PrairieSky Royalty Ltd. (PSK) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to today's conference call. PrairieSky Royalty announces their second quarter 2022 financial results. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Andrew Phillips, President and CEO. Please go ahead.

Good morning, everyone, and thank you for dialing into the PrairieSky Royalty Q2 2022 Earnings Call. On the call from PrairieSky are Cam Proctor, COO; Pam Kazeil, CFO; and myself, Andrew Phillips. There are certain forward-looking information in my notes today. So I would ask investors to review the forward-looking statements qualified in our press release and MD&A. Before turning the call over to Pam to walk through the financials, I will provide an operational update. PrairieSky achieved its third consecutive quarter of strong organic production growth, realizing the benefits of an 18.5 million acre royalty footprint across the Western Canadian Sedimentary Basin. Our investments in low F&D cost oil royalties and mineral title lands are the primary contributors to the strong volume growth. Clearwater volumes reached a record 1,500 BOE per day of total royalty production and will continue to grow for the remainder of the year and in future periods. Viking oil -- Viking oil volumes also grew approximately 10% over the quarter. We expect to have over 300 Viking wells drilled on our acreage this year. PrairieSky has over 10,000 Viking development wells that can be drilled over the next few decades on its fee title and royalty land base. On Monday, there were 206 rigs operating in the basin compared to 150 rigs in the previous year on the same day. As a reminder, PrairieSky also saw volume growth in 2021 in a lower activity environment. Our natural gas volumes increased as new [ liquids-rich ] wells came on production and solution gas associated with oil drilling contributed to growth. Natural gas revenue alone now covers the entire dividend. Activity was noted across the entire Western Canadian Sedimentary Basin, which has not been observed since 2014. Leasing activity remains strong with 54 leasing arrangements entered into with over 45 different companies. This resulted in $3.8 million of bonus consideration. Year-to-date, we have entered into 106 leasing arrangements versus 67 in the first half of 2021. The advancements in multilateral drilling techniques and better drilling fluid systems has structurally changed the value of PrairieSky's heavy oil royalty portfolio. PrairieSky acquired the largest heavy oil fee title royalty portfolio in Canada through the acquisitions of Canadian Natural Resources royalties in 2015 and through the Heritage acquisition, which closed in December 2021. Thick 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 lands at no additional cost to our shareholders. Our unique fee title royalty model allows PrairieSky to capitalize on cyclicality and countercyclicality. 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. The PrairieSky Royalty model provides high margins, inflation protection and strong growth rates, which will lead to strong dividend growth in the coming years. From an ESG perspective, we have now published our most recent sustainability report, which can be found on our website. Since publishing the report, we have received an updated MSCI ESG ranking and achieved the highest possible rating of AAA. I will now turn the call over to Pam to walk through the financials.

Thank you, Andrew. Good morning, everyone. As Andrew mentioned, there is certain forward-looking information in the notes today, so I would remind investors to review the forward-looking statements qualifier in our press release and MD&A for Q2 2022. This was PrairieSky's third quarter -- consecutive quarter of organic royalty production growth and a record quarter for oil production. Production growth and strong commodity pricing for oil -- 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. Royalty production totaled 25,992 BOE per day, which was 58% liquids, and generated $190.2 million in royalty production revenue, the highest quarter in our history. PrairieSky's oil royalty production grew to 12,220 barrels per day in Q2, which was up over 1,000 barrels per day compared to Q1 and over 5,192 barrels per day over Q2 2021. Backing out all acquisitions, PrairieSky's oil royalty production grew organically 9% over the first quarter and 33% over Q2. PrairieSky anticipated the increase in royalty production, given our active leasing program and the number of spuds across your acreage in May 2021 and first half of 2022. Oil royalty revenues grew to $135.6 million in the quarter. Natural gas royalty volumes averaged 66 million a day, up 9% over both Q1 2022 and Q2 2021. Volumes included 1.9 million a day from the acquisition closed in the quarter as well as the return of 1 million a day of volumes that were shut in due to cold weather in Q1, with remaining incremental volumes from new wells on stream and workovers and recompletion. With strong AECO pricing, natural gas royalty revenue totaled $36.8 million. NGL royalty volumes averaged 2,772 barrels per day, which was up 6% over both Q1 2022 and Q2 2021, and included 50 barrels a day of incremental production from the acquisition closed in the quarter and incremental volumes from new liquids-rich natural gas wells that came on production. NGL royalty revenue totaled $17.8 million in Q2, driven by strong benchmark pricing. There were 1,670 BOE per day of prior-period adjustments in the quarter related to new wells on stream as a result of a very active first quarter drilling, with an additional 232 BOE per day related to compliance activity. Overall, PPAs were 60% liquids. The compliance group recovered missed and incorrect royalties through forensic accounting, collecting $1.6 million in the quarter. Compliance revenue since IPO now totals over $70 million. There were 122 wells spud in Q2, which were 94% oil. The Viking was the most active play with 42 wells spud, followed by the Mannville with 19 heavy and light oil wells and the Clearwater with 14 wells. Additional oil-focused activity took place across the portfolio, including wells spud in the Cardium, Duvernay, Mississippian and 6 wells at Lindbergh. There are also 7 natural gas wells spud, including wells in the Montney, Spirit River and Mannville. Although activity in the quarter was moderated by seasonal breakup, the number of wells drilled was up 37% from 89 wells spud in Q2 2021. Other revenue included $7.9 million and included $2.9 million in lease rentals, $1.2 million of other income, including $900,000 of Potash revenue and $3.8 million of bonus consideration for entering into 54 new leases with 45 different counterparties. 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. Compliance recoveries will be incremental to this amount. Cash administrative expenses totaled $5.2 million or $2.20 per BOE in Q2. We anticipate cash administrative expense to be well below $3 per BOE for the full year. At June 30, 2022, PrairieSky's total outstanding dilutive was 0.6%. PrairieSky recorded a current tax expense of $27 million in Q2 due to our record royalty production revenue. Entering the year, PrairieSky had $1.75 billion of tax pools to offset future taxable income. So in 2022, the first $170 million of cash flow is tax-free with the remainder taxed at our statutory tax rate of approximately 23.5%. During the quarter, PrairieSky declared dividends of $28.7 million or $0.12 per share, with a resulting payout ratio of 18%. Excess funds from operations above the dividend in our $15.6 million of acquisition was used to repay bank debt. Net debt at June 30 was $453.9 million. PrairieSky has reduced net debt by 29% or $181.1 million in the first 6 months of 2022. Since IPO, PrairieSky has generated $1.9 [ billion ] of funds from operations and returned $1.5 billion to shareholders through dividends and buybacks. We will now turn it over to the moderator to proceed with the Q&A.

[Operator Instructions] Our first question comes from Aaron Bilkoski with TD Securities.

You guys talked about the Clearwater growing, I think it was 25% year-to-date to 1,500 BOE a day. I was curious if you could provide a bit more color about the other top plays that are driving the growth.

Sure. It's all on the gas side. It was primarily liquids-rich drilling in the kind of [ flare ] and glauconitic that created some of the growth on the -- 10% growth on the gas portfolio as well as associated gas from oil drilling. And then the Viking actually grew by 10% as well. So what was unique about this quarter, Aaron, as it was kind of broad-based growth. We saw growth in the Mississippian and Southeast Saskatchewan, we saw growth in Manitoba all the way to the Alberta-BC border. So almost every place, just growth, with the strong activity, both in terms of the drilling, but also in the recompletion and reactivation activity.

Perfect. Can I ask you guys another question?

Of course.

Is there an absolute debt level like the -- I guess, you'd like to reach before reinstating a buyback or revisiting the dividend?

Yes. Typically, we revisit the dividend annually in February. And payout ratio is quite low right now. But again, I think we used -- we effectively view the financing that we did by only financing it with 1/3 equity, 2/3 debt. We viewed it as prefunding the buyback at [ 1,340 ] effectively. So our goal is to pay the debt down. We believe having net cash or zero debt balance sheet is optionality in our business. So we'd like to get it there. But we certainly -- there's certainly lots of room for a dividend increase while still paying down a lot of debt in a short period of time.

Our next question comes from Matthew Weekes with iA Capital Markets.

Just trying to understand the production growth in the quarter a little bit in terms of the dynamic with the PPA volumes that came on. I'm just wondering how you often expect these while you can sort of act, going forward. Is there ever a reversal sort of that happens is a little bit after that? Or is it really just due to the timing of sort of wells being brought on and the compliance in the quarter? And I was just wondering if you could share any sort of expectations, going forward.

Yes, certainly. Matt. So the way that PPAs work is -- so in Q2, if there were new wells that were brought on in March of the first quarter, for example, we don't have that information. So we're making an estimate for the production. So what ends up happening is if new wells come on in their -- producing more than we would have expected, we will incur a PPA adjustment to our production. But when you're looking at Q2, what you need to do is back out the Q1 PPAs and add in the Q2 PPAs. So you have a net amount that you're adjusting your production for. So it is a rolling item, and we would expect to see PPAs in every quarter just because we are estimating what production will be. Sorry, and I'll just add that compliance activity that can range -- that can be plus 200 barrels as of what, this quarter. But that will depend on what we collect during that period.

Yes. So effectively, because 2 to 3 months are accrual -- it's 2 to 3 months of accruals, we're effectively taking all these new wells and we'll have about 800 drilled this year on our lands. And we'll take them and conservatively estimate them. So that's what results in the positive PPA. So it's real production. It's just from the trailing quarter.

Okay. That makes sense. And you talked about sort of part of it coming from estimating production, and then maybe the production coming on from new wells tend to be a bit better than you think. Are you tending to see sort of better well results in your portfolio than you'd anticipated at this point in the year?

Yes, we are actually. We're seeing quite a substantial improvement in type curves. And we take a pretty conservative approach, even in our asset handbook that we put out once every 2 years. We use 5-year trailing type curve. But in these cases, we kind of use the lower end of the type curve, and we've seen some very strong results across the basin, particularly in the Clearwater. IPs are significantly above where we anticipated a -- and we're also seeing technological advancements, even in the Viking, we're seeing better IPs. So it's pretty strong across basins.

Our next question comes from Jamie Kubik with CIBC.

Maybe just a little bit on -- further on Aaron's question there on capital allocation. I'm curious if you can talk about what you're seeing on the M&A side of things right now? And has the opportunity sort of thinned out a little bit with the improvement in operator balance sheets over the last couple of quarters and year?

Yes. It's definitely -- I think expectations would be pretty high. I think the need for capital is pretty low right now, just amongst producer universe. They're generating a huge amount of cash, which is great for our business. And -- so we're -- again, I kind of mentioned on the call, the one nice thing is in the downturns with our strong balance sheet. We can execute on this accretive M&A and acquire high-quality royalty packages, including the fee title [ tax ] we acquired at the end of last year. But then in the really good times, we can just lease our big undeveloped land-based industry, and that's what we've been really active in. We were successful on one piece of M&A, you probably saw in the quarter there. And it was a royalty package we've been trying to buy for about 8 years. It's in the Deep Basin. We think there's a lot of upside. It's mostly verticals in Spirit River, et cetera, that could be horizontally drilled, and we think it will, over time. So it was, again, a quality royalty package that we knew about for a long time and had done a lot of work on. So there's little ones like that. But I think for the most part, there's a little less out there right now.

Okay. And then maybe a next question from me is just -- very strong Q2, production-wise. I know PrairieSky doesn't really provide guidance, but can you talk a little bit about how we should think about the second half of 2022, given how strong this update was and some of the rig activity that you're seeing currently? How does that set you up for the back half of this year?

Yes, for sure. And I think Q3 is obviously our breakup quarter because it's a trailing orders that will kind of represent the Q2 activity, which was only 112 spuds. So as is normal with all our previous 8 quarters, you have lower PPAs. And then there's people who can't haul oil, et cetera, during the road bans and breakup. So that's typically our Q3, but activity right now in Q3 remains very strong, which should represent a very strong back half of the year, 206 rigs versus 150 last year. We grew last year with 150 running. And we're seeing drilling on some of the most efficient [ place ], on our lands as well. So I think it should be a strong back half of the year as well. But without giving guidance, I'm not sure exactly what that looks like, Jamie.

[Operator Instructions] We're showing no further questions in queue at this time. I'd like to turn the call back to Andrew Phillips for closing remarks.

Thank you, everyone, for dialing in to the PrairieSky Q2 2022 conference call. And please feel free to call Pam or myself if you have any further questions. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.