Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, and thank you for standing by. Welcome to the PrairieSky Royalty announces their first quarter 2022 financial results. [Operator Instructions ] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Andrew Phillips, President and CEO. Please go ahead.

[Andrew Phillips, executive]

Thank you, Catherine, and good morning, everyone, and thank you for dialing into the PrairieSky First Quarter 2022 Earnings Call. On the call from PrairieSky are Cam Proctor, COO; Pam Kazeil, CFO; and myself, Andrew Phillips.

Before we start, there are certain forward-looking information in my notes today, so I'd ask investors to review the forward-looking statements qualifier in our press release and MD&A for Q1 2022. The basin-wide resurgence in activity levels that resulted in strong Q4 2021 per share liquids growth continued into the first quarter of 2022.

Excluding acquired royalty barrels from 2021, the company achieved 13% oil royalty growth when compared with the quarter 1 year ago. Combined with an almost double-digit free cash flow yield and some of the strongest growth rates in the industry, PrairieSky provides a strong total return proposition at a very low risk.

Two new major oil discoveries were announced subsequent to quarter end on our undeveloped Clearwater acreage. These include Utikuma Lake and McLeod Lake. This further highlights the optionality associated with large undeveloped land bases that is a differentiating factor when owning PrairieSky shares. On that front, we received $3.5 million in lease issuance bonus and entered into 52 different leasing arrangements with 43 different companies. Leasing activity on the newly acquired Heritage fee title was particularly active with one leasing transaction covering numerous sections of land targeting a Clearwater opportunity using low-cost multilateral technology.

In 2022, we will have exploration wells drilled for both helium and lithium carbonate, both opportunities are on PrairieSky fee title lands. Our large-scale CCUS project in Meadowbrook received initial approval from the Alberta government, and we look forward to continuing to advance this opportunity with our project partners.

Q1 drilling activity remains strong with 194 wells spud on royalty acreage, almost double last year's Q1 total. Private operators represented approximately 50% of the spuds. Spuds were broadly distributed across the basin and included both oil and natural gas targets.

A notable increase in workover activity was also evident across our already drilled 43,000 well portfolio. A notable increase in new oil and gas start-up companies was observed over the last 6 months as M&A activities have picked up. PrairieSky offers newly capitalized entities, consolidated undeveloped lands and a significant high-quality seismic database that can allow them to shorten cycle times and lower upfront costs, which can help them accelerate activity to take advantage of the strong pricing environment.

Existing clients at PrairieSky are also looking to expand their inventory in our existing core areas and uncover new plays. Along with our 33% dividend increase in February, debt levels are dropping faster than anticipated, which will allow both stronger dividend increases in the future and the ability to execute on accretive M&A, provided it improves the quality of our business on a per share basis.

We are seeing the benefits of an inflationary activity environment and an unhedged energy portfolio with 98% operating margins. I will now turn the call over to Pam to summarize the financial results.

[Pamela Kazeil, executive]

Thank you, Andrew. Good morning, everyone. As Andrew mentioned, there are certain forward-looking information in the notes today, so I would remind investors to review the forward-looking statements qualifier in our press release and MD&A for Q1 2022. PrairieSky generated record funds from operations again in Q1 of $105 million or $0.44 per common share, more than double Q1 of last year and about 3% above Q4 2021, which included a $12.4 million tax recovery. The increase was driven by our 23,892 BOE per day of royalty production and strong commodity pricing, which combined to generate $134.7 million of royalty revenues. This is $78 million above Q1 and $40 million ahead of Q4. PrairieSky's oil royalty production grew to 11,188 barrels per day in Q1 2022, 54% above Q1 last year and 35% above Q4. Backing out all acquisitions made in 2021, organic growth totaled 13% over Q1 and 6% over Q4. PrairieSky anticipated strong organic growth given our active leasing program and the number of spuds across our acreage in the second half of 2021 and into Q1 2022. Natural gas royalty revenue -- sorry, natural gas royalty volumes averaged 60.5 million a day, up 5% over Q1 and in line with Q4. Natural gas royalty revenue totaled $22.9 million, driven primarily by strong AECO pricing, which averaged $4.67 per Mcf in the quarter. PrairieSky's 10,000 BOE per day of natural gas is unhedged, and we will benefit from the improvement in AECO pricing, which is currently over $7 per Mcf. NGL royalty volumes averaged 2,621 barrels per day, which was up 5% over Q1 and 29% over Q4 when volumes were negatively impacted by ethane curtailment. NGL royalty revenue totaled $13.1 million in Q1, driven by strong benchmark pricing and increased NGL volumes. There were 1,433 BOE per day of prior period adjustments in the quarter, of which 1,078 BOE a day or 75% were from new wells on stream and better well performance.

There was an additional 355 BOE per day from compliance activities. Overall, PPAs were 58% liquids. The compliance group recovered missed and incorrect royalties through forensic accounting, collecting $1.5 million in the quarter. There were 194 wells spud in Q1, which were 87% oil. The Viking was the most active play with 68 wells spud followed by the Clearwater and 35 -- with 35 wells and the Mannville with 22 wells spud.

Additional oil-focused activity took place across the portfolio, including wells spud in the Cardium, Devonian, Duvernay, Mississippi and Montney and Nisku. There were also 26 natural gas wells spud in the Montney, Mannville and Cardium.

Activity in the quarter was well above Q1 2021 when there were 100 wells spud and higher than Q4 2021 when there were 166 wells spud. Other revenue totaled $5.2 million and included $1.2 million in lease rentals, $0.5 million of other income and $3.5 million of bonus consideration for entering into 52 new leases with 43 different counterparties. New leasing is a leading indicator of sales activity, and we anticipate near-term drilling on many of these new leases. As mentioned on our year-end conference call, PrairieSky's forecasting other revenue in the range of $20 million in 2022 including lease rental, bonus consideration and other revenue.

Compliance recoveries will be incremental to this amount. Cash administrative expenses totaled $10.3 million or $4.79 per BOE in Q1. As in prior years, Q1 is always the highest quarter, as long-term incentives vest and are paid in this quarter. We expect cash administrative expenses to be below $3 per BOE again in 2022.

PrairieSky recorded a current tax expense of $18 million in Q1 due to our record royalty production revenue. Entering into 2022, PrairieSky had $1.75 billion of tax pools to offset future taxable income. So in 2022, the first $175 million of cash flow is tax free, with the remainder taxed at our statutory tax rate of approximately 23.5%.

During the quarter, PrairieSky declared dividends of $28.7 million or $0.12 per share, with a resulting payout ratio of 27%. Excess funds from operations above the dividend were used to primarily -- were used primarily to repay bank debt.

Net debt at March 31, 2022, was $568.9 million, down $66.1 million in 3 months. We will apply to the TSX to renew our NCIB, which we may use opportunistically. As previously communicated, PrairieSky's current focus is retiring the bank debt used in connection with the acquisition of the Heritage Royalty assets in December 2021.

Since IPO, PrairieSky has generated approximately $1.8 billion in funds from operations and returned $1.5 billion to shareholders through dividends and buybacks.

We will now turn it over to the moderator to proceed with the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Jeremy McCrea with Raymond James.

[Jeremy McCrea, analyst]

A quick question on the Heritage property. Are you seeing lease activity higher than expected, in line with what you guys are expecting? And maybe just some thoughts just on what you kind of see on that land just given where oil prices are here over the next 6 months here?

[Andrew Phillips, executive]

Yes. Thanks for the question, Jeremy. We -- one of the things that was, I guess, not unexpected, but we did identify a pretty significant-sized play for this multilateral technology, and we did one large lease which is probably one of the more impactful things we've done as a business from a pure leasing perspective in a number of years.

But I think the current oil price environment has really stimulated a lot of smaller leasing activity. And with oil, of course, you can drill sometimes 8 to 16 wells per section. So there's been a lot of smaller leasing people adding on to their current portfolios or plays.

We've seen leasing all the way from Southeast Saskatchewan, where we acquired the most significant position in the Southeast Saskatchewan Bakken Viewfield pool, so there's been some follow-on leasing there from a couple of different operators as well as in the kind of Mississippian stack. And then when you jump to Provost and kind of Elk Point, Lloydminster, there's been quite a bit of heavy oil leasing given the narrow differentials and high WTI prices.

[Operator]

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

[Aaron Bilkoski, analyst]

I know you don't provide corporate production guidance, but I'd be curious to know your thoughts on the pace of development of the private operators operating on your land. What are they telling you they're expecting to grow over the next 12 to 24 months?

[Andrew Phillips, executive]

Yes. So they all differ, and actually, private operators Aaron have made up a bigger proportion of our spuds. I know it's -- I mentioned in my notes that it's 50% of current well spuds. I know our largest royalty payer currently, Spur, is targeting about 30% production growth, and everything in between. There's been -- probably the most positive thing on the private side, I guess, would be all the new start-ups, and they're pure growth companies with just cash and some land.

So they'll probably grow the highest rate. And I think some of the publics on the margin are probably looking to grow a little more. I guess what was -- we were pretty positively surprised by Q1 just given the very strong liquids growth rates we saw in Q4. We would have been even happy after Q4 of just a flat production profile. So to see growth off of that already increased base we saw in Q4 was quite encouraging.

[Operator]

Our next question comes from Harshit Gupta with Accountability.

[Harshit Gupta, analyst]

Congrats on another strong quarter. I just wanted to first ask about the hedging strategy. Do you guys still want to go unhedged, looking at the commodity prices where they are, or you are looking at some strategy over there to hedge some of the production in the coming quarters?

[Andrew Phillips, executive]

Yes. Thanks for the question, Harshit. I think the -- we're very consistent with hedging. We've never hedged since our IPO, and we're not protecting capital programs because there's 0, and our debt is coming down at a very quick pace, and ultimately, we view it as speculating with investors' capital. And I think longer term, we are one of the few companies that give pure exposure to unhedged, unlevered oil and gas in Western Canada with no operational leverage. So we'll plan to keep it that way.

[Harshit Gupta, analyst]

Sure. Makes sense. I see some of the companies are actually rolling off hedges now, but on the cash operating expenses, I see a significant increase, and you mentioned that you're still looking at below $3 for the year. Is that increase related to the acquisition, a onetime kind? Or what led to this one, like $4.80 almost?

[Andrew Phillips, executive]

Yes. So it's a good question. I think for the -- so the management last 2 years have received 0 on their performance share units because of the poor performance of the share price, so they were paid out this year. And there was higher payouts to the entire staff as well, just as a result of the increased share -- or the share appreciation over the year.

And then there were some moderate costs with the Heritage acquisition. One of the places we're fortunate with the Heritage acquisition is we do most of the work on those acquisitions internally. We don't hire consultants. We kind of do it all ourselves. So they were moderated.

But because of some of the improvements we've made and the efficiencies of the business, the G&A will trend down significantly throughout the year. So -- it's always the highest in terms of cash G&A is Q1, and that will trend down materially, and it will be below $3 per barrel in cash G&A for the year.

[Harshit Gupta, analyst]

So the $3 guidance is including these expenses, right?

[Andrew Phillips, executive]

That's correct, including all expenses, that's correct. And it's -- we report a cash number because that's what we actually pay out. The other number can bounce around a fair bit with share price. So we just report what we actually pay out and track that, and it's come down from $4.50 in 2014, down below $3 per barrel the last year, and we expect that again this year.

[Operator]

Our next question comes from Jamie Kubik with CIBC.

[James Kubik, analyst]

With respect to the CCUS project at Meadowbrook that you announced, can you offer any additional details on that project? And can you talk a little bit more about future exposure to CCUS that you see possible on your acreage?

[Andrew Phillips, executive]

Yes. Thanks for the question, Jamie. We're excited about that one. That's been about 2 years in the making, and it's a great operator and really good project partners there. It's a multi-client approach west of Edmonton. And I think there'll be more in the future. We -- again, in that whole area where you generate the most carbon dioxide, between Edmonton and Calgary, where the railways sit, where the QE2 sits, you've got all checkerboard PrairieSky acreage as well as one of the largest seismic databases in Western Canada. So we've got a great technical knowledge and understanding of where you can inject carbon dioxide and I expect to -- that ultimately, over the next 3-, 5- and 10-year period, we'll be involved in more projects going forward, but we're pretty excited about the Meadowbrook project, and it's kind of unique because it's west of Edmonton.

It's in kind of a unique geographic area where we think we're -- we've got some opportunities to bring in multi-clients there.

[James Kubik, analyst]

Okay. And maybe with respect to the Heritage acquisition and the 52 lease agreements you announced on the quarter, can you talk a bit about how we should think about future leasing on this acreage and the pace that you've seen thus far compared to your expectations on the Heritage asset?

[Andrew Phillips, executive]

Yes. And I think one of the things that gets us most excited about the pace of leasing on the Heritage is the amount of different counterparties throughout the acreage. So it's not -- in the past, if you went back to 2017, our leasing programs were very concentrated amongst a handful of operators. But today, we're leasing to new start-ups right through to the big incumbents who haven't been leasing land for years.

So I think it's -- on the oil side, in particular, I think people always got to look at acreage on gas and acreage with oil. There's a lot more resource density with oil. And again, you can have a 1,000 barrel a day gross project on a single section of land. So these smaller leasing opportunities on the oil side can be quite impactful. And given it's such a broad group of operators, we're pretty excited about the potential over the next few years just given the activity.

I think again, it is the biggest heavy oil region in Canada where we acquired our acreage. So just given the narrow differentials and the high WTI price, we expect that to continue.

[Operator]

Our next question comes from Patrick O'Rourke with ATB Capital Markets.

[Patrick O'Rourke, analyst]

Just wanted to ask, in terms of the return of capital focus here and debt repayment, obviously commodity price continues to strengthen here, I'm wondering if there's any changes to that strategy? You did have the dividend bump last quarter, I know that the NCIB renewal was just mentioned now.

And then in terms of the paydown of the debt, any sort of update in terms of when you would hit that target there?

[Andrew Phillips, executive]

Yes. Thanks for the questions, Patrick. In terms of capital allocation, I know we increased the dividend in February by 33% and the debt repayment's happening at a faster pace, just due to the strong pricing and the growing production volumes underlying that.

We -- our priority is paying down the debt. We view -- on the NCIB, we effectively, for the first time in our history, made an acquisition using leverage. And we used 2/3 leverage for that acquisition, $500 million in pretty low cost debt. And so I think our priority is paying that down, and we view that as effectively prefunding the buyback.

So that was effectively NCIB and now we're paying it down by returning the leverage. So I think when you look into the next time we review the dividend early next year, there's going to be continued strong cash flows. The debt targets will be -- we'll be retiring debt at a faster pace and there'll be the opportunity for a significant increase at that point on the dividend.

[Patrick O'Rourke, analyst]

Okay. And then I think you might have mentioned an update in terms of Clearwater exploration success. Are you able to provide any further color on that?

[Andrew Phillips, executive]

Yes. So, I can. So, Utikuma Lake was a 2-leg lateral. So it's public data, so it could be viewed on Accumap or geoSCOUT, and pretty strong rates on that 2-leg lateral. And again, it's an exploration play. So it's with 8-leg lateral or 6-leg laterals and the new fluid systems people are using, we're -- we think that's a very significant accumulation. There's actually another sand there that hasn't been tested as well. So that was a pretty significant discovery.

And then McLeod Lake, it's an interesting one. It's -- a lot of people would know it as North [ Doucette ], it's on some of the exploration lands we bought in early 2017 when we made the first large Clearwater acquisition before it was kind of known as a significant play.

And this is the second winter where there's been exploration done on this play and it's confirmed and expanded the resource opportunity there. So both plays should see significant developments this upcoming winter season and should be significant contributors to both production and cash flow in the future. I think, again, the part of the reason we highlighted those is it's the difference between owning just a discounted cash flow stream over time, but also owning the undeveloped land -- without any future acquisitions, PrairieSky shareholders will see growth in these types of environments just because we've already prefunded the future with the undeveloped land piece.

[Operator]

[Operator Instructions] Our next question comes from Matthew Weekes with iA Capital Markets.

[Matthew Weekes, analyst]

I think I just wanted to ask in terms of the Heritage royalty integration, how is that going so far? I was just wondering if you could provide an update on progress around that.

[Andrew Phillips, executive]

For sure. Yes, it's a big job, Matthew, and I appreciate the question, and it's going to be a huge amount of administration, everyone's working very hard here. And in addition to Heritage, of course, we bought another 1 million acres last year as well, primarily the Paramount fee, which was the old Apache fee title land in kind of west central Alberta in the Deep Basin.

So we continue to be very active inputting all of the different leases in properly into our systems. The one place we're fortunate with Heritage is it's -- it was broken up originally from the same asset base we IPO-ed with. So because of that, we understand the leases quite well. And -- but it's work in progress. We're quite active on it, but it's definitely going to be a busy year from an integration perspective. And we're just doing it slowly and pragmatically to make sure -- to ensure everything is entered in correctly.

[Matthew Weekes, analyst]

Okay. I appreciate that. And just my last question, looking at the organic growth outlook here, it looks like it's pretty solid, some indicators as far as the amount of wells being spud as far as leasing activity. Just thinking about alternative minerals like lithium, and I know you had the one lease that was announced with the quarter,

and maybe not necessarily material by itself yet, but as you look at that optionality going forward, do you think that it will increase given the federal government's budget and wanting to develop a critical mineral strategy where we do more exploitation of these minerals such as lithium going forward?

[Andrew Phillips, executive]

Yes. I do think it will be a bigger focus of industry and a lot of the core competencies of the E&P business can be transferred over for exploration for things like lithium and helium. So we do think there'll be -- it will be a bigger asset 10 years from now.

Now, it's not going to be a major contributor. Now having said that, we did receive just under $1 million in lease issuance bonus to lease those lithium lands. So we are -- again, we think it's a great opportunity set for investors who -- these are some of these resources we didn't even know we owned a few years ago, and now we're receiving bonus and explorations being done on them. And there's also resources like helium, where Canada's the fifth largest resources reserves in the world of helium, and it's the exact same core competency for natural gas. So I think people can take those skills and explore for helium as well.

And there's been some recent notable expansions from some of the potash companies in Southeast Saskatchewan. We already collect potash royalties as part of our other income stream, and that's likely to grow over the next period of time as well. So other minerals, again, while not significant in the large amount of EBITDA that we're going to generate this year, I think in the future they'll be -- have some significance.

[Operator]

I'm seeing no other questions in the queue. I'd like to turn the call back to Andrew Phillips for closing remarks.

[Andrew Phillips, executive]

Thank you very much, and thanks, everyone, for taking the time to dial in to our call and hope everyone had a good Easter and look forward to a great year in 2022. Thank you.

[Operator]

This concludes today's conference call. Thank you for participating. You may now disconnect. Everyone have a great day.