen numerous bankruptcies over the last 5 years, the receiver pays on time monthly to ensure they secure that lease and ensure they keep their asset intact.

[Operator]

And I'm not showing any further questions at this time. I would now like to turn the call back to your speakers.

[Andrew M. Phillips, President, CEO & Non]

Thank you very much, again, for everyone dialing into the PrairieSky Q4 (sic) [ Q1 ] conference call. And as always, please call Pam or myself if you have any questions.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a great day.