PrairieSky Royalty: We Are Holding At Present

• PrairieSky Royalty Ltd. makes money from leasing drilling rights and from a royalty on production.
• We think the company will report weaker results in Q-3, measured against Q-2.
• This could create a slightly better entry point from present levels. We rate PrairieSky Royalty a hold at present levels.

 Introduction

PrairieSky Royalty Ltd. $Prairiesky Royalty Ltd.(PREKF)$  is a Canadian landowner that leases the rights to drill and produce subsurface minerals - oil and gas mostly - to operating companies.

It derives revenues from leasing the right to drill and then receives royalty payments based on production. It is the largest landowner in the country, with mineral rights to over 18.5 mm acres across the Western Canada Sedimentary Basin ("WCSB").

In particular, the company has a solid footprint in the hot Clearwater play that we have discussed on a number of occasions. (The Clearwater was discussed in detail in an Obsidian Energy (OBE) article last July.) The present PrairieSky is the product of some key acquisitions of a couple of other royalty companies in 2015 and 2021.The company has underperformed the market since our last article in February, although it hit the analyst targets in the mid-teens before succumbing to the June Swoon (I've always wanted to write that). Although their price chart looks like the mountains of the moon, analysts are still high on the stock in the $14's, with Overweight ratings and price targets ranging from $20-$32.00 Canadian.

With earnings coming up, we will take a run through the last quarter and see if the tea leaves suggest that the analysts are right. Or, if we might want to have a little patience, waiting for a slightly better price as I will discuss in the article.

The macro picture for oil: things have changed 

I've been predicting an inflection point in oil prices for a while now, driven by my belief -based on a lot of research - that the market was under-supplied. There were a lot of fits and starts while I was pushing this notion - the world ended, oil and gas became pariah energy sources and were tossed into the dust bin of history, then the wind quit blowing in Europe, and suddenly oil and gas were cool again and were pulled out of the dust bin of history as people held their nose and accepted the benefits they brought.

In fact, people couldn't get enough of it. I mean that literally. They couldn't get enough of it. People are worried now. Winter is coming, and in far-off places around the world, and increasingly here at home, people are wondering if they will have any energy, and if they do...will they be able to pay for it.

Bottom line, this turn in the oil market is starting to feel very much like an inflection point. I've also called it a singularity - just because I like to use that word, and it fits the situation. Whichever word is used, what it amounts to is the market has shifted in sentiment, from worries about a decline in demand creating excess inventory and driving prices down, to FOMO - Fear Of Missing Out - meaning the market is suddenly scared to death of not having the energy it needs when it's needed.

As I said before. Things are different now.

Why PrairieSky?

PREKF has a couple of drivers we associate with doing well. First is substantial acreage in the hottest plays in Canada: the Clearwater, as mentioned above, and Viking. Both have low finding and drilling costs. If their customers are doing well, PREKF is going to do well.

The second thing is no operating expense associated with production. That is what makes them different from operators - companies that drill and produce. For PREKF, the opex is nil. Once their acquisition cost is sunk, it's all gravy for these guys.

The only thing they really have to worry about is the oil price sinking below production costs. Worries about PREKF lessees laying down rigs may have had a role in the lackluster performance of the stock this year, at least as compared to operating companies that have doubled or tripled.

Andrew Phillips, CEO, commented on PREKF assets:

We have heavy oil reservoirs with low recovery factors can be exploited using these drilling techniques pioneered in the Clearwater and will result in decades of new drilling activity for heavy oil on PrairieSky lines at no additional cost to our shareholders. Our unique fee title royalty model allows PrairieSky to capitalize on cyclicality and counter cyclicality. In the lower cycles we can use our strong balance sheet to execute on organic opportunities and in the high commodity environments we can lease our large undeveloped land base to qualified industry participants.

What to expect when they report Q-3

PREKF's lessees are busy. Production grew 25% YoY from frenzied growth in drilling that took the rig count from ~150 rigs to 206, the highest number in Canada in years. Production growth and strong commodity pricing for oils, oil NGLs, and natural gas combined to generate record quarterly funds from operations of $159.6 million, or $0.67 per common share more than double Q2 of last year and 52% above Q1 2022. Net debt of $453 mm CAD, which has been reduced by $181 mm, or 29%, is <20% of their $3.3 bn market capitalization.

What was noteworthy about their press release was the realized prices they received for their oil, gas, and NGLs. Their oil-heavy production lifted their average Price/BOE to $80.44, a feat that is unlikely to be repeated in Q-3.

The Q-3 declines in realized prices will pull these figures down when the results of the quarter are released, and that may create an improved entry point.

A possible catalyst for 2023

New leasing is still hot and heavy, the company reports. Bonus revenue of nearly $4.0 mm CAD was reported on 54 new leases with 45 separate counter parties. Pamela Kazeil, CFO commented:

New leasing is a leading indicator of field activity and we anticipate near-term drilling on many of these new leases. Given the level of leasing activity, we now expect other revenues in the range of $25 million to $30 million in 2022. This is up from our original estimate of $20 million.

4X bonus revenue is significant for future revenue, but obviously the key hope is for production growth. PREKF is notoriously circumspect in giving forward guidance, but this quote from the call is illuminating as to what they expect as the year turns. Commentary from Andrew Phillips, CEO:

So, that's about typically your Q3 but activity right now in Q3 remains very strong, which should represent a very strong backup to your 206 rigs versus 150 last year. We grew last year with 150 running and we are seeing drilling on some of the most efficient plays on our lands as well. So I think it should be strong back half of the year as well.

As rigs become available, and taking human factors into account, this interest in leasing will drive production and revenue growth.

Your takeaway

I think PREKF is a hold at current prices. It trades currently at a relatively modest 6.3X EV/EBITDA, so it is not terribly overpriced. That said, if revenues are down from the 40% decline in realizations - not something we know yet, but are guesstimating - we might get an entry point similar to what was first discussed in February. Something in the $10-$11.00 range, or $12-$13 Canadian.

If PREKF interests you, then patience for this reaction to a quarterly decline in revenues is required for an optimal entry point. This, along with a readiness to pounce when the news is released, could result in an excellent entry point in the $10's and one that would evaporate quickly. Strike while the iron is hot, as the saying goes.

Long term, I think PREKF is a stock you want to own at a slightly better price than the market is offering now. Keep an eye on this one, remains the recommendation!

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