Earnings Transcript for PREKF - Q3 Fiscal Year 2023

Operator: Ladies and gentlemen, thank you for standing by. PrairieSky Royalty Ltd announces their Third Quarter 2023 Financial Results. After the speaker's presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to turn the conference over to Andrew Phillips, President and Chief Executive Officer. Please go ahead.

Andrew Phillips: Thank you, Michelle, and good morning, everyone, and thank you for dialing into the PrairieSky Q3 2023 earnings call. On the call from PSK are Pam Kazeil, CFO; Dan Bertram, CCO; and myself, Andrew Phillips. There's certain forward-looking information in my commentary today. So I would ask investors to review the forward-looking statements qualifier in our press release and MD&A. PrairieSky achieved its highest total production in the third quarter since our IPO at 25,469 BOE per day. This included 12,084 barrels per day of crude oil royalties, up 6% from the same quarter in 2022. Natural gas volumes were positively impacted by the return of shut-in volumes from wildfires and a significant well padded Wembley placed on production. 246 spuds occurred on PrairieSky lands over Q3 at an average royalty rate of 7.1%. 45 of these were Clearwater oil wells and 92 of the total were Viking oil wells. 35 Mannville stack, multilateral and fishbone wells were drilled, which is on pace with our record 37 wells in Q3 2022. Leasing activity remains very strong as it has for the last two years, and we entered into 46 new leasing arrangements with 40 different counterparties. Leasing was spread across the entire basin with a focus on oil. Our team executed on $15.6 million in acquisitions throughout the quarter, focused on the Mannville stack play in the heavy oil fairway. These lands will see immediate activity and provide strong returns, allowing us to compound at a faster rate. Given our fee mineral title, seismic and relationships with top-tier developers, we expect to remain active adding to this opportunity set. These lands will provide decades of inventory to an already industry-leading opportunity set. PrairieSky will review its capital allocation priorities in February and make its decision on the dividend at that time. Using strip pricing will be in a net cash position in 18 months. After achieving 22% oil growth in 2022 and 6% year-to-date, we are confident that our strong organic growth rates will continue in this pricing environment. The transformation of the primary heavy oil region in Western Canada with new drilling techniques will benefit our shareholders for years to come. I will now turn the call over to Pam to walk through the financials.

Pam Kazeil: Thank you, Andrew. Good morning, everyone. There are 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 Q3 2023. As Andrew mentioned, this was a record Q3 for PrairieSky Royalty volumes, which totaled 25,469 BOE per day. Oil royalty production volumes averaged 12,084 barrels per day, a decrease from Q2 2023, which was expected as fewer new wells come on stream following spring breakup. Oil royalty production increased 6% over Q3 2022 with strong production growth in the Clearwater and Mannville stack. We anticipate higher oil royalty volumes into Q4 and 2024 due to the level of activity on our land. PrairieSky generated $102.8 million of oil royalty revenue in the quarter at a realized price of $92.53 per barrel. Natural gas royalty volumes averaged $64.1 million a day, and NGL royalty volumes averaged 2,702 barrels per day as shut-in volumes related to Q2 wildfires and operational downtime came back on production, the overpayment recognized in Q2 was not repeated in the quarter and new Montney wells came on stream. PrairieSky generated $11.6 million of natural gas revenue and $13 million of NGL revenue in the quarter, bringing total royalty production revenue to $127.4 million. Other revenue totaled $5.7 million and included $3.6 million of bonus consideration for entering into 46 new leases with 40 different counterparties. In addition, $1 million in lease rentals and $1.1 million of other income. Cash administrative expenses totaled $17.9 million in the quarter and included a $13.3 million one-time payment. This was a cash outflow for the period but had a lesser impact on net income as $10.5 million of the payment had been accrued over the past four years until payout, primarily as stock-based compensation. PrairieSky recorded a current tax expense of $14.9 million in the quarter. Entering the year, PrairieSky had $1.55 billion of tax pools to offset future taxable income. So in 2023, the first $155 million of cash flow is tax-free with remainder taxed at a statutory tax rate of approximately 23.5%. PrairieSky generated quarterly funds from operations of $93.8 million or $0.39 per common share and declared dividends of $57.3 million, or $0.24 per share, with the resulting payout ratio of 61%. Excess funds from operations above the dividend and our $15.6 million in acquisitions were used to retire bank debt. Net debt at September 30, 2023 was $253.7 million, a decrease of 19% since December 31, 2022. PrairieSky has generated approximately $2.5 billion in funds from operations and returned $1.8 billion to shareholders through dividends and buybacks since our IPO. We will now turn it over to the moderator to proceed with the Q&A.

Operator: [Operator Instructions] The first question comes from Aaron Bilkoski with TD Cowen. Your line is open.

Aaron Bilkoski: Good morning. I would be interested to know who the most active drillers are on your Mannville stack acreage? And I guess a follow-up question to that is where do you see industry activity levels on your land, specifically in the Mannville stack next year?

Andrew Phillips: Yeah. Thanks for the question. Good morning, Aaron. The two most active drillers on our lands are Canadian Natural Resources and Caltex Trilogy, which is a newly formed private company. It was formed actually about a year and a half ago, but they've been quite active. They did a large lease arrangement with us on our fee and then have added lands in between throughout that period. But I think they're just over 2,000 barrels a day and likely exit close to 5,000. So it's a pretty substantial growth rate. And then Canadian Natural, through their Devon Canada acquisition, acquired the largest position in the area. So they were our incumbent largest royalty payer going into this new technological advancement in the play. And then to answer your second question in terms of activity, we expect that there will be a significant uplift in activity on this kind of Mannville stack play next year. I'm not sure that, it will outpace the Clearwater next year, but it will be -- it's going to start to get closed just given all the leasing arrangements we've entered into in the play and it's very good economics into these prices.

Aaron Bilkoski: Thanks, Andrew. I also have a follow-up question for -- I guess probably Pam, bested to answer this. How should I be thinking about G&A in the first half of 2024, given long-term incentive plan payments in Q1 and potentially DSUs held by the retiring board members coming in Q2?

Pam Kazeil: Yeah. So thanks for the question, Aaron. In Q1, we will give guidance, I guess, in February with our year-end call. But we would expect, just given the increase in our share price compared to when some of the long-term assessment reps were granted to -- to the executive to be higher than Q1 of last year. And then with retiring Board members, all of the Deferred Share Units for all of our Board members sit in accounts payable, so they are in our net debt number. So we anticipate paying out some of those next year. But of course, directors do have the opportunity to hold on to their DSUs for 18 months following departure. So the timing of those payments will be dependent upon when the directors decide to exercise those DSUs.

Aaron Bilkoski: That's very helpful. Thanks, Pam.

Operator: Please standby for our next question. The next question comes from Jamie Kubik with CIBC. Your line is open.

Jamie Kubik: Yep. Good morning, and thanks for taking my question here. You did have a smaller acquisition in the quarter, but in the disclosures indicated it was on producing and non-producing properties. Can you just talk a little bit more about what that acquisition entails and how we should think about it going forward?

Andrew Phillips: You bet, Jamie. Thanks for the question. And it entails over 50 sections of oil sands, right? So it's primarily undeveloped almost exclusively and about. There's a small producing properties that the operator will take along with it, but that's a very minor royalty. We do expect immediate activity on it on the one acquisition that totaled $10 million. They're right now acquiring surface leases, and they expect to run a rig all of next year on those lands. So it should be a pretty significant IRR for the company, just given the immediate activity in the multi-zone nature of the land. So it is, again, it's a unique area because it's within that oil and tenure. So you get 15 years on the leases and then upon reaching an amount of production, it's held in perpetuity effectively. So we're expecting immediate activity on those lands and should be some positive growth rates on those newly acquired lands in 2024.

Jamie Kubik: Okay. Great. And then in your remarks, did talk about looking at the dividend in 2024, can you just talk about capital allocation, how you're thinking about the NCIB and what you would need to see for a potential dividend increase, just things around that nature, Andrew and Pam?

Andrew Phillips: You bet. So right now, the dividend is $229 million annually or $0.96 per share per year. We obviously are seeing organic growth in the business. And -- when we look into February, there's a good opportunity, I think, for a dividend increase. But I think we look out over the next 10 years, we should be able to increase it annually more ratably alongside the growth of the business and still have a lot of excess free cash flow. So given that the business will be in a debt pre-position within the next 18 months, I think it's reasonable to expect a dividend increase, but we'll evaluate it in February when we look at strip pricing, connectivity levels on the land and the opportunity set in front of us.

Jamie Kubik: Okay. Thanks. And maybe last one for me. Can you just talk about the M&A environment? You PrairieSky has been fairly quiet on this side over the last a little while. Can you talk about how you're viewing M&A opportunities and things of that nature?

Andrew Phillips: Yes, you bet. I think the interesting thing is that $90 crude, we're typically fairly inactive. Almost all the M&A we've done over the last decade has been in kind of $40 to $6 price environment. So we're typically in active on the larger assets at this part of the cycle. Where we've been fortunate is unlike a few other times when there was really good pricing like 2014 or 2017, we've been able to find these kind of large undeveloped land packages that have significant IRRs for the company and long-term resource potential on the new Mannville stack play, which is very similar to the Clearwater in terms of IPs and resource in place. So we've been fortunate that we've been able to have a significant land position in that play. Land prices have gone up almost five-fold since we even over the last year and almost 20-fold since we first started acquiring land in there. So we may be priced out of that play completely now, but we've got a very large land position that will give us decades of drilling inventory. So we're quite pleased with that. It looks like that it will be a significant growth place similar to the Clearwater and so again, with the strong organic growth rates within the business. It's challenging to find something that's growing at a faster pace than your existing business. So for now, we're quite comfortable with the portfolio we have, and we'll continue to focus on land leasing at this higher part of the cycle.

Jamie Kubik: Okay. Thanks for the color. I'll turn it back.

Operator: Please stand by for our next question. The next question comes from Jeremy McCrea with Raymond James. Your line is open.

Jeremy McCrea: Hi, guys. This is a bit off tune [ph] question here, too. When -- you talked about a lot about the Clearwater and the Mannville growth. Is -- what would be like the other kind of place to watch here that could surprise us next year? I'm just thinking like is there anything in the Duvernay and the Montney that could surprise us in terms of additional production growth or other places than those?

Andrew Phillips: Yes. No, thanks for the question. I think in the Duvernay, initial Duvernay, we do expect some growth there in the double digits. I don't know exactly where it will land. And then in the Montney, we've seen some significant well licensing on some of our core lands. Obviously, we had a big tailwind from lot of pass that went on in Wembley this previous quarter, but we have seen some license subsequent to the quarter end. So we do expect growth there. And then probably the other one that's kind of more under the radar is in Southern Alberta, there's light oil play in the Basal Mannville that started to gain some momentum. We have a huge land position in Southern Alberta. And in some of the top wells, as I know you've noted, Jeremy, have come out of that region. So that's a light oil play with liquids-rich solution gas and we're starting to see licensing pick up there significantly. And if you break out the Mannville drilling actually in Q3 there is double-digits, sort of, over 10 wells drilled in the -- on that light oil play. So that's one that's kind of under the radar that could provide some light oil growth as well.

Jeremy McCrea: And would you say the leasing that you're seeing from different operators like that we saw for Q3, how like -- and what you've kind of maybe seen so far, like in the first month of October here, like is it picking up more aggressively than what you saw last year, even though oil prices are down, or is it the same? Is it -- like when you sign these new leases, are they for more multiple wells, or are they just for single wells? I'm just trying to get a better sense of the leasing activity numbers that were reported -- agreements from that

Andrew Phillips: No, for sure. And it's -- one of the interesting things we're seeing is different from last year, if you look at the 40 different companies that lease from us in this quarter, it's similar leasing activity levels, similar land that we're leasing and similar, I guess, total acreage numbers. What's unique is it's a lot more different companies. So, there's been a lot of new capital formation in the basin this year. There's two private companies, both that have lease arrangements with us that we're out doing financings a week ago that they lease what we consider some excellent land. So, there's just a lot more different companies, but similar levels of leasing in terms of total acreage, Jeremy.

Jeremy McCrea: Okay. Perfect. Thanks guys.

Operator: [Operator Instructions] Our next question comes from Patrick O'Rourke with ATB Capital Markets. Your line is open.

Patrick O'Rourke: Hey good morning guys. Hopefully, I'm not plugging a bit of a dead horse here because we've talked a lot about demand built so far. But I'm just kind of curious, and you got it into the leasing activity. Like where do you think you are in terms of the leasing cycle in terms of asset quality that's left? I know you've had well-capitalized incumbents. You mentioned new capital formation juniors there. Guys have been working this fairway and it's become extremely competitive. So, what sort of diamonds are left in the rough? And how does this sort of play out over the next couple of years, or does it start to kind of tail off or taper off?

Andrew Phillips: Yes, it's a good question, and thanks for the question, Patrick. One of the interesting things about it is the original play was kind of the sparky -- and then now we have the Sica [ph],the Rex, the Cummings, there's people trying kind of the fan wells or fishbone wells in less consolidated reservoirs -- so as you move into the Saskatchewan side, there's actually quite a significant resource there as well, and we actually just started to do some leasing on the Saskatchewan side for similar type plays. So, I think what's unique is demand the Manville, obviously the biggest producing formation in Alberta, the world's fourth largest oil producer. It's a massive resource and people are testing this play in a number of different zones. So, I think because of zonal, we believe they'll be still a few years ahead of people uncovering new opportunities in different places where it will work. And we've actually seen some leasing on a light oil play for a similar type of technology where they're going to try multilaterals. So, again, I do think there's still years ahead of opportunities. And there was one operator that was Baytex, which made a discovery and they announced it called Manville, that's about 1,000 meters. So, everyone's kind of targeted between 400 and 600 meters and that whole fairway pretty active, but they jumped a little further west and it seemed to work there. Sometimes realize better oil quality, you can handle smaller grain size. So, we believe there's some pretty significant potential between 600 and 1,000 meters as well. So it's a pretty significant information on Alberta, and we think this technology can unlock quite a bit more oil potential. So hopefully that answers your question.

Patrick O'Rourke: Yes. No, that's terrific. And then sort of just moving over, there's been a little bit of volatility in terms of the oil and NG oil, gas oil ratios, gas liquids ratios over the last couple of quarters, you have wildfires here. Most of the -- or almost all of the new drilling that you're seeing in your land is targeting oil formations. Just wondering sort of how you envision the rate of change in that gas oil ratio over the next couple of years.

Andrew Phillips: Yes. We do -- just given the significant amount of oil drilling, we do expect the oil drilling to continue to become a bigger part of the mix. I think if you go all the way back to our IPO, which is almost a decade ago, we were 40% oil and liquids and 60% natural gas. Today, it's completely reversed. We're 60% oil and liquids and 40% natural gas. The one thing we have accumulated is a basket of options in the deep basin and in the Montney, so you see situations like this last quarter where one single well pad can significantly impact the natural gas volumes. So just given you don't need a huge amount of drilling to impact gas volumes. It will be lumpier, as you mentioned. But again, the oil volumes we expect to continue to grow just given the strong leasing activity. But there will always be volatility in terms of -- in the short-term like in the quarters because you've got 42,800 wellbores you're collecting royalties on monthly and then another 850 or so wells to get drilled on an annual basis and the pace at which they come on really impacts the quarterly volumes. But if you look out on an annual basis, it smoothes out pretty well.

Patrick O'Rourke: Okay. Thank you.

Andrew Phillips: And one other just follow-up to your question. A lot of the gas volumes we've seen over the last two years have been associated gas. So a third of our gas volumes are now just associated with gas or with oil drilling. So, a lot of that oil drilling is actually giving us a bit of a gas boosts as well.

Patrick O'Rourke: Thank you.

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

Andrew Phillips: Thank you, everyone, for dialing into the PrairieSky Q3 conference call. And please feel free to call Pam, myself or Dan, if you have any further questions. Have a great day.

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