Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Transcript

[Operator]

Good day, ladies and gentlemen, and welcome to the PrairieSky Royalty Ltd. Announces Third Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Andrew Phillips. Please go ahead, sir.

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

Good morning, and thank you for dialing into the Q3 2018 PrairieSky Royalty earnings call. On the call from PrairieSky are Pam Kazeil, CFO; Cam Proctor, COO; and myself, Andrew Phillips.Free cash flow for the third quarter was $67 million, up 7% quarter-over-quarter. With this free cash flow, we paid $45.8 million in dividends, canceled 514,000 shares for $12.5 million and used the remaining $8.7 million to partially fund $19.5 million of acquisitions.Positive working capital was $10.6 million at quarter-end. PrairieSky continues to focus on cost compliance, acquisitions and land leasing. First acquisition PrairieSky completed in the quarter was for $5 million and included $3.5 million of seismic data, 100 barrels a day of liquids-rich gas and over 20 future Spirit River drilling locations at an 8.5% royalty.The second acquisition was $5.5 million and included 65 barrels per day of royalty heavy oil production and a potential SAGD opportunity in the upper McLaren formation in Western Saskatchewan. And the third acquisition was a 153,000 acres of undeveloped land in the Clearwater play with a multiwell commitment. Other minor land fund and fee title acquisitions rounded out the total.Compliance recovered $2.1 million, bringing year-to-date collections to $7.7 million. Cash G&A per barrel for the quarter was $2.41, and we anticipate the total to be in the low $3 per barrel range for the year.Quarterly drilling activity was directed 95% towards oil and include 242 wells. Average net royalties on these new spuds was 8%, up from 6% in the previous quarter. We anticipate the majority of these new wells will come on production in late Q4 and early Q1 2019. One change observed year-over-year was 20 wells spud in the Cardium oil trend in West Central Alberta. Eight distinct operators drilled the light oil targets, and based on offsetting well data, the well should exhibit strong IP rates.Twelve new East Shale Duvernay wells were also spud, and the trend of higher IPs and lower costs looks to continue.Bonus consideration for the quarter was $5.3 million from 28 different counterparties. The 2 plays that made up the majority of the quarterly bonus revenue were the Duvernay and the Cardium. Our negotiators continue to work hard finding qualified operators to drill on our large land base.PrairieSky generated its billionth dollar free cash flow after tax and G&A and has now returned over $900 million to shareholders since our May 29, 2014, IPO. The only other companies in oil and gas in North America that have returned close to 20% of their market cap to shareholders over the same period are Schlumberger, Core Labs and Exxon Mobil, but 2 of these companies used debt to pay their dividend during the downturn.Looking forward, the PrairieSky team is working hard on our 2019 edition of the Royalty Playbook. We will update our plays, type curves, pricing and provide investors with the current asset value of only the known development plays. We'll have a half-day Investor Day in Toronto on May 23rd at the Royal York hotel to walk through the contents, provide more detail on individual play advancements and answer investors' questions. As shareholders ourselves, we believe that the 66,000 acres per million share zone have the potential to deliver outside returns over the next 3-, 5- and 10-year periods. I would like to thank our staff for their continued contributions and our shareholders for their continued support.I will now turn the call over to Pam to walk through the financial results.

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

Thank you, Andrew. Good morning, everyone. PrairieSky generated funds from operations of $67 million, or $0.29 per share, in the quarter, up 7% from Q2 2018. Cash flow was generated primarily from royalty production revenue of $71.4 million on average production volumes of 23,438 BOE per day. Oil and NGL revenue represented 90% of total royalty revenue and approximately 49% of production volumes. WTI was up over Q2 2018, but wider heavy and light oil differentials in the quarter resulted in lower realized oil pricing. Natural gas revenue represented 10% of total royalty revenue due to continued low AECO pricing.Q3 2018 oil volumes were 9,018 barrels a day, which was flat with the prior quarter. The third quarter consistent with prior years has been quite active in the field, with 242 wells spud comprised of 231 oil wells and 11 gas wells. Most of this production is expected to come on in the fourth quarter and early in 2019.Natural gas volumes totaled 71.5 million a day, and NGL volumes totaled 2,503 barrels a day. Natural gas volumes have trended downwards from 2017 due to limited drilling and work-over activity. PrairieSky's production volumes included 1,798 BOE a day of prior period adjustments, which included 638 BOE a day from compliance activity, which was 33% liquids and an additional 1,160 BOE a day of other prior period adjustments related to new wells on stream and better well performance. These volumes were 43% liquids.The compliance group continues to recover missed and incorrect royalties through forensics accounting, collecting $2.1 million in the quarter. That brings the year-to-date compliance collection to $7.7 million and collection since IPO to $48.5 million.Other revenue totaled $6.7 million, which included lease rental income of $1.2 million and bonus consideration of $5.3 million. During the quarter, PrairieSky entered into 29 leases -- leasing arrangements with 28 different counterparties.PrairieSky has 3 cash costs: production and mineral taxes, administrative expenses and income tax. In the quarter, production and mineral taxes totaled $1.1 million, bringing the annual rate to approximately 2% of product revenue. Cash administrative expenses totaled $5.2 million, or $2.41 per BOE. Cash G&A per BOE is expected to be in the low $3 per BOE range for the full year. Cash taxes were $5.6 million in the quarter, bringing the effective cash tax rate to approximately 19% year-to-date. Acquisitions totaled $19.5 million in the quarter, which included additional royalty interest in both producing and nonproducing properties as well as seismic. Acquisitions added approximately 165 BOE per day of production as well as additional interest in the Clearwater oil play.At September 30, PrairieSky had positive working capital of $10.6 million. PrairieSky declared dividends of $45.8 million, or $19.5 per share, in the quarter, with a resulting payout ratio of 68%. Under the normal course issuer bid initiated on May 4, PrairieSky repurchased 514,200 common shares for $12.5 million. Including the NCIB, PrairieSky's payout ratio totaled 87%.From inception to September 30, 2018, PrairieSky has returned $804 million, or $4.18 per share, in dividends to shareholders and repurchased 3.6 million in common shares for $104 million. Since IPO, PrairieSky has generated $1.2 billion in total revenue, which is converted to $1 billion of free cash flow. And of that $1 billion in free cash flow, $908 million has been returned to shareholders.We will now turn it over to the moderator to proceed with the Q&A.

[Operator]

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

[Jeremy McCrea, Energy Analyst]

I think probably just the elephant in the room here is just these little differentials. And I just wanted to know how you guys are running your business any different here today here and, say, maybe over the next 6 months. Are you looking -- ramping up -- looking at different acquisitions in the slow price environment? Are you looking at buying back more of your shares here at these different prices? Just anything that you guys are maybe doing a bit different here?

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

Yes, Jeremy, I guess, in terms of -- we don't really change our business strategy based on short-term pricing changes. Then obviously, we've got refinery maintenance system combined with some too much production for the pipes today. But again, when there's $100 million in loss revenue days, someone will find that opportunity and close that arbitrage. So we're confident that over the longer term, that will get solved. It will certainly result in probably lower drilling activity for the cold flow heavy oil portion of our portfolio, which has seen fairly muted activity over the last 3 years anyway. But certainly, I think it probably created opportunity for us to buy that $5 million heavy oil package in Western Saskatchewan. The Cummings pool has been producing for 25 years, and in addition, we got a SAGD project that we think might get developed in the future. So it does create some small acquisition opportunities, but we haven't made any changes to our business strategy.

[Jeremy McCrea, Energy Analyst]

Okay. Let me just quickly -- so you're talking about some smaller acquisitions. Is there any bigger acquisitions on the horizon that you guys are potentially looking at here? Like I know you've always talked about the Exxon one before, but is there anything that's emerged in the last, say, 6 months?

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

There are a few packages that are out there. Just for us, again, it's difficult to find things that meet the quality and duration of our existing asset base. And where we trade here today at a $5 billion valuation, interestingly enough, is you take our 700,000 acres of Duvernay fee lands and you think about they're all leased and some of the companies drilling on them are financed by Warburg Pincus and Riverstone, and the reason they're financing these businesses is because full-cycle F&D are competitive with the Permian in these shales. So even if you use CAD 10,000 an acre, which is a quarter of what some of these U.S. shales trade at, that's $7 billion in value just for our undeveloped land, forget about the rest of the 14.8 billion -- million acres. So I guess, for us, it's pretty hard to find things that look like us where you have a long-duration cash flow stream, but also the future optionality that's inherent in our portfolio. So on the larger side, I guess, to answer your question, we see a lot of manufacturing opportunities that probably just don't meet the quality of our existing asset base.

[Operator]

And our next question comes from Shailender Randhawa with RBC Capital Markets.

[Shailender Randhawa, Analyst]

My question is on the Duvernay. I noticed that the well count in the quarter, but just curious about the royalty rate. It says an average royalty rate of 5% that would probably be more weighted to GORRs, I'm guessing. How do you see that average royalty rate for the Duvernay evolving through 2019, Andrew?

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

Yes, it's a good question. I think we'd like if those royalty rates go up. So on a lot of our agreements, we have a royalty holiday for the exploration wells, or the first 5 wells in a deal. And that royalty rate would be, typically, half of the rate that they'll go to over the long term, which is either 15% or 16%. In addition, half of the wells on Crown and half of the wells on PrairieSky fee. So that's how you get that 5% rate. When these wells reach a minimum amount of production or a time limit of 2 years, they go up to that 15% or 16% rate. In addition, only a certain amount of wells are at that lower royalty rate. So you should see that go to 7.5% over the long term, Shailender, because half the wells are on Crown and half are on fee because of these 2 mile long laterals. So hopefully, that answers your question.

[Shailender Randhawa, Analyst]

It does, yes.

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

But they are on fee.

[Operator]

Our next question comes from Michael Dunn with GMP FirstEnergy.

[Michael Paul Dunn, Director of Institutional Research]

Just -- Andrew, just looking for, I guess, reconfirmation. I think you had said earlier this year that you were expecting oil growth in the second half of the year. Obviously, the drilling activity was up in Q3, and you're expecting wells online in Q4. But oil -- the oil rates were roughly flat quarter-over-quarter in Q3. So should we be expecting a jump in Q4?

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

Yes. Of course, I know we don't give guidance, but we did indicate that we did think you'd see some kind of single-digit growth in our oil volumes. And I think we still maintain that, given the drilling activity we saw in Q3 and a lot of those wells will come on in Q4. I think it's a reasonable expectation, Mike. If you look at Q3 of last year, we were roughly flat from Q3 of last year to Q3 of this year. So basically, the 2 major factors were a decline of 289 barrels from Elnora and Southern Alberta Bakken, and then we had growth in the 2 oil sands project. And that kind of offset each other, and the rest of the business kind of stayed flat. So that kind of kept us at 9,000 barrels a day. We do expect, again, 3% to 5% oil growth in the next 6 months as lot of these newer wells come on. Now going forward, if you look out 12 to 18 months, it really depends on drilling activity in early '19, and it remains to be seen where people's capital budgets end up. So hopefully, that helps answer your question, but I do think we should see some of these new volumes come on and provide a little bit of growth for the oil part of the business.

[Operator]

And our next question comes from Edward Friedman with McLean.

[Edward Friedman]

I have 3 questions. One is, you did a line of credit -- sorry, a revolving line of credit of $200 million last quarter. I was wondering if you can share a little bit what was the reason for -- what are you going to do with share of money? Second, now that everybody is impacted by the differentials equally, I was wondering if you can share a little bit how your producers are affected by these differentials and if you are going to bear the full brunt of it or maybe there will be some mitigating factors? And last, in Q1, you signed, I think, around 28 leases for only 1 year and I was wondering if you can share a little bit about what activity was on these plans throughout these first 3 quarters?

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

You bet it, Edward. So the first question, with regards to the line of credit, our belief is that as opportunities arise, we wanted to have that in place to allow ourselves to execute on them. We don't anticipate using it. We don't have any -- necessarily use the proceeds for it. We do think that if a good acquisition that met our quality criterion came along, we could use it and then slow down the buyback until the debt was retired. So that's why it fits in place. So that, hopefully, answers your line of credit question. Number two, all our producers are affected differently by the different factors. For example, some of them in, Saskatchewan, actually, haven't seen the full brunt of the differentials and some of our larger Alberta producers have contracts with pipelines and offtake agreements that allow them to get slightly better pricing. So they're all affected slightly differently. Again, I think, every single one of them has slightly different effect from these differentials depending on not only the quality of their crude, but also their offtake agreements. And then on the 28 different leases, the one thing that was consistent quarter-over-quarter or last 1.5 years was continued Duvernay leasing. The one change was we saw a lot of leasing in the Cardium light oil play, as some of the older leases expired. So we do expect to have a bigger activity on that light oil play.

[Operator]

This concludes the question-and-answer session. I would now like to turn the call back over to Andrew Phillips for any further remarks.

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

Thank you for calling into the Q3 PrairieSky earnings call. And if you have any further questions, please call Pam or myself at 587-293-4005. Thank you.

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. And everyone, have a great day.