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david milstead

As oil prices have muddled along over the past couple of years, up from their troughs but still well below robust levels, the energy space has been a place to try to find bargain stocks.

And then there's PrairieSky Royalty Ltd., which has been expensive, and then more expensive, during the energy doldrums. There's little dispute that PrairieSky's position as a royalty concern – ownership of its resources without the expense and risk of actually doing the drilling – merits some premium. But PrairieSky's price has gotten so far out of line with the Canadian energy sector – and, arguably, other royalty peers – that investors need to be aware of the sky-high price they're paying.

I've used that pun before, because I've made this point before, and it didn't really matter. In August, 2015, I noted how investors had flocked to the PrairieSky model and warned that made it far more expensive than other S&P/TSX composite stocks. Since then, it's up 35 per cent, according to Standard & Poor's Global Market Intelligence. It's not the best performance by an energy stock in the S&P/TSX, but it's not shabby, either. (The index itself is up 15 per cent in that period.)

Where does PrairieSky stand now? Let's get some perspective from the folks at the generally skeptical Accountability Research Corp. Analysts Michael Ruggirello and Mark Rosen acknowledge PrairieSky "offers a somewhat unique option for safer exposure to upside in energy prices," but, they write in placing a sell rating on it, "even taking its relative strengths into account, it trades at far too rich a premium versus other options in the market."

Accountability, which has a Street-low $25 target price, versus Monday's close of $31.55, says PrairieSky trades at about 28 times its expected 2018 EBITDA, or earnings before interest, taxes, depreciation and amortization, against 10 times for the exploration-and-production (E&P) group average. Importantly, that was also double its closest Canadian royalty peer, Freehold Royalties, which sat at 14 times EBITDA. (Want a conventional price-to-earnings ratio for PrairieSky? Try 104, as of this week, according to S&P – which is what you get when you pay more than $30 for a stock expected to deliver about 30 cents of earnings in the next 12 months.)

PrairieSky's premium expanded over the course of 2017, Accountability Research notes, even as quarterly production on its properties dropped from the first quarter to the second, and then again from the second to the third. (We'll get fourth-quarter numbers on Feb. 26, the company says.)

Accountability Research says PrairieSky's declines came from transportation issues, intentional cutbacks in production in response to low pricing, and problems at newly acquired properties. These could all be viewed as temporary setbacks, one might say. "To us," says Accountability Research, "this illustrates the extent to which PrairieSky really is not in control of its top line and the susceptibility it has to the spending patterns of its customers/potential customers."

PrairieSky's multiples have led to a relatively cool reception on Bay Street – there are just five buy ratings of the 16 analysts who cover the company, versus nine holds and two sells. And to be fair, we should sample some of the bullish views.

CIBC World Markets' team says PrairieSky's ability, in a weaker quarter for production, to cover its dividend, do a little bit in the way of share buybacks and fund some acquisitions "speaks to the resiliency of the business." At a $40 target price, they're at a Street high.

Another analyst, who preferred not to be quoted, said the best comparison to PrairieSky is with little-known U.S. company Texas Pacific Land Trust, which has no analyst coverage and hence, no forward earnings estimates. On a trailing basis, however, its EBITDA multiple has ranged from 34 to more than 40 – making it easily more expensive than PrairieSky, even with a dividend yield of 0.1 per cent, puny in comparison to PrarieSky's yield of 2.3 per cent over the past four quarters.

Still, we let the skeptics have the final word here. Veritas Investment Research's Nima Billou, the author of Bay Street's other sell rating, says investors are "overpaying for PrairieSky's debt-free balance sheet and an expectation of multiple expansion that may not come." And Accountability Research says that PrairieSky boosters who point to Freehold's small production obligations, and miniscule debt, as a key differentiator between the two, are misguided. "Arguing that PrairieSky's business model is so unique that it should trade at twice the multiple of Freehold seems like quite a stretch to us," they say, describing the valuation variance as "unhinged."

Really, it's been unhinged for a while, and may continue to be in the first months of 2018, as we see what this year holds for the energy sector. I'd say, however, the price of holding PrairieSky might just be too high.