Multilateral Drilling And Waterflood Programs Will Drive Durable Long Term Royalty Upside

Catalysts

About PrairieSky Royalty

PrairieSky Royalty generates royalty revenue by owning a large portfolio of Canadian mineral title and leasing it to third party oil and gas operators.

What are the underlying business or industry changes driving this perspective?

• Continued shift toward longer reach multilateral drilling and expanded waterflood and polymer flood programs on PrairieSky lands should lift recovery factors and sustain higher royalty volumes per well over time, which supports steady revenue growth and stronger earnings resilience.
• Ongoing development in high growth plays such as the Clearwater, Mannville stack and Duvernay, including new and returning operators with strong balance sheets, positions the company to capture a growing share of basin activity. This can underpin double digit royalty volume growth and rising cash flow.
• Persistent leasing momentum, evidenced by a large number of new leases signed with a diverse set of counterparties, signals a deep inventory of future drilling locations on underdeveloped acreage. This can translate into higher bonus income and long duration royalty revenue.
• Disciplined acquisitions of fee mineral title in core heavy oil and light oil corridors during softer commodity price periods, combined with selective share repurchases, increase per share exposure to high return assets. This can enhance net margins and per share earnings as prices normalize.
• Improving capital efficiencies and lower breakeven oil prices for key operators, together with a supportive currency backdrop for Canadian light oil exports, increase the likelihood that drilling activity is sustained through commodity cycles. This can help stabilize royalty revenue and support expanding funds from operations.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming PrairieSky Royalty's revenue will grow by 6.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 48.0% today to 50.2% in 3 years time.
• Analysts expect earnings to reach CA$282.3 million (and earnings per share of CA$0.92) by about December 2028, up from CA$220.8 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 28.0x on those 2028 earnings, down from 28.8x today. This future PE is greater than the current PE for the CA Oil and Gas industry at 15.0x.
• Analysts expect the number of shares outstanding to decline by 2.61% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.12%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• PrairieSky's recent royalty growth is heavily dependent on high activity levels in a few key plays such as Clearwater, Mannville and the Duvernay. Management explicitly notes that current efficiency gains and step changes in productivity per well are unlikely to be repeated in 2026 and 2027. This could slow royalty volume growth and constrain revenue expansion and earnings growth.
• The business model relies on third party operators maintaining aggressive drilling programs despite a challenging commodity environment, with management acknowledging subdued oil prices, a lower basin rig count and private operators still targeting growth. A prolonged period of weak oil and gas prices or tighter capital markets could force operators to cut activity, pressuring royalty volumes, revenue and funds from operations.
• Balance sheet risk remains given PrairieSky exited the quarter with net debt of CA$281.7 million while also pursuing share buybacks and acquisitions during a volatile commodity cycle. If oil and gas prices weaken further or bonus and leasing revenues normalize lower, leverage could increase and constrain capital allocation flexibility, negatively impacting net margins and earnings.
• The long term value proposition assumes that under leased fee mineral lands and new acquisitions in heavy oil corridors and SAGD prone areas will be successfully developed. Only about 30% of certain Saskatchewan lands are currently leased and emerging primary and thermal technologies may take longer than expected to scale, delaying bonus income and royalty production growth and thereby reducing revenue and earnings versus expectations.

• PrairieSky's strong recent performance in high growth light oil plays such as the Duvernay benefits from favorable pricing linked to MSW and a weak Canadian dollar. Any structural shift such as a stronger Canadian currency, widening light oil differentials or policy and regulatory pressures on emissions intensive upstream development could erode operator economics over time, resulting in lower drilling activity on PrairieSky lands, weaker royalty volumes, softer revenue and stagnant earnings.
• Management is actively pursuing acquisitions when WTI trades in the low CA$60 range and has executed multiple deals including a CA$50 million Petro Canada fee purchase. If long term commodity prices fail to recover as expected or if secular shifts toward decarbonization and alternative energy reduce demand for oil and gas, the returns on these royalty and mineral title acquisitions could fall short of high teens internal rate of return targets, depressing long run returns on capital, net margins and earnings growth.
• Payout policies are built around a dividend, ongoing share repurchases and incremental acquisitions funded by an estimated CA$100 million of excess free cash flow a year. This assumes current production trends and bonus leasing income can be maintained. If secular cost inflation in the basin, declining capital efficiencies or lower leasing appetite from operators reduce free cash flow, PrairieSky may need to slow buybacks or acquisitions, limiting per share growth in funds from operations and earnings.
• The narrative leans on continued success of waterflood and polymer flood programs and multilateral drilling to reduce declines and increase recovery factors. As these plays mature, decline rates could steepen and incremental recovery may become more capital intensive for operators, reducing their returns and potentially moderating future drilling on PrairieSky lands, which would pressure long term royalty volumes, compress revenue growth and ultimately weigh on earnings.
• Concentration risk in a relatively small set of core operators and plays such as Spur, Canadian Natural, Caltex Trilogy, Paramount, Baytex and Spartan Delta increases PrairieSky's exposure to operator specific capital allocation decisions. Any strategic pivot, balance sheet stress or merger driven slowdown at one or more of these companies could disproportionately reduce drilling on PrairieSky acreage, diminishing royalty revenue, lowering net margins through reduced scale and hampering earnings growth.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of CA$30.82 for PrairieSky Royalty based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$35.0, and the most bearish reporting a price target of just CA$25.0.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be CA$562.7 million, earnings will come to CA$282.3 million, and it would be trading on a PE ratio of 28.0x, assuming you use a discount rate of 6.1%.
  
• Given the current share price of CA$27.35, the analyst price target of CA$30.82 is 11.3% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.