What’s interesting about this deal is CNQ will take cash and shares for selling its royalty lands to PrairieSky, and then give their CNQ shareholders a special dividend of PSK stock. With this transaction, PSK will get much bigger than rival Freehold Royalties, which needs to manage a controlling shareholder in the CN Pension Plan.
Freehold and Prairie Sky are both royalty trusts that are traded on the TSX. While both have similar structures and histories, they have exposure to different energy and different leverage, which should cause investors to be careful which one they choose and why. Freehold has more exposure to crude oil than Prairie Sky. Each has a fairly balanced mix though. Freehold’s revenues come from 34% natural gas and 66% oil and liquids. Prairie Sky gets 45% from natural gas and 55% of its revenues from oil.
The biggest difference between Freehold & Prairie Sky is their balance sheets. Although Prairie Sky has a bigger market cap, Freehold is more leveraged with an LTV of 23% compared to Prairie Sky which has no debt. This difference shows up in their relative distribution yields. Freehold currently pays out a distribution yield of 7.75% whereas Prairie Sky has a distribution yield of 3.83%.
Prairie Sky’s balance sheet won’t be impacted by rising interest rates, and their unit price will also be less sensitive to rising rates. Since Freehold has some debt on its balance sheet and it has a high distribution yield, it will be more sensitive to rising interest rates. Investors should take these factors into consideration when deciding to add either of these trusts to their portfolio. Freehold is probably riskier but carries a higher yield and could be more sensitive to rising interest rates. But investors should also consider the relatively low cost of debt in this low interest rate environment and Freehold is better positioned to take advantage of this cheap financing. Investors should also be cautious of the additional competition for royalty lands. With more players in the market looking for deals, overall royalty yields could also be under pressure, offering investors lower returns.