DJ Basin Execution And Regulatory Risks Will Pressure Margins Yet Long-Term Production Upside Remains

Catalysts

About Prairie Operating

Prairie Operating is an oil and gas exploration and production company focused on disciplined development and optimization of its DJ Basin asset base.

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

• Although the company is rapidly ramping production from newly acquired and drilled DJ Basin wells, sustained execution risk around pad development, workovers and offset frac management could limit the anticipated production uplift and thereby constrain revenue growth.
• While long dated hedges and an expanded credit facility provide visibility on cash flows and funding capacity, prolonged cost inflation in drilling, completion and facilities, even with current service contracts in place, may prevent operating leverage from translating into higher net margins.
• Although the deep inventory of more than 600 gross drilling locations and over 100 million barrels of oil equivalent in proved reserves supports multi year development, potential regulatory tightening or permitting delays in Colorado could slow the pace of converting undeveloped reserves to producing barrels and weigh on earnings growth.
• While optimization initiatives such as workovers, plunger installations and compression upgrades are currently enhancing per well productivity, diminishing returns on these low cost programs over time could reduce incremental volume gains and limit future improvements in cash flow from operations.
• Although growing scale and a track record in M&A position Prairie to pursue additional bolt on acquisitions in an increasingly consolidated basin, heightened competition for quality assets and stricter bank underwriting may force higher deal costs or slower transaction velocity, tempering accretive impacts on revenue and EBITDA.

Assumptions

This narrative explores a more pessimistic perspective on Prairie Operating compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Prairie Operating's revenue will grow by 73.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -47.7% today to 51.5% in 3 years time.
• The bearish analysts expect earnings to reach $445.7 million (and earnings per share of $2.3) by about December 2028, up from $-79.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 0.5x on those 2028 earnings, up from -1.3x today. This future PE is lower than the current PE for the US Oil and Gas industry at 12.7x.
• The bearish analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.87%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Prairie remains heavily exposed to long-term fossil fuel demand trends. Any accelerated global shift toward decarbonization, stricter emissions policies in Colorado, or federal methane regulations could impair the economic life of its DJ Basin reserves and reduce long-run revenue and earnings power.
• The company is executing a capital-intensive growth strategy with CapEx of roughly $260 million to $280 million this year, against quarterly revenue of $77.7 million and a recent net loss attributable to common stockholders of $22.5 million. Any sustained cost inflation or operational underperformance could prevent the expected scale benefits from translating into structurally higher net margins and earnings.
• Prairie relies on a large inventory of more than 600 gross drilling locations and over 100 million barrels of oil equivalent in proved reserves to support long-term growth. If type curves disappoint, decline rates are steeper than expected, or workover and optimization gains prove short lived, the company could face lower production than planned and weaker revenue and EBITDA growth.
• The growth story is partly built on accretive M&A in a consolidating DJ Basin. Increased competition for quality assets, tighter reserve-based lending standards, or a less constructive bank funding market could limit Prairie’s ability to execute future deals on attractive terms, which could dampen expansion of reserves, production, and long-term earnings.
• Prairie’s comprehensive hedge book provides near- to medium-term price protection through 2028. If oil and gas prices structurally trend higher than the hedge levels of roughly $62 to $66 per barrel of oil and just above $4 per MMBtu of gas, the company will surrender upside compared to unhedged peers. This could cap growth in revenue, EBITDA, and net income and weigh on relative share price performance.

Valuation

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

• The assumed bearish price target for Prairie Operating is $2.0, which represents up to two standard deviations below the consensus price target of $4.5. This valuation is based on what can be assumed as the expectations of Prairie Operating's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $8.0, and the most bearish reporting a price target of just $2.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $866.1 million, earnings will come to $445.7 million, and it would be trading on a PE ratio of 0.5x, assuming you use a discount rate of 11.9%.
  
• Given the current share price of $1.68, the analyst price target of $2.0 is 16.0% 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.