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 2019 Conference Call. Please be advised that certain statements on this call constitute forward-looking information. These statements, other than those of historical facts, may be forward-looking, and we caution the listener. I will now pass the call over to Tom Mullane, Chief Executive Officer of Freehold. Please go ahead, sir.
Thank you, and good morning, and thanks for joining us. Also joining me from Freehold are David Spyker, our Chief Operating Officer; Bob Lamond, our Vice President, Asset Development; Alan Withey, our Interim Chief Financial Officer; and myself. We will summarize our first quarter results and then will be happy to answer questions. Some quarterly highlights we want to expand upon include on the operations front Q1 2019, royalty production averaged 10,139 BOEs a day, down 9% versus Q1 2018 and 2% versus the previous quarter. The variance in royalty volumes year-over-year was driven by a combination of natural declines, reduced audit function additions, weather-related shut-ins and lower third-party drilling during the second half of 2018. Royalty interest accounted for 95% of production and 99% of operating income in Q1 2019. On the working interest side, we expect to remain active in further dispositions through the remainder of the year. We also expect to shut in some natural gas working interest volumes through the summer months with the expectation that pricing will not justify returns. We continue to forecast 2019 royalty production between 9,900 and 10,300 BOEs a day. And given the level of activity on our lands for the past 2 quarters, we believe royalty production should stabilize. Freehold saw continued strength in activity on our royalty lands over the quarter. In total, we had 147 or 7.3 net wells drilled on our royalty lands during the period, down 38% on a gross measure, but up 14% on a net measure versus the same period in 2018 and flat versus the previous quarter. Our average royalty rate on non-unit wells totaled 6.4% versus 4.1% the same -- in the same period last year. Activity through the first 3 months of 2019 was primarily focused on Saskatchewan oil prospects, including Viking at Dodsland, Mississippian play in Southeast Saskatchewan and Shaunavon in Southwest Saskatchewan, representing 32% of the total gross wells drilled. Together, Saskatchewan and Viking locations represented greater than 65% of our gross non-unit drilling in the quarter. Developing plays remain active with 4 East Shale Basin Duvernay and 2 Northern Alberta Clearwater wells drilled on our acreage. We are currently forecasting 20 net wells as part of our 2019 guidance unveiled in March, and we feel we're off to a good start through the first quarter. On the leasing side, we completed 20 new agreements over the quarter with much of the focus on our oil perspective lands in Southeast Saskatchewan and in Viking. We're typically seeing lease rates between 12% and 16% as part of these agreements. On our dividend, with improving commodity prices through the quarter, our funds from operations improved materially relative to Q4 2018. Dividends represented 64% of funds from operations for the quarter. This compares to 101% during the previous quarter. We will continue to evaluate our dividend quarterly. But given the volatility associated with Canadian energy, particularly associated with pricing, we have chosen to maintain our dividend at current levels. For 2019, we are forecasting a payout of approximately 60% versus our previous guidance of 76%. We have set a dividend strategy between 60% and 80% of funds from operations for 2019, so we remain at the lower end of this range. I'll now pass the call to Alan, who will walk through our financials.
Thanks, Tom. Good morning, everyone. This quarter, we continue to position Freehold with strong financial flexibility and as a lower-risk investment. During the first quarter of 2019, Freehold generated funds from operations of $29.3 million or $0.25 per share. Revenue from oil and NGL production represented 81% of total revenue for Q1. As a result of our acquisition program over the last 2 years, we have added higher-quality oil barrels, improving our netback. Freehold reported a loss in the first quarter driven by a $14.1 million nonrecurring impairment charge, partly offset by a $3.8 million deferred tax recovery, all related to the conversion of a production volume royalty contract into the gross overriding royalty. We anticipate this first quarter loss to be fully recovered within the next 2 quarters. Freehold declared dividends of $18.7 million or $0.1575 per share in Q1, implying a 64% payout ratio. As part of our Q1 2019 results, we updated our West Texas Intermediate and Edmonton oil price assumptions for the balance of 2019. As a result, we are forecasting a payout of approximately 60% at the low end of our payout range for the year. Freehold closed the quarter with net debt of $78 million, representing 0.7x net debt to funds from operations. Net debt decreased 13% versus the same period last year, reflecting free cash flow over and above our dividend and acquisitions in the interim. For year-end 2019, based on our forecast and without additional acquisitions, we forecast net debt to funds from operations of approximately 0.3x. Subsequent to the quarter end, we extended our $180 million credit facility to mature May 31, 2022, one year further. One additional item of note. Freehold received a proposal letter from the Canada Revenue Agency where the CRA stated that it intends to reassess Freehold's deduction of certain noncapital losses and noncapital loss carry-forwards in the tax returns filed for 2015. Freehold will vigorously defend its tax filing position and believe it is without merit. No provisions have been made in the financial statements relating to this proposal letter. Now back to Tom for his final remarks.
Thanks, Alan. In closing, we executed on our strategy in Q1. We continue to position Freehold in some of the highest netback plays in Western Canada that will continue to see development. This is evidenced by the strong -- by strong drilling on our royalty lands in Q1. With the improvement in commodity prices, our payout is still comfortably at the low end of our guided thresholds. In the near term, we will strive to maximize value for our shareholders by investing our free cash flow in the form of dividends, value-enhancing acquisitions and/or paying down our debt. Overall, Freehold offers investors a lower-risk oil and gas investment vehicle with upside oil prices. I'll now pass it on to the moderator for questions.
[Operator Instructions] We have a question from Amir Arif.
Just a couple of quick questions for you, Tom. First of all, just the valuations in this space has come down. And so you would think that would increase producers' willingness to do some deals and -- but at the same time, there's more producers who are trying to live within cash flow. So I'm just curious how those 2 opposing forces are resolved in terms of your outlook on the acquisition market for royalties right now.
Thanks, Amir, for the question. When we look at the physical prudence of producers, I think that's a good sign for producers. Producers are also trying to develop their lands and live within cash flow. One of the means that we can help producers to develop their lands is with a royalty. We see that there's still quite a few people that are challenged that like to drill more or showcase their lands more. And so we are seeing a number of producers that are looking to do royalty deals. We didn't do any substantial deals in Q1, but there is pretty good deal flow out there.
Okay. Thanks for the color. And just a second question on that CRA proposal letter that came in. For now, it's just for 2015. Is there any concern or chance of that increasing to other years post 2015? Or is it just specific to that one year?
No, we expect the loss carry-forwards to impact later years. The reassessment will be 2015 with no impact on 2016 or 2017. Going forward, if the letter turns into reassessment, it would affect the loss carry-forward, which we use to reduce tax to nominal or 0 amounts in forward years. So we were at an early stage on that point. They haven't done the reassessment yet. We expect that, that would only occur later in the year, and the exposure that we've had would be a reduction of our tax pools of approximately $160 million.
Okay. Sounds good. And then the one final question, if I may, just -- I know, Tom, you mentioned the use of free cash flow for debt reduction or acquisitions, dividends. How would you rank those today in the current environment in terms of where you'd like to be using that free cash?
Well, we -- Thanks, Amir, for that question. Right now, we like where our dividend is. It's at the low end of our payout threshold -- our payout targets. So when we look at the next use of proceeds, we do believe that we will execute on our -- on acquisitions through the year. And so we believe that we will use our excess free cash flow towards acquisitions during the year. Timing is something that we can't predict, but we think there's plenty out there that we should be able to transact and use that excess free cash flow towards acquisition. By default, we pay down our debt and only if our debt is down, like it's a 0 or something and we're starting to build cash, would we consider buybacks, et cetera. It all depends at the level we trade at, at the time as well.
[Operator Instructions] We have a question from Dennis Fong from Canaccord Genuity.
Just the first one here that I have is just on PPAs and compliance. You said the revenues and volumes associated with that were lower this quarter. Just kind of curious as to how you're thinking about that on a go-forward basis. Should we expect that to decline continuously or kind of level out here? How are you guys forecasting and focusing on that component itself?
Yes. Thanks, Dennis, for the question. I think you're referring to our audit and compliance barrels and revenue that we typically get -- give a quarter through our audit function. We typically have higher -- as you notice in previous years, we had higher reported audit compliance fraction numbers, or PPAs. We believe that's probably in the 100 to 200 range a year going forward on a barrels per day on compliance. That's quite a bit lower than it was in previous years because we haven't done a major acquisition that had lots of title lands.
Okay. So we should be expecting just as we get further away from historical transaction that, that should be a little bit compliant.
A little smaller, yes, but we're thinking 100 to 200 BOEs a day.
Okay. Perfect. The second question that I had is just on H2 CapEx and kind of how you guys are going maybe try and up your net wells essentially drilled where you can take a larger share of second half CapEx as producers start -- or continue drilling for the remainder of this year.
Dennis, it's Dave Spyker. I'm going to take your question there. Dennis, we've been getting a lot more dialogue recently with operators. We've positioned ourselves to compete for drilling dollars. And a lot of things that we're looking at -- is if we look at our lands where we see that the drilling activity is a little bit less than offsetting lands, that would have those discussions with the operators to see if we can put some well-specific royalty incentives in place in exchange for drilling commitments. It is very early on in the process, but discussions have been quite constructive. And really, we see there's a willingness from both parties' part to understand each other's business objectives. And we think that there is -- we are going to see some additional net wells out of that this year and into next year as well. It's been quite constructive.
Okay. Perfect. And then are there certain areas that you believe producers are focusing in on that you want to maybe potentially think about further incenting incremental activity?
I think that our focus area really is in on the light oil areas in Southeast Saskatchewan. That's where we see the biggest opportunity right now. And there's a lot of older leases in there with royalties in that 20%-plus range. If we can just draw those back a little bit, then we can compete with other lands that we compete with ground opportunities.
Okay. Perfect. And then final question here and I'll turn it over after this. How should we be thinking about the remaining working interest production that you guys have? And how are you going to manage around that for either further dispositions or around the remaining production and so forth?
Yes, Dennis, Dave again. We are going to [ re-margin ] the remaining assets outside of the Anderson assets. And so there will be a package that's coming out on The Street this quarter, and the goal is to have those -- a good chunk of those sold before year-end.
We have no further question registered at this time. I would like to turn back the meeting over to you, Mr. Mullane.
Well, thank you, everybody, for joining us on this conference call. We had a quarter that was in line. We believe that our drilling activity was above basin average because of our light oil targets. We believe that we are an investment that -- in oil and gas that has a lower risk, and we continue to have a long-term auction value with the many prospects that we have on our lands. Thank you.
The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.