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. Second Quarter Conference Call. Please be advised that certain statements on the 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 over to Tom Mullane, Chief Executive Officer of Freehold. Please go ahead.
Good morning, and thank you for joining us. On the call from Freehold are Darren Gunderson, our CFO; and myself. Rob Lamond, our VP Exploration is also here. We will summarize our second quarter results and then we'll be happy to answer questions. A key theme for the quarter is that we saw a steady increase in our royalty revenues and funds from operations as oil prices moved upwards. Over the quarter, Freehold's royalty interest revenue totaled $38.2 million, up 11% over the same period last year. Funds from operations for the quarter totaled $34.5 million or $0.29 per share, up 8% from $31.8 million or $0.27 a share in Q1. The increase year-over-year reflected the improvement in revenues and the reduction in our total cash costs, as we enhance our royalty focus. We increased our monthly dividend as part of our Q1 2018 results for the second consecutive year. Based on 12-month trailing funds from operations, our basic payout totaled 54% over the period, while our adjusted payout was 56%. We will continue to monitor our payout ratios and we'll adjust our dividend to maximize shareholder return.On the operations side, Q2 2018 Royalty production averaged 11,052 BOEs a day, down 1% versus our last quarter. On a debt-adjusted measure, however, we grew Royalty volumes by 1% versus the previous quarter. We are maintaining our 2018 production guidance of 11,750 to 12,250 BOEs a day. Royalties as a percentage of our production, 94% and operating income, 100% were at all-time highs, reinforcing the success of our acquisition and disposition programs. On the activity front, drilling totaled 324 gross, 7.6 net wells on our royalty lands during the first 6 months of 2018. This was an increase of 56% on a gross measure, but a decrease of 25% on a net basis versus the same period in 2017. Activity through the first 6 months of 2018 was primarily focused on Saskatchewan oil prospects, including the Viking at Dodsland, Mississippian plays in southeast Saskatchewan, and Shaunavon and Cantuar in southwest Saskatchewan.Together, Saskatchewan and Manitoba drilling was approximately 60% of our gross, non-unit drilling through the quarter. Alberta activity had been -- has been concentrated in the Cardium with strong drilling on our newly acquired Pembina Cardium acreage. Drilling in the Deep Basin for Spirit River, Ellerslie and Montney targets, along with Mannville Oil drilling in eastern Alberta remains positive. Well, the second quarter typically represents a period of slowed activity. We saw even lower drilling activity than expected. As a result of some of this weakness, we are drilling -- we are reducing our 2018 drilling forecast from 25 to 20 net wells. We saw reduced drilling in southeast Saskatchewan and better drilling in the Deep Basin Cardium active areas relative to our original forecast. Forward-looking, we have seen an uptick in licensing activity by approximately 60% year-over-year. So we remain optimistic drilling will ramp up into year-end. Our leasing team continues to outpace expectations. Over the quarter, the team issued 18 new lease agreements with 10 companies. This compares to 12 issued in Q2 2017. Year-to-date, we have generated $1.5 million in bonus revenue, which compares to $1.2 million all of last year. These bonuses were focused on activity in East Shale Duvernay, Cardium, Frobisher, Midale and Viking. We have seen activity associated with some very well capitalized operators and expect licensing activities convert into future drilling in our lands through the second half of the year. I will now pass the call to Darren to walk through the financials.
Thanks, Tom. Good morning, everyone. Financially, we achieved a number of objectives that continue to position Freehold as a low-risk oil and gas investment. During the second quarter, Freehold generated free cash flow of $15.1 million, which we applied to net debt and funded a minor tuck-in acquisitions. Freehold closed the quarter with net debt of $78 million, representing 0.6x net debt to funds from operations. Net debt increase versus the same period last year reflecting acquisition activity, which we closed over the previous 2 quarters, but decreased quarter-over-quarter. Net debt to funds from operations is expected to be 0.4x as of year-end 2018. Based on our commodity and production forecast and with no additional acquisitions completed, we could be debt-free in the latter half of 2019. Revenue from oil and NGL production represented 92% of total royalty and other revenue in Q2 2018, and it forecasted 88% of full-year 2018 revenue. Our operating netback for the quarter totaled $35.94 per BOE. This was a 17% increase year-over-year. Cash costs for the quarter totaled $5.17 per BOE, down from $5.63 per BOE in Q2 2017. For 2018, we are forecasting cash costs under $5 per BOE. Now back to Tom for his final remarks.
Thanks, Darren. In closing, we generated strong growth in our royalty revenue and funds from operations during the quarter. We continue to pay down our outstanding debt. At current commodity price levels, we maintain significant flexibility in our balance sheet and expect to be debt-free sometime in 2019. We continue to improve the quality of our royalty portfolio through an active leasing program and through acquiring quality low decline high netback assets. We continue to receive multiple questions on how we prioritize free cash flow. In the near-term, our priority is to use excess free cash flow to fund value-enhancing acquisitions and improve the quality of our royalty portfolio. If we do not execute transactions, we will pay down outstanding debt. Overall, Freehold offers investors a low-risk investment in the oil and gas industry. Now I'll pass it over to the moderator for questions.
[Operator Instructions] And the first question is from Amir Arif from Cormak Securities.
Tom, I had a couple of questions. First, just if you can help me reconcile the difference between the leasing activity where you've been increasing your leasing activity year-over-year, but the drilling activity in the first half is lower. I understand you -- I appreciate the comments that you mentioned on the licensing. So is it just a timing issue or is there something else we should be thinking about there?
Thank you, Amir for the question. There's a couple of things that's going on. One, we do believe that with sustained oil prices, producers will get back drilling during the latter half of the year, and we are expecting our drill count to pick up. So there is a timing issue here. Overall, when we look at PSAC drilling forecast for the year, they are forecasting the overall year average to be down. They just came out with it, I think about last week or so. So they're -- they reduced their drilling in the basin by 7%. We are seeing a little bit of that effect as well. But based on the licensing activity, we do believe things will pick up in the second half.
Okay, and the licensing activity numbers you have mentioned, those were on your royalty lands specifically?
That's correct.
Okay. And then just a second question. Just with higher oil prices and the higher cash flows for producers, are you seeing a change in the type of transactions that you are looking -- you are contemplating to doing on the royalty front?
I guess, there is still a good flow of royalty product in the market. Some are early-stage, some are a small transactions, just like the one we announced in Q2. We do expect perhaps some gassier names to look at creating royalties.
The next question is from Shailender Randhawa from RBC Capital Markets.
Tom, wondering if you could give us sense of what's happening in the East Shale Basin in terms of leasing and drilling on your lands. And is that included in your second half outlook?
Well, I'll turn this one over to Bob Lamond, our VP Exploration to talk about the drilling activity.
So a good question. Again, for the leasing side, we continue to look at our leases from the Freehold piece. On the drilling side, quarter 2 has been really quite slow. We have had a couple wells drilled, but we do anticipate many more through the rest of the year. Yes, I mean, and just really a continuation on the drilling plans you've seen from some of the operators around. We're happy with our current exposure and are looking to increase that as it goes.
Thanks, Bob.
[Operator Instructions] There are no further questions at this time. I'd like to turn the meeting back over to you, Mr. Mullane.
Well, thank you very much. And thank you, everybody, for joining this conference call. I must remind everybody, Freehold offers investors a low-risk investment in the oil and gas industry. We have performed very well over our history and will continue to do so into the future. We're well positioned for that. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time, and thank you for your participation.