Freehold Royalties Ltd
TSX:FRU
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Freehold Royalties Ltd
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Good morning, ladies and gentlemen. Welcome to the Freehold Royalties Ltd. First Quarter Conference Call. Please be advised that certain statements on this call constitute forward-looking information. These statements relate to future events or our expectations for future performance. All statements, other than those of historical facts, may be forward-looking, and we caution the listener. I will now pass the call to Tom Mullane, Chief Executive Officer of Freehold. Please go ahead, sir.
Good morning, and thank you for joining us. On the call from Freehold are Darren Gunderson, our CFO; and myself. We will summarize our first quarter results, and then we will be happy to answer questions. Some quarterly highlights we wanted to expand upon include, firstly, on the operations side, Q1 2018 royalty production averaged 11,197 barrels a day -- BOEs a day, up 5% versus Q1 2017 and 2% versus the previous quarter. Growth in volumes year-over-year was associated with acquisitions completed in late 2017 and the strength of our audit function and third-party drilling on our lands. We have grown our royalty production 7 out of the last 8 quarters. Royalty interests accounted for 99% of operating income in Q1 2018. Our leasing team continues to improve our organic growth. Over the quarter, the team issued 42 new lease agreements with 15 companies. This compares to 32 issued in Q4 2017 and 25 leases in Q1 2017. We increased leasing in the East Shale Duvernay, Southwest Saskatchewan and the -- in the Cardium plays. We expect production additions associated with our leasing efforts to continue to show up in volumes in the second half of 2018 and in future years. Secondly, the first quarter was a busy period for Freehold, executing a number of transactions. In total, we completed $31 million in acquisitions over the quarter. Freehold closed 2 royalty acquisitions: one in the Weyburn unit in Saskatchewan and the other in the Mitsue Gilwood Sand unit #1 in Alberta, for $24 million plus the assignment by Freehold of certain minor working interest assets. Total production and net operating income at the time of the transactions was 110 BOEs a day and $2.6 million, respectively. We see both of these transactions as improving our corporate decline netback and overall quality of our royalty portfolio. Both of these transactions were funded with our free cash flow. In addition, Freehold closed a $7 million royalty acquisition in the prospective East Shale Duvernay Basin in Central Alberta. As part of the transaction, Freehold acquired a 1% gross overriding royalty on approximately 114,000 gross acres and a 3% gross overriding royalty on 1,920 gross acres of royalty lands. We see the asset as offering multiple years of upside. In total, we had 4 gross wells drilled on our East Duvernay acreage during the quarter. Freehold also closed the sale of noncore working interest production in the Pembina Cardium Unit #9 in Alberta for $8.1 million. As part of the transaction, Freehold retained a new 4% gross overriding royalty on the same interests that were sold. Thirdly, Freehold saw continued strength in activity on our royalty lands. In total, we had 239 wells, 6.4 net wells, drilled on our royalty lands during the quarter, up 59% on a gross measure but down 26% on a net measure versus the same period in 2017. When compared to Q4 2017, activity was up 113% and 12% on a gross and net measure, respectively. Activity through the first 3 months of 2018 was primarily focused on Saskatchewan oil prospects, including the Viking at Dodsland, Mississippian plays in Southeast Saskatchewan and the Shaunavon play in Southwest Saskatchewan. Together, Saskatchewan and Manitoba wells represented greater than 60% of our gross non-unit drilling through the quarter. Alberta activity has been concentrated in the Cardium, with strong drilling, 17 gross wells, on our newly acquired Pembina Cardium acreage. Drilling for Deep Basin Spirit River and Montney remains positive. Our top payers continue to represent some of the most well-capitalized E&P companies in Canada. Including the previously mentioned transactions and incorporating our estimates for declines, third-party activity and lease-outs on our lands, we are maintaining our 2018 production guidance. Volumes are expected to range from 11,750 to 12,250 BOEs a day. We expect to update this forecast through the year. Fourthly, we increased our monthly dividend by 5% in the first quarter to $0.0525 share per month, in line with our previously guided adjusted payout strategy between 60% and 80%. Based on our Q1 2018 funds from operations, we continue to position our dividend at the bottom of this range. We continue to generate strong free cash flow over and above our dividend, with the expectation to allocate funds from operations to debt, acquisitions and further dividend increases. We will continue to monitor our dividend adjusted payout ratios with the next review in Q2 with our results for Q2 2018. Lastly and subsequent to the quarter end, we held our inaugural Investor Day in Toronto on April 9, unveiling our 2017 Asset Book. In creating the book, we highlighted the long-term value proposition and investment Freehold royalty provides. Under our analysis, we identified approximately 21,000 future royalty locations on our lands, implying greater than 40 years of future development at current drilling rates and an undiscounted future upside value of approximately $7 billion for Freehold. We see approximately 70% of the upside on our lands associated with oil prospects, with a number of well-capitalized operators continuing to allocate capital towards development on our royalty lands. A copy of our Asset Book is available on our website.Now I'll pass the call to Darren to walk through the financials.
Thanks, Tom. Good morning, everyone. Financially, we achieved a number of objectives and continued to position Freehold with strong financial flexibility as a low-risk investment. During the first quarter of 2018, Freehold generated funds from operations of $32.4 million or $0.27 per share as both production and cash costs met our expectations. Revenue from oil and NGL production represented 82% of total revenue in Q1 2018 and is forecast at 88% of full year 2018 revenue. Through some of our recent acquisitions, we have added higher-quality oil barrels, improving our netback, which was $34.86 per BOE for the quarter. Freehold declared dividends of $18 million or $0.1525 per share in Q1 2018, implying a 60% adjusted payout ratio. After the 5% increase to our annual dividend and based on our 2018 funds from operations estimate, we forecast an adjusted payout of 54% at the new dividend level. We are looking for further stability in commodity pricing before making a decision on future dividend levels. Freehold closed the quarter with net debt of $90 million, representing 0.7x net debt to funds from operations. Net debt increased, reflecting acquisition activity which closed over the quarter. For year-end 2018, based on our forecast, net debt to funds from operations is expected to be 0.3x. Now back to Tom for his final remarks.
Thanks, Darren. In closing, we have executed on our strategy in Q1. We continue to position Freehold in some of the highest-netback plays in Western Canada, which will continue to see development. With our earlier dividend increase, our payout is still comfortably at the low end of our guided thresholds. To summarize, we continued to generate royalty production growth, we had strong drilling in our royalty lands, and we completed a number of quality acquisitions. Overall, Freehold offers investors a low-risk vehicle with significant torque to oil prices.Now I'll pass it over to the moderator for questions.
[Operator Instructions] We have a question from Jeremy McCrea from Raymond James.
When you talk about new lease agreements that were signed here for the quarter, how did those leasing agreements look in terms of our projections in terms of new wells coming on here later this year? Specifically, are they drillers related to maybe one well? Is that multiple wells? How do the royalty agreements look with these new leases that were signed this quarter versus, say, a year ago? I'm just trying to compare the new lease agreements that were signed this quarter versus how those may have differed or changed from a year ago.
Jeremy, thank you for the question. So we did have a lot of new leases created in the first quarter. The royalty percentage is slightly down from, I would think, a year ago's quarter. There was a little more leasing in the Duvernay, which has lower royalty rates than, let's say, Southeast Saskatchewan, which was the predominant kind of area we were leasing out last year. So overall, there's more leases but at a slightly less royalty rate.
Okay. But I think [ if it's still drilling in ] Duvernay, it's [ going to ] impact well results anyways, I guess, right?
I'm sorry?
Like if the leases -- if the new leases were in the Duvernay versus Southeast Saskatchewan, I got to think the impact would still be greater for you on a net-net basis?
Yes. We are pretty optimistic about what's going on in the Duvernay. We do believe that we won't see any of those results in the -- very few of those results this year, probably into next year. And we don't have any of those in our forecast right now.
[Operator Instructions] We have a question from Shailender Randhawa from RBC.
Two questions from me. So one, you left the guidance unchanged. I was just wondering if you could provide any commentary on what you saw in terms of activity and CapEx levels year-to-date versus the assumptions and if there's any surprises in that. And then secondly, just to go back to the Duvernay, how much of your mineral title in the Duvernay is now leased? Just ballpark-wise would be helpful.
Okay. Shailender, as far as when we look at the Duvernay, we're still -- we have quite a few -- quite a bit of acreage in the Duvernay itself. Like how much of it's prospective, we're still going over that. So I would think, on a percentage basis, it's actually quite low. But a percentage on the quality, Duvernay, I have -- we have to still work those numbers. As far as guidance go, one of the things that we were a little cautious with as we go forward here was the number of net wells that we have. We were hoping for a few more net wells in Q1. The total activity on a gross well basis surprises on the upside, but on the net basis, it was -- it's a little slightly lower. We're hoping that the room for scheduling is that the operators, with this recent bump in oil prices, that they'll get a little more active drilling on our mineral title land through the back half of the year.
We have no other further question registered at this time. I would like to turn back the meeting over to you, Mr. Mullane.
Well, thank you for joining this conference call this morning. We're very proud of our quarter. We are projecting good things for the balance of the year, and we continue to be a low-risk way to play the oil and gas space. Thank you very much.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.