Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Analysis

PrairieSky Confirms Strong 2023 Performance and Dividend Hike

In 2023, PrairieSky experienced a solid year marked by 6% organic oil growth and drilling efforts replacing 4.5 million barrels of produced royalty oil. The company reported the drilling of 804 wells and continued leasing activities with 202 new leases. Fourth-quarter royalty production reached 25,608 barrels of oil equivalent per day (BOE/d), a 6% increase in oil volumes year-over-year, mainly from the Clearwater and Mannville heavy oil plays. Revenue for the fourth quarter hit $122 million, 90% from liquid royalties, and $474.6 million annually, predominantly from liquids. They announced a 4% increase in the annual dividend to $1 per share, effective March 29, 2024. Looking ahead, they project other revenues between $25 million to $30 million for 2024. PrairieSky plans to use excess cash flow to reduce bank debt and pursue high-return acquisitions.

PrairieSky Finishes Strong with Record Oil Royalty Volumes

PrairieSky Q4 marked a period of robust performance, capping off a year underscored by organic growth in oil royalty production and dynamic leasing operations. The quarter witnessed an average royalty production of 25,608 barrels of oil equivalent (BOE) per day. This was bolstered by record oil royalty volumes—peaking at 12,844 barrels per day, a 6% uptick from the same quarter in the previous year. While natural gas liquids (NGLs) remained steady, natural gas experienced a slight 9% drop. On an annual scale, oil royalty volumes surged by 6%, with a noteworthy contribution from the Clearwater and Mannville heavy oil plays, averaging 12,438 barrels per day. Financially, PrairieSky's fourth quarter raked in $122 million in royalties, predominantly from liquids (90%). For the year, total royalties hit $474.6 million with 88% from liquids, suggesting a strong liquids-focused revenue base.

Stable Pricing with a Positive Outlook for 2024

The pricing environment for PrairieSky remained steady with realized oil pricing at $82.52 per barrel, closely tracking Edmonton Par at 82%. NGLs realized pricing held at $47.60 per barrel, or 47% of Edmonton Par. Heading into 2024, the company forecasts these price realizations to mirror the consistent performance of 2023. Natural gas was realized at $2.60 per Mcf and sold primarily based on AECO monthly and daily pricing. 'Other revenue' for the quarter tallied up to $14.6 million, which included significant bonus considerations totaling $11.4 million, leading to an annual bonus of $26 million and a total other revenue of $38.6 million—the highest since 2017. In looking ahead, PrairieSky has set a target range for 'other revenue' between $25 million to $30 million for 2024.

Anticipating Growth and Positive Momentum in Reserves

Looking into the first half of the year, the company is optimistic about continued growth, supported by both leasing and drilling activities. Especially notable was the year 2023, which revealed over 9 horizons within the Mannville stack as commercially viable. Although the booking was conservative, only accounting for a single well in the reserves, with increased activity around the Cold Lake region, there is an anticipation of a significant increase in the bitumen reserves, potentially surpassing 50%. Whilst year-over-year oil reserves appeared relatively flat, given the 6% rise in Q4 oil production, this steadiness is viewed positively as it reflects the company’s ability to replace every barrel produced without needing to acquire proven developed producing (PDP) assets. This capability is crucial since it contributes to over 90% of PrairieSky's cash flow.

High Hurdles for Acquisitions and Commitment to Reduce Debt

When assessing the company's capital allocation strategy, management revealed a keen focus on reducing debt, which takes precedence over acquisitions and share buybacks. However, the intrinsic value of PrairieSky's shares was highlighted as tremendous, suggesting that buybacks could be an effective tool for returning value to shareholders over the next decade, especially under current market valuations where the company perceives its stock as undervalued. Nevertheless, the primary goal remains to achieve a debt-free status, which is underscored by a desire for financial flexibility in an environment where interest rates have climbed to notable levels compared to the past 15 years.

Earnings Call Transcript 2023-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. Welcome to PrairieSky Royalty Ltd. announces their annual and fourth quarter 2023 financial results. [Operator Instructions] Please be advised that today's conference is being recorded. I would like now to turn the conference over to Andrew Phillips, President and Chief Executive Officer. Please go ahead.

[Andrew Phillips, executive]

Thank you, operator, and good morning, everyone, and thank you for dialing into the PrairieSky year-end conference call. On the call from PrairieSky Pam Kazeil, CFO; Dan Bertram, CCO; Michael Murphy, VP Geosciences and Capital Markets; as well as myself, Andrew Phillips.

There are certain forward-looking information in my commentary today, so I would ask investors to review the forward-looking statements qualified in our press release and MD&A. As we approach our tenth year as a publicly traded company, our team continues to strive to improve our business over the next 10 years. The industry's leading organic growth rates in our liquids portfolio are the result of assets acquired years ago.

2023 was another great year on multiple levels. Organic oil growth was approximately 6% and the 4.5 million barrels of produced royalty oil were organically replaced by drilling. Of note, our $14 million fee title acquisition, which closed near year-end was not included in the 2023 reserve report.

During the quarter, there were 197 well spot on our lands bringing total wells spud to 804 wells in 2023. This included 147 Clearwater wells; 139 Mannville heavy oil wells; and 236 Viking wells. We also saw our first helium well drilled in our acreage. We estimate that $2 billion of gross capital and $112 million of net capital was sent on PrairieSky Royalty lands in 2023.

Based on an estimated $26.7 billion of gross capital on conventional oil and gas assets spent in 2023, approximately 7.5% of industry capital was spent on PrairieSky lands. Net capital increased 38% year-over-year, although this is partially inflation related. The increase led to PrairieSky's strong oil royalty production growth.

Leasing activity remains at high levels. Throughout the year, we entered into 202 new lease arrangements with 110 separate counterparties. This resulted in $26 million in bonus consideration over 2023 and $11.2 million in Q4. Leasing activity was strong across the basin, primarily for oil targets. Strong recent well data and lower costs have resulted in stronger producer interest in the Duvernay shale, and we expect light oil growth from this play over the next 10 years.

The moat around our business is our irreplicable fee mineral title land base. We also have seen stronger interest in viewing our large seismic database as operators are conducting exploration to expand their drilling inventory. PrairieSky controls 54,200 linear kilometers of 2D seismic and 20,100 square kilometers of 3D seismic. Our seismic data is continually improving as we receive a copy when a producer reprocesses the data.

This data is available with third-party leasing our lands, and we also use it to develop prospects for an industry, which we can then lease. Our compliance group, who are always busy, return land to inventory and brought in $6.6 million throughout 2023. As we look into 2024, our team will continue to focus on controlling costs, compliance, leasing our large undeveloped land base and executing on high-return acquisitions.

We are pleased to announce a 4% increase to our annual dividend, bringing it to $1 per share and $0.25 per share quarterly. This increase is effective for the March 29, 2024, record date. We will use excess cash flow above the dividend to retire bank debt and execute on high return on invested capital acquisition opportunities, if available. I'd like to thank our staff for their continued hard work and our shareholders for their support. I'll now turn the call over to Pam to walk through the financials.

[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 our forward-looking statements qualified in our press release and MD&A for Q4 and the year ended December 31, 2023.

PrairieSky had a strong Q4, which closed out another year of organic oil royalty production growth and momentum in leasing activity. PrairieSky Q4 royalty production averaged 25,608 BOE per day and included a record 12,844 barrels per day of oil, 6% higher than Q4 of 2022. NGL royalty volumes averaged 2,697 barrels per day, flat with Q4 2022 and natural gas royalty volumes averaged 60.4 million a day, down 9% from Q4 2022.

Annually, royalty production revenue -- royalty production averaged 24,857 BOE per day with a record oil royalty volumes of 12,438 barrels per day, an increase of 6% year-over-year with growth primarily in the Clearwater and Mannville heavy oil play. PrairieSky's Q4 royalty production revenue totaled $122 million, generated 90% from liquids royalty volumes. Annually, royalty production revenue totaled $474.6 million, 88% from liquids.

In 2023, realized oil pricing of $82.52 per barrel was 82% of Edmonton Par and NGL realized pricing of $47.60 per barrel was 47% of Edmonton Par pricing. We anticipate 2024 price realizations to be in line with 2023. Realized natural gas pricing was $2.60 per Mcf, with approximately 90% of our volumes sold at monthly and daily AECO pricing and approximately 10% being sold at [indiscernible] pricing.

Other revenue totaled $14.6 million in the quarter and included $11.4 million of bonus consideration. This brought annual bonus consideration to $26 million and total other revenues to $38.6 million, the highest total since 2017. PrairieSky is forecasting other revenue in the range of $25 million to $30 million in 2024, including lease rentals, bonus consideration and other revenue.

Compliance recoveries will be incremental to this amount and included in royalty revenue. Looking forward, PrairieSky's 2024 annual pricing sensitivities, which are all net of taxes, are as follows: a $5 per barrel change in U.S. Dollar WTI would increase or decrease funds from operations approximately $22.5 million; a $0.25 per Mcf change in AECO, which increase or decrease funds from operations approximately $4 million; a $0.01 change in the U.S. to Canadian FX rate would increase or decrease funds from operations approximately $4 million; and if the U.S. -- if the WCS oil differential moved by $1, we would see an increase or decrease in funds from operations of approximately $2.5 million. This impact would be the same for a $1 move in the MSW differential.

Cash administrative expenses totaled $5.1 million or $2.14 per BOE in the quarter. We expect 2024 cash administrative expense to be in the range of $35 million to $40 million due to strong stock performance impacting share-based compensation. Current income tax expense totaled $14.4 million in Q4, bringing 2023 current tax to $58.8 million.

Entering 2024, PrairieSky has $1.4 billion of tax pools to offset future taxable income, which is primarily deductible at 10% per year. For 2024, that means the first $140 million of pretax cash flow is tax-free with the incremental cash flow tax at 23.6%. During the quarter, PrairieSky's funds from operations totaled $111.1 million, and we declared dividends of $57.3 million or $0.24 per share with a resulting payout ratio of 52%.

Annually, PrairieSky generated $382.5 million in funds from operations, which were used to fund dividends of -- sorry, $229.2 million with remaining cash flow used primarily to reduce PrairieSky's bank debt. At December 31, 2023, PrairieSky's net debt totaled $222.1 million, a decrease of 30% from December 31, 2022. Once again, in 2024, PrairieSky will receive the full pricing reduction related to our sustainable credit facility based on the evaluation by third-party rating agency Sustainalytics, which included PrairieSky and its list of the Global 50 top-rated ESG companies for 2024.

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

[Operator]

[Operator Instructions] The first question comes from Michael Dunn with Stifel.

[Michael Dunn, analyst]

A couple of questions from me. Just looking at your second half spuds on your lands folks, more Mannville and less Viking than if we looked at the second half of 2022. Just noticing from your reserve disclosures of your oil production in 2023, it looks like it was about 52% light, 48% heavy bitumen kind of the same split as in 2022. How do you think the second half activity from 2023 plays out, I guess, into your heavy versus light split into 2024? And maybe any thoughts on the absolute level of oil production in the first half of this year, I guess, relative to Q4?

[Andrew Phillips, executive]

Yes, I'd hate to speculate -- sorry, I did speculate on the actual levels of production in the first half of the year. We do expect some growth over the year, again, with the strong leasing activity and the strong drilling activity we've seen. And then as it ties to the reserves, I do think you're going to see the bitumen reserves go above 50%. And I think the -- there's been -- 2023 was a year of multiple discoveries. There was over 9 different horizons within the Mannville stack that were proved commercial. But of course, because we just booked the one individual well in our reserve report and probably conservatively given their new wells, it didn't add a huge amount of new barrels from a reserve standpoint. But I do think as people start to develop those, which we're already seeing today, there's quite a few rigs running around the Cold Lake region, we should see a significant uptick in those reserves over 2024.

[Michael Dunn, analyst]

I thought I'd try on the guidance there, Andrew, but -- and then -- just secondly then looking at the -- your year-end reserves. Your oil reserves were about flat year-over-year. And of course, they're all developed reserves, but your Q4 oil production was up close to 6% year-over-year. So is that implying a little bit shorter like developed reserve life? Or is it just exit volumes were lower than the Q4 average? Or how should we think about the, I guess, the lack of oil reserves growth?

[Andrew Phillips, executive]

Yes, that's interesting. I think the flat was a pretty good result for us, replacing every barrel that was produced without making any PDP acquisitions. I think one of the things that we saw this year was -- just from an inflation standpoint on the operating costs and the tail of the wells were truncated. So again, if people can get their operating costs down in future years, you can see that come back. Again, we do believe a lot of those do long RLIs, or reserve life indexes, but I think there was some truncation based on inflation and operating costs on the tail end of the of the well. Otherwise, we would have seen growth there. But again, it's always a good result when you don't spend money on any PDP acquisitions and you replace every barrel you produce, which generates, right now, over 90% of our cash flow.

[Operator]

The next question comes from Adam Schwartz with [ Black Bear ] Value Partners.

[Unknown Analyst]

First, as shareholder, thank you for your quality stewardship of the company. We appreciate it. Curious if you can comment on where share buybacks fit into your plan? And when you look at the acquisition or potential M&A, are they more attractive than the stock? Or the same? How do you think about that? Because today, it seems like the stock price is in a pretty benign energy price environment and virtually no value for any kind of volume growth or call options that you guys call out in your presentations, which I think are real. And over the long haul, the intrinsic value per share can compound at even higher rates than you've been experiencing if you use this tool. So I'm just curious, buybacks aren't always a good idea. But when the stock is really cheaper and including fairly bearish, not benign assumptions, if you're positive on the outlook [indiscernible] could be a pretty helpful value-add action. So just if you can comment on that, I'd appreciate it.

[Andrew Phillips, executive]

And we do see tremendous value in the shares right now. And I will say that when looking at any acquisitions, the hurdle rate is quite a bit higher, just given the value we do see in the shares that I do think it is a unique compounding business over time, generates a lot of cash. We've kind of refreshed our 10-year budget and you generate almost your entire market cap and free cash flow net of tax, net of G&A and have a business that's likely bigger at the end of that period. So we do see great value in the shares right now. We always trade below intrinsic value. So I think -- but our priority right now is retiring the debt and any acquisitions that we enter into. The IRR hurdles have to be quite a bit higher. So again, it's definitely a higher hurdle rate right now, but the retirement of the debt is definitely our #1 priority right now. Interest rates are, again, in a pretty high historical level based on the last 15 years anyway. And we'd like to have the optionality of having all of the debt retired. So hopefully, that helps answer your question, but we definitely do see value in the buybacks. We do have a buyback in place that we could execute on at any time. And I think it will be part of the capital return over the next 3, 5 and 10 years as part of the returns to our shareholders.

[Unknown Analyst]

That's helpful. I would say, just as far as a comment, it's great for it to be a tool used if the stock is cheap. If it's not, then done. But clearly, if it stays around here or even meaningfully higher, it still seems very attractive given the prospects.

[Operator]

The next question comes from Jamie Kubik with CIBC.

[James Kubik, analyst]

I've got two here for you. I'm hoping you can talk a little bit more about the bonus revenue in the quarter and expand a little bit on it. As you know, it was the highest since you've -- or since 2017. And Pam, your comments indicate that other revenues in 2024 be between $25 million to $30 million. But I'm wondering, is there more to do on the bonus side as it relates to the Duvernay? And can you expand a little bit more on that side?

[Andrew Phillips, executive]

Yes, you bet. So the bigger leasing arrangements that we entered into in Q4 were West Shale Basin arrangements, Jamie. And I think that's where we've seen recently a fair bit of activity. One of the media producer had plans for very significant growth in the area. And I think just with costs coming down and kind of the not being [ fracked ] in terms of the technical application of fracking and we're seeing some very good well results and wells that likely are well over 500,000 barrels on an individual well. So again, pretty good results and costs are getting figured out. So I think that's where the majority of the bonus was for last year, particularly Q4. And then what we're seeing is a similar thing happening in the East Shale Basin in both the Westerdale Embayment and Ghost Pine Embayment where some improvements have really changed the [indiscernible] per well and costs have come down there as well. So I do expect some leasing arrangements entered into there as well this year. I just don't know the exact timing of it. And as a refresher, the stuff in the West Shale Basin, there's 200,000 acres that we had leased to [indiscernible] upon the IPO that had 8 years till expiry. And again, so we finally have received all that land back and now entering into lease arrangements with well-capitalized producers, but what we're more excited about rather than lease bonus is that it's very significant individual well events, and we do see a huge amount of resource there. It's a very thick shale. And it will really complement -- we kind of have pretty good visibility into our growth from heavy oil portfolio, both in terms of the Mannville stack and the Clearwater, but this will complement that growth with some light oil, which is 40-degree API oil and then a lot of liquids-rich solution gas. So likely over the next 10 years, the proportion of solution gas goes over 1/3 or significantly over 1/3 of our total gas volumes. So again, some positives there, and we're definitely excited about the play. But I do think there will be some more leasing arrangements, but probably not of that size.

[James Kubik, analyst]

Okay. Got it. And then other question is PrairieSky did acquire 22 million properties in the quarter. You outlined a little bit between the Mannville stack and Central Alberta as being the areas that you acquired. Can you break apart a little bit further what was acquired in the quarter? What has you excited on that side? And can you talk about what the types of opportunities are that are coming across your desk these days?

[Andrew Phillips, executive]

Yes, you bet. There are a few royalty packages out there. And as we said with the previous question from Adam, the hurdle rates are definitely high right now for us as a company. The $14 million acquisition, which was mostly fee mineral title and also a handful of [ GORRs ]. That was in Southeastern Alberta. So we see both Mannville and Viking potential there. We've actually already entered into a lease, two days after closing that acquisition, which could have the potential to grow that asset in the double digits. And again, it was the really good IRR even on just the PDP. So that's fee mineral title acquisition. That's the last of the [ old apache ] fee mineral title left in Canada, so [ 8s and 26s ] primarily. And then the $8 million was spent on 6 different private operators to acquire 15-year oil leases in the Mannville stack. So we're expecting some drilling to test those opportunities over the next year.

[Operator]

I show no further questions at this time. I would now like to turn the call back to Andrew for closing remarks.

[Andrew Phillips, executive]

Thank you, again, everyone, for dialing into the PrairieSky conference call, and I hope everyone has a great rest of the week.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect. Have a great day.