Freehold Royalties Ltd
TSX:FRU
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Freehold Royalties Ltd
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Good morning, ladies and gentlemen. Welcome to the second quarter results conference call. I would now like to turn the meeting over to Mr. David Spyker. Please go ahead, sir.
Good morning, everyone, and thank you for joining us today. Joining me on the call this morning are Dave Hendry, our CFO; and Rob King, our Vice President of Business Development.
Over the last 2 years, Freehold has expanded its asset base into the premier basins across North America, providing the company with a high-quality inventory that will underpin our dividend and further our ability to reinvest in the business for years to come. Our low leverage and high-margin business model means that Freehold can generate material returns for our shareholders in all cycles of the commodity, with the added benefit in the current inflationary environment of having returns that are sheltered from compressing profit margins if operating and capital costs continue to increase.
Key highlights as part of our news release yesterday include: we posted our third consecutive quarter of record funds from operations at $84 million or $0.56 per share. This represents an 81% increase on a per share measure versus the same period last year and a 17% improvement versus the previous quarter. Driving funds from operations is a structural shift in Freehold's business to higher-return U.S. production, with U.S. realized pricing 19% higher on a per BOE basis versus the price we received in Canada during the same period.
With the enhanced scale of our portfolio and confidence in the long-term performance of our asset base, we are increasing our monthly payout 13% to $0.09 a share from $0.08 per share. Freehold has been able to grow our dividend over 500% since the lows of COVID in 2020, with yesterday's increase the sixth consecutive -- the sixth revision over that period. The ability to ramp up Freehold dividend is a direct result of the portfolio reinvestment we have executed, the strength in commodity pricing and the flexibility we have maintained with our balance sheet. Looking forward into 2023, the company's dividend remains as sustainable as ever, backstopped by a strong suite of payers from a high-returning portfolio.
From a guidance perspective, we're maintaining our full year production guidance of 13,750 to 14,750 BOE a day. Production in the second quarter averaged 13,453 BOE a day. Volumes were up 21% versus the same period last year and slightly down quarter-over-quarter. Excluding the acquisition work announced subsequent to the quarter end, our production for the year would be coming in at the lower end of our guidance range. This is driven primarily by timing delays in getting new wells on production by our U.S. operators.
Our base asset performance, our new well performance and our drilling inventory are meeting or beating our expectations at the time of acquisition. Drilling activity levels have exceeded expectations with on production timing disrupted by supply chain and completion crew availability challenges, particularly in the U.S. We continue to expect production growth through the second half of this year and into 2023, supported by the drilling activity we are seeing year-to-date and in Q2 '22, in particular.
The acquisition work in the Midland and Eagle Ford basins, that I will talk about in a minute, will close in the third quarter and bring our annualized production back into the midpoint of our guidance range. On the Canadian side, Canadian production was down 1% quarter-over-quarter with spring breakup impacting activity levels. Our drilling activity to date is targeting the Viking, Sparky and Clearwater oil in addition to gas-focused drilling in the Deep Basin. Given our third-party capital spending assumptions, we expect Canada production to remain flat or modestly grow through the balance of 2022.
The activity on our royalty lands remains robust. Currently, we have 24 rigs active on our U.S. assets and 11 rigs on our Canadian assets. Subsequent to quarter end, we entered into 2 definitive agreements to acquire high-quality mineral title and royalty assets in the Midland Basin and Eagle Ford Basin. On August 4, we closed the Midland asset transaction for $123 million.
This Howard County Midland transaction positions us in an emerging section of the Midland Basin with development underpinned by an exciting public operator with significant near-term growth targets. We are forecasting greater than 20% growth in production associated with this transaction into 2023.
The Eagle Ford transaction is expected to close in September and will layer in a low-volatility production profile driven primarily by a diversified group of large public payers. This transaction further complements our current production base in the Eagle Ford, which is backstopped by an investment-grade producer with multiple years of future developments.
I'll now pass the call to Dave Hendry just to walk through some of the financial highlights.
Thanks, Dave, and good morning, everyone.
As commodity prices improved over the quarter, Freehold continue to deliver on the core financial aspects of its return proposition, providing a meaningful dividend while also providing investors with a lower risk investment. As noted by Dave, Freehold generated record funds from operations for the third straight quarter of $84 million or $0.56 per share. Broad increases in energy pricing alongside the larger proportion of revenue derived from our higher priced U.S. volumes contributed to the increase.
Dividends declared for Q2 2022 totaled $36 million or $0.24 per share. This represented 150% increase versus the same period in 2021. Freehold's dividend payout ratio for Q2 2022 was 43% versus 33% during the same period in 2021. We expect to continue to position our payout at 60% of forecasted funds from operations. Accordingly, we've increased our monthly dividend to $0.09 per share.
Freehold's average realized U.S. crude oil price was $138.70 per barrel during Q2 2022, up 75% versus the same period in 2021, while Freehold's average realized U.S. natural gas price was $7.79 per Mcf, up 114% versus the same period in 2021.
In Canada, Freehold's average realized crude oil price was $128.30 per barrel during Q2 2022, up 85% versus the same period in 2021. Freehold realized a natural gas price of $6.30 per Mcf for the second quarter, up 159% versus the same period in 2021.
Cash costs in the second quarter totaled $8.38 per BOE, up over both Q1 2021 and the previous quarter. However, I would like to point out that this includes the yearly cash payment for our employee award plan and the DFU cash redemption for a retired director. These share-based compensation payments totaled $4.77 per BOE. Excluding these charges, cash costs for the quarter amounted to $3.61 per BOE, down from $3.70 per BOE in the previous quarter.
For Q2 2022, Freehold reported current income taxes in Canada of $9 million and $3 million in United States, driven by strong commodity pricing and production volumes. Current tax rates realized in Q2 2022 as a percentage of funds from operations can be used to estimate cash taxes for the remainder of the year.
Net debt totaled $33 million at quarter end, representing 0.1x net debt to 12-month trailing funds from operations. Freehold's net debt declined $68 million year-to-date and $30 million quarter-over-quarter, including the diversified Midland asset transaction of $19 million, which was closed and paid on June 28, 2022. Inclusive of the 2 transactions announced in early July, Freehold expects to remain well below our upper ceiling of our net debt to funds from operations of 1.5x.
Now back to Dave for his final remarks.
Thanks, Dave.
So Freehold remains focused on executing our strategy of continuing to enhance our North American asset base, providing growing shareholder returns and maintaining low leverage. With the acquisitions announced year-to-date, we have added to our high-quality portfolio, enhancing our funds flow profile and enabling Freehold to increase our dividend payout by 13%. We are enthusiastic for the remaining of the year, and we remain focused on the execution of our strategy moving forward.
We'll now turn it over to questions.
[Operator Instructions] The first question is from Aaron Bilkoski.
My question is about the U.S. asset acquisitions that you've made to date. When you look back on these deals, at least the ones you've closed, how did they perform relative to your expectations? And specifically, I'm thinking about operational metrics, like number of wells drilled, wells brought on stream and the production volumes themselves?
Thanks for the question. So we're constantly reviewing the acquisition investments that we've made and using this look back work to calibrate our modeling and evaluation work going forward. So if we look at the 3 major U.S. transactions that closed in 2021, the diversified royalty asset package that closed in January last year and the Eagle Ford asset in late September and the Midland asset in October, so with the bulk of these closing 9 months ago and representing these 3 deals were about USD 290 million. We were ready to recover 30% of the purchase price revenue from those investments. So we're super pleased with this. And Rob's going to give you a little bit more color on the specifics and how it feeds into what we're seeing going forward.
Thanks, Dave. So on the volume side across those 3 transactions that Dave mentioned, we've seen our cumulative volume relative to -- our actual cumulative volume relative to our expectations at the time of each of the 3 acquisitions [indiscernible]. When we dig a little bit more into that, we're seeing the gross well activity on the lands on these 3 transactions, largely again across all 3, they're basically in line.
Where we did see some differences is on the net -- the difference of the actual net and the forecast net wells that are brought online. So we have seen at least on the November 2020 deal and the September -- I should say, October, Midland deal, the net wells have probably been a little softer than our expectations with lower NRI wells being brought on, which speaks to some of the softer first half of production in our U.S. assets from those 2 acquisitions.
On our larger Eagle Ford deal, which is about by value of 65% of the purchases that we did in the U.S. over the last 2 years, that is actually exceeding our expectations on the number of net wells that have been drilled.
I guess I have a follow-up question. I'm curious about the activity level that underpin your 2022 guidance. I don't know the best way to ask this, but I guess how many net wells in the U.S. you anticipate will come on stream in the back half of this year?
Yes. I mean what we have on our -- what we call our net activity inventory at the end of Q2. And this would be pro forma, the 3 acquisitions. We have 1.5 net drilled but uncompleted wells and about 2.5 net permitted wells. So those 4 activity wells, if you were to put of what our average IP is across those, which we see about 700 BOEs a day IP 365 from our U.S. assets, that's 1.5 net well. Net DUCs would be about 1,000 barrels a day of productive capacity. The 2.5 net permits would be just shy of 2,000 barrels a day of productive capacity.
Now we're not suggesting that's what's coming on in the second half of this year. That's -- we've probably seen that there's a bit of gap in -- the average is about 5 months when the well is spud and brought online on our U.S. assets, but that's probably been moving a little bit higher over the last few months. But pro forma, the 3 acquisitions that we made, we need somewhere between 3 and 3.5 net wells to maintain our -- to hold our production flat. So that helps calibrate a little bit about where -- how those 4 activities well match into our forecast.
The next question is from Chris Jones.
And maybe a question for Rob. I know you guys had some direct gas exposure in the U.S. with royalties in the Haynesville, but gas is minor as a percentage of royalty sales. And recently, you've seen several U.S. operators shift asset mix to focus more on gas. Just wondering if you guys are looking at expanding your gas exposure, the DUC count in rig activity in the Haynesville still growing which typically indicates growth is coming, all else equal. I understand there may be some limitations on basin supply given current capacity, but it feels there is interesting added new capacity. So just curious on your thoughts there.
Yes. I mean Haynesville -- it's Rob speaking. Haynesville is definitely a basin that we're doing our homework on. Today, you're right. We don't have a lot -- more of our exposure is certainly in the Eagle Ford and in the Midland and pro forma the 3 acquisitions that we made, that would be close to 90% of our U.S. production will be in those 2 basins. And we do have some exposure to the Haynesville as well as Appalachia with the November 2020 transaction that we did. But I would say Haynesville is a basin that we're getting up to speed on, and we'd love to look at the right opportunity that add something in that, but it's on the -- it's on to come.
Okay. That's very helpful. I guess for my follow-up, are we seeing an end to the debate over dividend versus buyback? So always the best way to return capital to the shareholders still sort of considered in the board?
Yes. It's Dave Hendry here. Our -- we don't have any plan to do share buybacks in near term. We continue to always evaluate what's the best interest of shareholders. But at this point, our expectation with continuing accretion on our acquisition is to deploy that through increasing our dividend and maintaining a payout ratio with a longer-term pricing forecast in that 60% range.
There are no further questions registered at this time. I will now turn the call back to Mr. Spyker.
Thanks again, everyone, for your participation today. I say we remain pretty excited about what's going on at Freehold. We're looking forward to getting these new acquisitions rolled into our business and our numbers and looking forward to continued strong execution of our business plan. So thank you, and thanks again for your time today.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.