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Particularly in these beautiful summer months, a prairie sky is a high sky. And in this summer of discontent in Canada's oil patch, it's PrairieSky Royalty Ltd. that's riding sky-high – particularly when it comes to valuation.
That's a funny thing to say about a stock that, at Wednesday's close of $27.34, is off about one-third from its 52-week high. And certainly, those who bought on the first day of trading in its May 2014 IPO, when the shares closed at $37, aren't laughing.
But of course, there's been widespread carnage in the Canadian energy sector as global oil prices have plummeted. The debt-laden exploration and production companies have found their long-time combination of heavy capital expenditures and healthy dividends unsustainable in the current climate.
That's made investors flock to PrairieSky's model of getting royalty payments from producers, with none of the debt and capex that goes along with the drilling. It's widely perceived to have one of the safest dividends in Canada's energy sector, even though it's slated to pay out more cash than it generates this year. Analyst Brian Bagnall of Macquarie Capital Markets Canada Ltd. calls it "a core holding for any energy portfolio," with its portfolio of land giving investors "exposure to a low-risk [free cash flow] stream relative to the rest of the Canadian E&P universe."
Alas, everything's relative, it's frequently said. And a close look at PrairieSky's numbers show that investors are paying quite the price for the company's position as best in a weak class.
First, the balance sheet: PrairieSky has no debt, making it one of few of the 63-member TSX composite energy group that has a net cash position. (Per S&P Capital IQ, there are four others, all of which either operate in South America or are in the service or pipeline space.) The company's management eschews debt, preferring instead to raise capital through stock offerings, the latest of which was a $198-million bought deal in July. That has made the company "exceptionally well capitalized," says analyst Chad Ellison of Dundee Capital Markets.
That "dry powder," as Mr. Ellison calls it, raises the prospect of further acquisitions to go along with a number of purchases PrairieSky has made this year. FirstEnergy Capital analyst Michael P. Dunn notes that PrairieSky's CEO Andrew Phillips borrowed a line from Warren Buffett, saying in a recent conference call that PrairieSky is interested in "buying great assets at fair prices, not fair assets at great prices."
In order to do that and maintain a dividend that currently yields 4.8 per cent, however, the company has instituted (temporarily, it says) a cash-saving dividend reinvestment plan that makes its payout in shares. Analysts' forecasts for the company's payout ratio this year vary based on their estimates for the company's performance, as well as their assumptions about oil prices in the second half of the year. But CIBC World Markets' Arthur Grayfer estimates PrairieSky will pay out 122 per cent of available cash flow (post-acquisitions) in 2015, versus the 98-per-cent payout average for a dividend-paying Canadian E&P company. In 2016, he figures, PrairieSky's payout ratio will drop to about 94 per cent, while the Canadian average climbs to 126 per cent.
Other analysts with "buy" ratings are similarly confident about the dividend's manageability, but the analysts at Accountability Research Corp. note that the owners of all the new shares issued in the July-bought deal are entitled to a dividend, too. They believe the company's royalties won't grow fast enough in the near term to support the additional payments, and they've placed a "sell" rating on the shares.
"As long as the equity market spigot remains open for the company we do not see them being forced to decide between remaining debt free and paying out large dividends while growing," analyst Michael Ruggirello writes. "However, we do not see this as a viable option in perpetuity and believe a debt issuance or dividend reduction to be more realistic options for PrairieSky if commodity prices do not rebound materially."
While PrairieSky's current payout metrics seem little better than those of its peers, its valuation is surely higher. RBC Dominion Securities' Shailender Randhawa notes that PrairieSky's enterprise value, or market capitalization plus net debt, is 23.4 times its debt-adjusted cash flow, while Canadian dividend-paying E&P companies trade at an average of 8.7. Its enterprise value divided by its daily production values each barrel-of-oil equivalent at $227,200; the average for dividend-paying E&Ps is $62,311, Mr. Randhawa says.
As high as a prairie sky.
David Milstead