Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Transcript 2019-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the PrairieSky Royalty announces their Second Quarter 2019 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, President and CEO, Andrew Phillips. Mr. Phillips, you may begin.

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

Good morning, and thank you for dialing in to the PrairieSky Royalty Q2 2019 conference call. On the call from PrairieSky are Pam Kazeil, CFO; Cam Proctor, COO; and myself, Andrew Phillips. I will provide an operational update and then turn the call over to Pam to walk through the financials. PrairieSky generated $58 million in free cash flow in Q2 2019, which paid $45.6 million in dividends, a 79% payout ratio, canceled approximately 400,000 common shares for $5.7 million and reduced the working capital deficiency to $2.1 million. In addition, $1 million was used for land fund acquisitions to acquire 32,000 acres of prospective oil-prone acreage with well-capitalized private companies. Over the last week, there were just under 140 rigs operating in the Western Canadian sedimentary basin. This is down from just under 240 rigs the same week one-year ago. This highlights the importance of owning assets on the right part of the cost curve. 75 of the 112 wells spud in the quarter were drilled in the Viking formation in Alberta and Saskatchewan. 50% of all wells drilled were spud in Saskatchewan. Natural gas represented 49% of our production but only 7% of product revenue. The Clearwater asset, which totals over 700,000 acres of land was purchased 1.5 years ago for cash but on a leverage-neutral basis, represented 1% dilution. It is anticipated that approximately 10% of drilling on PrairieSky lands over the next 12 months will be on the Clearwater acreage. Our compliance team worked hard through the quarter and brought in $2 million. Compensatory royalty revenue totaled approximately $220,000 and 30 sections of land, or 19,000 acres, were returned to our land inventory through active management and land compliance initiatives. On the cost front, G&A per barrel was $2.41. We anticipate the cash G&A number to be below $3 per barrel for the year. The Alberta government has announced that they will lower provincial income tax rates by 1% in each of the next 4 years. This will make Alberta one of the lowest tax jurisdictions in North America. Given we generate a lot of cash and spend little, this will have a positive impact on our future free cash flows and allow Canadian companies to make further investments in the basin. The core of our business is land leasing and in Q2 we've received $4.3 million in bonus consideration. This came from 37 counterparties and 42 different leasing arrangements. Notably, almost all of the leasing was in the Mannville and included a SAGD leasing arrangement in Saskatchewan. We also did a sizable lease on 100 million barrel pool that is currently not producing but has produced over 9 million barrels of light oil, which the new operator is evaluating for a potentially OR scheme. The technical team continues to generate through ready prospects on PSK Fee land, and when capital returns to more historical levels, we are confident that a number of them will be drilled. PrairieSky will continue to work hard to partner with talented teams that are well capitalized to exploit our vast resource base. I will now turn the call over to Pam to walk through the financials.

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

Thank you, Andrew. Good morning, everyone. PrairieSky generated funds from operations of $58 million or $0.25 per share basic and $0.24 per share diluted in the quarter. Cash flow was generated primarily from royalty production revenue of $63.1 million on average production volumes of 220,297 BOE per day, which were 51% liquids. Royalty revenues were predominately from liquids production. Oil volumes were 8,740 barrels per day, down 164 barrels a day from Q1 due to lower activity in the basin overall as a result of curtailments and the seasonal impacts of break up. PrairieSky generated $52.1 million in oil royalty revenue, which was up 13% from $46.3 million in Q1 as lower volumes were offset by higher average WTI pricing and narrowed average heavy and light oil differentials. NGL royalty volumes averaged 2,690 barrels per day, and they were up 104 barrel a day from Q1. They generated an additional $6.5 million in revenue. NGL pricing is down during the quarter due to lower propane and butane pricing. Natural gas volumes total 65.2 million a day, up 2.1 million a day from Q1 as production volumes returned from freeze offs in Q1. Positive volumes were offset by lower natural gas pricing generating total revenue of $4.5 million down from $11.1 million in the first quarter. PrairieSky's production volumes in the quarter included 951 BOE per day of prior period adjustments, which were 56% liquids and included 508 BOE a day from compliance activities and an additional 443 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 $2 million in the quarter bringing year-to-date collections to $3.8 million. There were 112 wells spud in Q2, which included 99 oil wells and 13 natural gas wells. Although, the number of wells were down as compared to 168 in Q2 2018, the average royalty rate of the wells spud was 9.2%, up from 6% in Q2 2018 as there were higher percentage of wells spud on Fee Lands in the quarter. Other revenue totaled $6.2 million, including $1.5 million in lease rentals, $0.4 million in other revenue and $4.3 million in bonus consideration on entering into 42 leasing arrangements with 37 different counterparties. Production and mineral taxes totaled $0.7 million and cash administrative expenses totaled $4.9 million or $2.41 per BOE. Cash administrative expense is expected to be below $3 per BOE in 2019. During the quarter, the new Alberta provincial government announced the reduction to corporate tax rate. Effective July 1, 2019, the Alberta tax rate was reduced by 1% to 11%. Effective January 1, 2020, '21 and '22, the tax rate will be reduced by an additional 1% per year bringing the corporate rate to 8%. These rate changes reduced our deferred tax liability by $24.4 million in the quarter and are expected to positively impact our cash flow in future periods. During Q2, PrairieSky paid $45.6 million in dividends with a resulting payout ratio of 79% and repurchased common shares for $5.7 million for an all-in payout ratio of 88%. During the quarter, PrairieSky reduced its minor working capital deficiency by 66% from March 31, 2019 to $2.1 million at June 30. Since IPO, PrairieSky has generated approximately $1.2 billion in funds from operations and returned $1.1 billion to shareholders through $940 million in dividends and the repurchase and cancelation of 4.8 million common shares. We will now turn the call over to the moderator to proceed with the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Luke Davis of RBC.

[Luke Davis, Analyst]

Just a few quick ones for me. With your renewed NCIB you kind of outlined the ceiling of about $50 million in buybacks through to mid-next year. Do you kind of view that as an attainable goal? Or based on what you're seeing to date? Or how should we think about that for modeling purposes?

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

Yes. The NCIB will kind of be driven by the free cash flow generation -- generating ability of the business. And we talked about taking our debt down to $0, of course, and kind of maintaining it in that area. So it'll really depend on how much free cash flow we generate in the next 3 quarters that, that will kind of drive how much of that $50 million worth of buybacks that we've got approved we execute on. So that will really be the driver. So it depends on what you view on quantity price and then our production volumes would be.

[Luke Davis, Analyst]

Sure.

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

Does that make sense?

[Luke Davis, Analyst]

Yes. Yes. It does. On cash cost, G&A and tax continue to be the largest expenditures and kind of the apart from the recent Alberta government changes, is there anything that you are seeing or any opportunities to kind of bring that down over time? Or are you clearly happy with where you're sitting there?

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

Yes. I think we're always looking for improvements on the cost side. I think the G&A per barrel -- of course, we don't capitalize any of our G&A so we're always looking for efficiencies on that front and ways we can make the business more efficient there. On the tax side, there's not a lot of opportunities we have in our business because we don't create any taxables by not spending capital, but definitely a big positive for us when you take the tax rate from 12% to 8% provincially. That will save a lot of money over the next 20 years if those tax rates stay in place.

[Luke Davis, Analyst]

Perfect. And just on Clearwater. It remains fairly active it -- well results in the public system look to be improving over time. But maybe you can just expand on your comments in the release? And then what you're seeing there as kind of behind your outlook?

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

Yes. So it's one of our biggest land positions in Alberta, Luke, and I think the importance of it we are starting to see it already. We think somewhere north of 60 wells will get drilled from break up this year to break up next year. So it's going to be quite an active area for us. But probably the more impactful thing it's the most capital efficient play in our portfolio, and some of the volumes are being added at less than 10,000 a flowing barrel for oil. So for us 4% or 6% royalty is actually if you look at the rest of the portfolio is worth somewhere in the range of double to triple that. So -- for a regular well. So a 6% royalty in the Clearwater is worth 12% in most other plays or more. So that's one of the reason it's very important in this kind of more challenging environment with approximately 100 less rigs running than same time last year. So that's one the reasons we highlighted it. And then we're trying to show investors as well. We bought this year and a half ago with their money, $50 million of their money. And we just want them to see the results of some of those acquisitions on the smaller side and on the land fund side.

[Operator]

[Operator Instructions] Our next question comes from Mahad Nadeem from TD Securities.

[Mahad Nadeem, Associate]

My question is also on Clearwater. I see that you guys did say that 10% of the drilling activity will be on Clearwater? What is that amount in dollar terms?

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

Yes. Sorry, was there a follow-up to that?

[Mahad Nadeem, Associate]

No.

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

So from a dollar perspective, it's quite light on capital which is a great thing about the play. It should be in the range of about $1 million per well. But the actual cost probably slightly higher than that when you think about surface work that needs to be done because it is forested area. So in terms of all-in cost, I don't have full cycle cost from the operators, but we're seeing kind of half-cycle cost sub $1 million per well. So it will be in the range, if there is 60 to 70 wells, it'll be $60 million to $70 million. So roughly 5% to 7% of our total CapEx on our land over the year.

[Operator]

And I'm not showing any further questions at this time. I would now like to turn call back over to Mr. Phillips for any further remarks.

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

Thank you very much for calling into our Q2 2019 conference call. As always, please reach out to Pam or myself with any questions, and hope everyone has a good summer. Thank you.

[Operator]

Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.