Freehold Royalties Ltd
TSX:FRU
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Freehold Royalties Ltd
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Good morning, ladies and gentlemen, and welcome to the first quarter results conference call. I would like to turn today's meeting over to Tom Mullane. Please go ahead, sir.
Thank you very much. Please be advised that certain statements on this call constitute forward-looking information. All statements other than those of historical facts may be forward-looking and we caution the listener. Good morning, and thank you for joining us. With me on the call from Freehold are David Hendry, our CFO; Bob Lamond, our Asset Development VP; Rob King, our VP, Business Development; and Matt Donohue, our Manager of Investor Relations and Capital Markets.Before we get into the highlights for the quarter, we wanted to note that alongside government and public health officials, we are actively monitoring COVID-19 updates and follow the latest guidance from Alberta Health Services and other provincial health departments. At Freehold, we want to thank our health workers in Alberta, Saskatchewan and across Canada for battling COVID-19.As the COVID-19 pandemic evolve -- continues to evolve, Freehold is prioritizing the health and safety of our workforce by directing our employees to work from home since March of this year. We appreciate the continued efforts of our staff during this time and want to thank our shareholders for their ongoing support.Operationally, first quarter royalty production averaged 10,618 BOEs a day, up 5% versus the same period in 2019 and up 3% quarter-over-quarter. Increases in volumes were reflective of robust third-party drilling additions, strong production performance associated with recent acquisitions and meaningful prior period adjustments partly relating to our audit function.Royalty liquids production has averaged 5,973 BOEs a day for the first quarter, up 7% versus the same period in 2019 and up 1% when compared to the previous quarter. Production from Freehold U.S. royalty assets averaged 242 barrels a day in the first quarter, representing a 32% increase from the previous quarter. Royalty interest accounted for 96% of total production and 100% of operating income.We had a strong start for the year and drilled close to about 175 gross, 62 (sic) [ 6.2 ] net wells drilled on our royalty lands over the periods. This compares to 186 gross, 4.5 net wells drilled during fourth quarter 2019 and 147 gross, 7.3 net wells drilled on our land during the same period in 2019. Drilling continues to be focused in Saskatchewan and Manitoba, which together have represented approximately 64% of the gross first quarter drilling, 75% on a net basis. Freehold continues to target oil prospects, specifically the Viking oil play in West Central Saskatchewan and East Central Alberta with 65 gross, 3.3 net wells drilled during the quarter. Mississippian subcrop oil play in Southeast Saskatchewan and Southwest Manitoba saw 29 gross, 1.2 net wells drilled.The various Mannville oil plays across Saskatchewan and Alberta saw 17 gross and 0.8 net wells drilled, not including 10 gross, 0.2 net wells drilled on recently acquired Sparky royalty lands in Central Alberta and 7 gross, 0.3 net wells on the Clearwater royalty lands in Northern Alberta.In the quarter, 63% of the gross drilling, 78% net, was on gross overriding royalty lands, 13% gross on the title land, 20% net; and 24% of the gross drilling was on unit interests or 2% -- or being 2% net. Activity continued to be funded by some of the most stable operators in the industry.Subsequent to quarter end, Freehold announced that with continued weakness in crude oil prices due to the COVID-19 pandemic and a OPEC Russia supply war, Freehold's Board of Directors revised our monthly dividend rate from $0.0525 to $0.015 per common share to be paid on May 15 to shareholders on record on April 30. At the revised monthly dividend level, Freehold's funds from operations are forecasted to exceed dividend outflows for the remainder of 2020 and are currently below the low end of our payout range of 60% to 80%. Adjusting the dividend at this time preserves the strength of our balance sheet and enhances optionality to pursue value-enhancing acquisitions as they present themselves later in the year.Freehold also announced that due to the uncertainty associated with underlying business environment, including the potential for voluntary shut-ins of production, regulatory imposed production curtailments, high crude oil inventories and continued price volatility, its previously released 2020 guidance was no longer applicable. We expect to provide a revised and updated at a time of increased stability associated with the commodity price environment and our royalty payors capital programs.Lastly, on April 30, Freehold disposed of certain working interest properties with an estimated production of 265 BOEs a day. As part of the agreement, the purchaser has agreed to assume decommissioning liabilities of approximately $3.7 million on these properties. Freehold has agreed to pay $1.7 million into escrow that will be released to the purchaser once the legal interests in the assets are satisfactorily transferred. An additional $0.3 million will be deposited on behalf of the purchaser with various regulators as security deposits.I will pass the call to David to walk through some of the financials.
Thanks, Tom, and good morning, everyone.Financially, while we endured a significant retreat in global oil prices which commenced in mid-March, Freehold continues to pay a meaningful dividend which we adjusted for the lower commodity price environment and to manage our debt levels.In the first quarter, Freehold generated $26.3 million in royalty and other revenue, down 26% versus the same period in 2019, reflecting lower commodity prices partially offset by higher production volumes. The total royalty revenue was comprised of 83% oil and NGLs, which also reflected the decline in oil prices. Our royalty portfolio generated an operating netback of $25.22 per BOE in the first quarter, a 30% decline versus the same period in 2019. Funds flow from operations for Q1 2020 totaled $20.2 million, down 31% from Q1 2019 levels.Our payout totaled 92% in the first quarter of 2020, up from 64% during the same period in 2019. At the revised dividend level, we target Freehold's payout to remain at the low end of our outlined range through the second half of 2020 with the expectations to be greater than 100% for the second quarter of 2020 given the expected commodity prices, differentials and shut-in production volumes.Freehold's generated approximately $11 million in cash flow over our dividend in Q1 2020, which we allocated towards acquisitions and paying down debt. Freehold incurred a first quarter 2020 net loss of $9 million compared with a $7.1 million net loss recorded during the same period in 2019, with slightly higher net loss reflected lower volumes due to the retreat in oil prices later in the quarter as well as an impairment loss of $9.6 million related to Freehold's working interest properties recorded in the current quarter. This compared with a $14.1 million impairment loss recorded during Q1 2019 related to the termination of a specific production volume royalty agreement.Cash costs for the quarter totaled $5.74 per BOE, down from $6.39 per BOE during the same period in 2019. The decrease year-over-year reflects reduced general and administrative charges, deferred payment of stock-based compensation and increased production volumes. The first quarter typically represents a period of higher G&A for Freehold based on the seasonal nature of these expenditures. We will close the quarter with a $6 million reduction in long-term debt from year-end 2019 as cash flows exceeded acquisition spending.Net debt totaled $101.8 million at March 31, 2020, representing 0.9x net debt to funds from operations on a trailing 12-month basis. The increase in net debt quarter-over-quarter reflects the decline in oil prices, acquisition activity, a decommissioning liability disposition and the higher dividend payout. As the oil prices are likely to remain depressed through 2020, we expect a long-term debt to EBITDA ratio to increase through 2020 but remain covenant compliant. Freehold's prudent longer-term debt strategy of maintaining long-term debt to cash flow below 1.5x and dividend payout range of 60% to 80% of funds from operations provides cushion for volatile prices like those currently being experienced. However, COVID-19 pandemic has caused significant destruction of demand for oil, volatility in commodity prices and uncertainty regarding the timing for recovery, which has made the preparation of financial forecast challenging. As a result, there may be adverse changes in cash flows or debt levels that are currently unforeseen.Now back to Tom for his final remarks.
Looking forward, we expect the next 3 to 6 months to represent a challenging period for the North American exploration and production industry.Setting ourselves apart, Freehold provides investors a higher-margin business as we do not pay typical costs associated with oil and gas operations and reclamation, enabling more returns to be transferred to our shareholders. Further with revised dividend level, we continue to maintain flexibility in our balance sheet while maintaining sustainability in our dividend. At current share price levels, we feel the return proposition is an attractive entry point for investors and sustainable in the current commodity environment.In terms of how we expect to allocate free cash flow, our preference is to ensure stability of our -- sustainability of our dividend and having a clean balance sheet near term, with the medium-term outlook shifting to value creation via acquisitions to grow and improve our royalty portfolio.The ability to access capital, both equity and debt, remains challenged from any E&P producers, and we believe we can serve as a financing tool through the creation of new royalties in Canada and in the U.S. If we are unable to complete acquisitions with our free cash flow, we expect to pay down debt.Thank you for joining us, and we would now entertain any questions.
[Operator Instructions] We'll take our first question.
It's Dennis Fong over at Canaccord. I've got 2 quick questions. The first is I understand that you guys have pulled back your production guidance. But I was just hoping to find out in terms of how you guys were thinking about shut-ins going into Q2, what are some of the initial indications that you received from the conversations from your royalty payers.
So Rob, can you [ take that ]?
Sure, can. Thanks, Tom. In terms of shut-ins as we look into Q2, maybe just to provide a little bit of commentary around that, so when we usually have to, call it, 30 to 60 days where I book [ rapider ] well, it has been shut-in before it hits dark books. So we've actually been having a very regular and proactive discussions with our fee payers just to understand what they're thinking, how they're thinking, when they may be shutting in production. But if anything, we might be able to do to mitigate that. So that should be kind of feeding into a lot of where a lot of our intelligence as we look at what our production profile could look like through the balance of 2020.We really saw very minimal shut-ins in March time frame. When I say minimal, it was sort of something much less than 5% and probably even less than that. Our dialogue with our fee payers would sort of point to somewhere in the 5% to 10% range of shut-ins for April. And our suspicion is, as we get into May and June, that number is going to increase. And is it going to -- it could double to the 20% range? That's sort of a modeling assumption that we've put in place. And then it will be obviously highly sensitive in Q3 and Q4 as it relates to what the then current commodity prices will be. But that's sort of a bit of a flavor in terms of how we're thinking about shut-ins right now, Dennis.
Great. My follow-up here as well is, I know you mentioned on your AGM yesterday that there was still a fairly wide bid-ask spread for royalty assets. How are you thinking about this in the context of, obviously, your current balance sheet strength? I know Tom just made that comment about any excess free cash flow getting put towards the balance sheet. Then also kind of like the potential to do these type of deals in this type of market, how are you addressing or thinking about that side as well as what are you expecting as maybe near-term catalysts that could narrow sort of bid-ask spread?
Yes. In terms of -- Tom is absolutely right in terms of the priority order of our free cash flow and sort of dividend first, balance sheet second. And then the third will be allocation towards the acquisition side of our portfolio. In terms of how we're -- what we're -- we're optimistic in terms of what opportunities might come about here. We have a fair amount of dialogue particularly with Canadian producers in terms of what might be possible and are continuing to look at a number of opportunities in the Bakken. It is -- cash is -- capital is constrained for everyone right now, so it is one where we're being very careful. And I think our suspicion is our acquisition activity will likely be more second half weighted rather than things within the second quarter as we continue to build our free cash flow position and monitor the level of leverage that we have. In terms of what narrows that bid-ask spread, I think a lot of it is a factor of time. With the longer that prices are at the levels that they're at, that market therapy starts changing people's thought patterns relatively quickly.
We'll now take our next caller.
Tom, this is Amir Arif at Cormark. Just a couple of quick questions for you. Just on your 2020 outlook, I know there's no formal guidance and you've already provided some color on [ the strategy ]. But can you just give us some color if there are any drilling commitments on your lands? And if there is none, where do you see production getting to by year-end if there is no drilling?
Amir, I'm sorry. Can you repeat that question? It was a little rough for us to hear.
Sure. Yes. So just curious if there are any drilling commitment from your lands, where people were -- some of your royalty companies have to drill on your lands based on the royalty agreements as well. And then if there are none or even based on that, where do you see production declining to you by year-end based on no drilling on your lands?
Yes, Amir. That's -- I mean that's a guidance question, really, and we're not giving guidance right now. I think when we look at what Rob has mentioned about shut-ins, and we think that it's only going to be towards the end of the year before drilling starts taking off again, if we use strip price as our indicator. So it's very difficult to see a lot of near-term drilling, and it's very difficult to forecast. And we don't have guaranteed commitments to drill. We do have some contracts there, royalty [ changes ] and the commitment to drill doesn't -- those are -- doesn't happen, but those are more long term. Rob, do you have a comment?
Yes. Just a couple of thoughts from here. Maybe our Q1 net drilling of 6.2 net wells was certainly ahead of expectations. So we started the year, both from a production standpoint or royalty production is the highest it's been in the last 2 years in the first quarter. And we also have a number of net wells that were drilled in Q1. So certainly haven't had any wells drilled on our lands since March 17, so it's one where I think we're not anticipating near-term drilling activity. The other aspect, our decline rate on a corporate basis is 18%. So just in terms of how you're modeling it, an 18% decline offset with a pretty robust Q1 production levels as well as robust Q1 drilling levels, that can help you calibrate your model.
That's helpful. And then just a second question on the dividends. I mean some companies are viewing the dividend cuts more as a temporary suspension or reduction in dividends. And so do you see your dividends increasing next year based on just the extent of how much the strip prices improve into next year? Or do dividends only grow from here as production levels grow?
Amir, we will continue to set our dividend along our 60% to 80% payout ratio target. As you noticed in the last couple of years, we've been at the bottom end of that payout ratio, and we probably will continue to be that as we set the targets going forward. And as we see prices rebound, we will take a look at strip prices and other factors to set our dividend.
[Operator Instructions] We'll take our next caller.
Jamie Kubik from CIBC here. Most of my questions have been answered already, but curious on this one, if you can offer any insight. I mean a lot of Freehold's tax pools came through the acquisition of working interest properties over the years. And given the disposition at the end of Q1 there -- or at the end of April, sorry, do you foresee there being any challenges to utilize any pools going forward given how small working interest volumes have become in the corporate profile?
David Hendry here. So we didn't sell all of our working interest by any means. It was roughly around half of it. So as far as any challenge from the government or from CRA, we haven't heard anything back from them with regards to their challenge. The challenge we have already been posting that was even before disposition. This working interest disposition was largely around managing the decommissioning on some later life working interest assets. And so the other portion of the working interest assets, so we continue to operate them, and it's still an important part of the business. And so we're not expecting any change in our tax pools going forward. But obviously, until we get something back from CRA, it's hard for us to provide any further details on that.
[Operator Instructions] At this time, there are no further telephone questions in the queue.
Well, thank you very much for joining us on our call this morning. Stay healthy, everyone. Thank you.
Thank you. That will now conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.
Thanks a lot for your help.