PrairieSky Royalty: Well-Managed But I Remain On The Sidelines

seekingalpha04-23

PrairieSky Royalty's Q1 2024 results show an increase in oil and gas production and a higher average realized oil price.The low natural gas price negatively impacts revenue breakdown, with oil still ...

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Ramon Cliff/iStock Editorial via Getty Images Introduction I like oil (and gas) royalty companies to gain exposure to the fluctuating oil and gas prices. At the end of last year, I discussed PrairieSky Royalty (TSX:PSK:CA) (OTCPK:PREKF), but I decided I liked other oil royalty companies better and rated the stock a ‘hold’. As the company has now published two quarterly updates since the previous article, and as the oil price has shown a nice move up, I wanted to have another look at the company to see if my investment thesis needs to be fine-tuned. Data by YCharts As a reminder, the royalty model is very straightforward. A royalty company pays a lump sum upfront in return for the right to collect the revenue of a percentage of the production. This means there is no sustaining capex required while a royalty company needs to acquire new/other royalties to offset the depletion of existing assets, considering an oil asset per definition has a finite life. A high oil price means higher cash flows My most recent article had a look at PrairieSky’s third quarter of 2023, but as the company has recently published its Q1 2024 results, this likely is a good moment to have another look at the company’s performance. In the first quarter of the current financial year, the total attributable oil and gas production was just over 26,000 barrels of oil-equivalent per day. As you can see below, just over half of the oil-equivalent production actually consisted of oil with about 10% of the equivalent output contributed by Natural Gas Liquids with the remainder coming from natural gas sales. The first quarter of 2024 represented a quarterly record in terms of output.   PSK Investor Relations The average realized oil price was approximately C$77 per barrel (mainly due to the price difference between Western Canadian Select oil and the benchmark WTI oil price). The NGLs were sold at C$44/barrel, while the natural gas price was pretty disappointing at just C$1.89. The latter was hardly a surprise, but it obviously is a headwind for a company whose oil-equivalent output consists of approximately 40% of natural gas.   PSK Investor Relations The impact of the low natural gas price is clearly noticeable in the revenue breakdown. As you can see below, although natural gas represents roughly 40% of the oil-equivalent output, it represents less than 10% of the total revenue and oil obviously is the main contributor to the underlying results.   PSK Investor Relations As the income statement below shows, PrairieSky generated a total revenue of just under C$121M, and with a total operating expense of C$55M, the EBIT was approximately C$66M. That’s lower than the almost C$79M it generated in the first quarter of last year, and that’s caused by the lower revenue in combination with higher depreciation & depletion expenses as well as a 40% increase in administrative expenses.   PSK Investor Relations The higher G&A expenses are related to the higher share-based compensation for the management team which is a non-cash expense. The total net income was approximately C$47.5M and divided over the current share count of 239M shares, this represents an EPS of approximately C$0.80 per share. Considering almost three quarters of the operating expenses consisted of depletion and depreciation expenses, due to the ‘sunk cost’ nature of the business the cash flows are always stronger than the net income. That was once again proven in the cash flow statement (shown below). The company reported a total operating cash flow of C$83M before changes in the working capital elements.   PSK Investor Relations That also was the underlying free cash flow, as there are no follow-up investments required from PrairieSky to keep existing royalty assets in good standing. Of course, the company always has to add new assets to its asset base, and in the first quarter, it spent about C$8.8M on exploration, acquisitions and the evaluation of potential additions to the asset base. The cash flow came in at approximately C$0.35 per share excluding the investments in assets, and approximately C$0.31 per share if you’d include the C$8.8M spent on acquisitions and evaluation expenses. This means the current dividend of C$0.25 per share on a quarterly basis is fully covered by the incoming cash flows. The rest of the incoming cash flow was used to reduce the net debt on the balance sheet. As of the end of March, PrairieSky had approximately C$208M in net debt (defined as net financial debt plus the working capital deficit).   PSK Investor Relations The entire bank debt is classified as a current debt, as the C$700M revolving credit facility has a maturity date of February 2025 and will have to be renewed or extended. Considering the total bank debt represents just 0.5 times the annual operating (and thus free) cash flow, I don’t anticipate any issues, as I can’t see banks not being interested in providing financing to this company. The average cost of debt was approximately 6.4% in the first quarter, so lending cash to PrairieSky appears to offer a good risk/reward ratio to the lenders. Investment thesis PrairieSky is very well-managed and its balance sheet is clean. That explains why the stock is trading at a premium valuation. Excluding the cash spent on acquisitions and asset evaluation, the company is currently trading at approximately 20 times its cash flow. Although the Q2 results will likely be strong (with the caveat the quarter has just started) and considering the company has exposure to heavy oil which should benefit from changing dynamics in the market, PrairieSky is too expensive for me. I still prefer to own Freehold Royalties (FRU:CA) (OTCPK:FRHLF) in the oil and gas royalty segment. PrairieSky is well-managed but also appears to be fully valued, even if you’d expect a higher realized oil price and even if you expect the natural gas price to double from the current levels. I am still on the sidelines here.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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