Freehold Royalties Ltd
TSX:FRU
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Freehold Royalties Ltd
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Good afternoon, ladies and gentlemen. Welcome to the third quarter results conference call. I would now like to turn the meeting over to Mr. David Spyker. Please go ahead.
Good afternoon, and thank you for joining us. On the call with me today are David Hendry, our CFO; Rob King, our VP, Business Development; and Matt Donohue, our Manager of Investor Relations and Capital Markets. The third quarter of 2021 marked a start of a significant transformation for Freehold as the company was able to close on more than $250 million in portfolio-enhancing transactions. These transactions are focused on core U.S. and Canadian oil basins and further solidify Freehold's position as a North American royalty company. To start this afternoon, I would like to talk about the dividend increase, and then we'll focus on the excellent operational and financial performance that we've had. With the strength in our business model, we are continuing our measured approach to setting Freehold's monthly dividend, increasing it by 20% from $0.05 a share to $0.06 a share or $0.72 a share annualized. This represents our fifth increase over the past 5 quarters. Projected 2021 payout levels are below our stated dividend policy levels, which outlines a payout ratio starting at 60% over the long term based on forward-looking funds from operations. We feel this dividend increase strikes a balance between returning value to our shareholders, managing our balance sheet and positioning Freehold to remain active on the acquisition front. The opportunities to further build on the quality of our portfolio remains robust within both U.S. and Canada, and we view it as important to retain the flexibility to evaluate and acquire assets that continue to make us better. On the acquisition front, we are very busy. We announced 4 transactions which expanded our position in the U.S. Eagle Ford and Permian plays along with building on our already strong position in the Clearwater. The largest transaction, which closed late in the quarter was the acquisition of a best-in-class Eagle Ford basin asset for approximately USD 160 million, about CAD 200 million. This Eagle Ford property will significantly enhance the quality of Freehold's North American portfolio, projecting to add 2,500 BOE a day of production in 2022, improving both the near-term and long-term sustainability of Freehold's dividend while providing further option value to return capital to shareholders through multiple years of free cash flow growth. After quarter end, Freehold announced that it had closed its previously disclosed transaction to acquire concentrated, high-quality U.S. royalty assets in the Midland basin for approximately USD 55 million or about CAD 69 million. The Midland Assets in conjunction with the focused acquisition work completed year-to-date are expected to add multiple years of production and funds flow growth. The growth of the U.S. portfolio was in line with Freehold's strategy to add to our North American portfolio, focusing on high-quality development areas with multiple years of drilling upside and growth. These acquisitions were funded through a combination of Freehold's previously announced bought deal equity financing in which we issued 19.1 million subscription receipts at a price of $9.05 per share, and the utilization of our credit facility and our funds from operations. On the operations front, production for the quarter averaged 11,265 BOE a day, representing a 23% improvement over Q3 2020 and a slight gain versus the previous quarter. The U.S. portfolio averaged 1,748 BOE a day in Q3, a 13% increase from 1,544 in Q2. Growth in volumes reflect better well performance, slightly better than forecast activity levels and the integration of U.S. royalty acquisitions that have been completed so far this year. In Canada, production averaged 9,517 BOE a day for the quarter, up 5% from the same period in 2020 and essentially flat relative to the previous quarter. With the ramp-up in activity on our royalty lands in Q3, we expect Freehold's Canadian portfolio to deliver organic growth into year-end. After realizing the actual results for the first 3 quarters of 2021 and with Freehold's most recent acquisitions now closed, we are implementing guidance for the fourth quarter and expect production volumes to range between 13,500 to 13,750 BOE a day during the period. We had approximately 60% oil and NGLs and 40% natural gas. For 2022, Freehold is increasing our previous guidance and is now projecting volumes to average between 13,750 BOE a day to 14,750 BOE a day, with the same weighting of 60% crude oil and NGLs and 40% natural gas. On the drilling front, we had 179 gross, 6 net wells drilled on our lands in Q3, a substantial 450% improvement on a gross basis versus the same period in 2020 as activity continued to return to our land supported by higher commodity pricing and our expanding U.S. land base. For the quarter, drilling was very well balanced across our core play areas with 27 gross wells drilled in the Viking, 24 in Southeast Saskatchewan, 18 in the Cardium, 18 in the Spirit River, 17 in the Clearwater, 14 in the Eagle Ford and 11 wells targeting the Midland/Delaware basins. For the first 9 months of 2021, 375 gross, 11.8 net wells were drilled on Freehold royalty lands compared to 261 gross, 8.7 net drilled during the same period last year. In Q3 2021, approximately 70% of all gross locations on Freehold Canadian assets targeted core prospects with 25% focused on Freehold's mineral title lands and 5% from unit wells. 44% of all locations drilled targeted bid prospects in Alberta, 37% in Saskatchewan and 19% in the U.S. on a gross basis. Almost 90% of wells drilled focused on oil or liquids prospects. This improved activity was driven by a broad increase in overall industry spending across North America. With the upward move in crude oil pricing, activity continues to increase on Freehold's royalty lands with approximately 20 rigs, 6 in Canada and 14 in the U.S. running on our lands last week. We have considerable optimism heading into the final quarter of 2021 and into 2022, and we'll continue to focus on positioning Freehold via premier North American royalty company with a strong balance sheet, a sustainable dividend and prospects for growth in top-tier oil and gas operating areas. I will now pass the call to Dave Hendry to walk through some of the financial highlights.
Thanks, Dave, and good afternoon, everyone. As commodity prices improved over the quarter, Freehold continued to deliver on the core financial aspects of its return proposition, providing a meaningful dividend while also providing investors with a lower risk investment, differentiating itself from traditional oil and gas E&P companies. Royalty and other revenue totaled $50.9 million for Q3 2021, up 13% from the previous quarter and 120% when compared to the same period last year. Funds from operations for Q3 2021 totaled $48.2 million, an all-time record for Freehold, up 20% versus the previous quarter and 143% for the same period in 2020. This significant increase in funds flow from operation provides added financial strength and flexibility in how we manage our business. On a per share basis, funds from operations was $0.36 per share during Q3, representing a level not achieved since 2014. Freehold's royalty revenue and funds flow benefited from the strong upward momentum in oil price and natural gas prices while growing production, particularly in the U.S., which receives better pricing relative to our Canadian assets. Freehold’s dividend payout totaled 35% for Q3 2021, up slightly from Q2 2021 and 8% from Q3 2020. As previously mentioned, we are increasing our monthly dividend from $0.05 per share to $0.06 per share, reflecting a measured response to an improved commodity price outlook, strong production volumes and increasing third-party spending on our royalty lands in 2021, which is expected to continue into 2022. For Q3 2021, cash costs totaled $2.49 per BOE, the lowest in Freehold’s history, down materially from $4.48 per BOE in Q2 2021 and $3.70 per BOE during the same period in 2020. We continue to drive efficiencies in this area through reduced G&A and operating costs while increasing production volumes. Acquisitions completed late in the quarter and after quarter end are expected to only add a marginal amount of G&A as we continue to drive optimization on our cost structure, resulting in a better netback to our shareholders. Net debt totaled $75.3 million on September 30, representing 0.5x net debt to 12-month trailing funds from operations. Overall, Freehold's net debt increased by $35 million versus the previous quarter, but was still lower than September 30, 2020. The increase in net debt reflects acquisitions completed over the quarter with stronger funds from operations also meaningfully contributing to the funding of these acquisitions. Freehold's prudent strategy of maintaining net debt to funds flow well below 1.5x, alongside a lower -- a longer-term dividend payout target starting at 60% of funds from operations provides protection to the business from commodity price volatility and while maintaining capacity to continue to grow through strategic acquisitions. Concurrent with the closing of the Eagle Ford transaction highlighted earlier, Freehold amended its credit facility with a syndicate of 4 Canadian banks increasing the committed revolving facility to $285 million and maintaining the operating facility at $15 million. The amended credit facility includes a permitted increase in the committed revolving facility of up to $360 million subject to lenders' consent. Both the committed revolving and operating facilities mature September 28, 2024. Lastly, Freehold's Board has approved the filing of the preliminary short form base shelf prospectus. Upon filing the final base short form shelf prospectus, Freehold will be able to, from time to time, offer and sell common shares, preferred shares, subscription receipts, warrants and units on an aggregate amount of up to $500 million during the next 25-month period. Freehold’s has no immediate plans to raise equity capital, however, the filing of a shelf prospectus is a natural and prudent step for the company for financial flexibility as it continues to enhance and expand its asset base and drive continued business improvement. Now back to Dave for his final remarks.
Thanks, Dave. So on November of this month -- November 25, Freehold will celebrate its 25th anniversary of business. The leadership team is committed to continue building on our successful history as we evolve Freehold into the premier North American oil and gas focused royalty company. The current economic conditions are very positive for our industry and the strength of our royalty model and the strong return proposition and investment that Freehold provides will continue to be showcased going forward. We remain incredibly enthusiastic about the next 12 months. There's been a steady trending up of capital spending and associated production growth on our lands, both in Canada and the U.S. At current commodity price levels, our high royalty margins offer significant option value to provide returns to our shareholders. With today's increase to our monthly dividend, we reiterate that this is the fifth consecutive quarter that we have revised our dividend upwards. The acquisition work that has been completed in Q3, along with the transaction after quarter end, are expected to provide both near- and long-term value for our shareholders and further our patient execution of our strategy. There's been a tremendous amount of work completed in the transformation of Freehold from a premier Canadian royalty company to a premier North American royalty company. The fourth quarter of this year will be the first period our shareholders will see the full impact of the approximately USD 320 million -- sorry, $320 million of acquisition activity in the third and very early in the fourth quarter, and we are confident that Freehold will deliver record levels of royalty production and funds from operations. I would like to personally thank all of our shareholders for their support over the past 25 years and thank our Board and employees that contribute the ideas, the energy and the inspiration that has made an investment in Freehold a success. Thank you, and we will now take questions.
[Operator Instructions] We will take the first question.
Luke Davis.
Just kind of a quick one here relating to the shelf. Just wondering if you can kind of frame out the thinking behind this. I know you hit on it a little bit, but -- should we read into that, that you're kind of setting up to do something larger? Are you really just looking to kind of enhance flexibility there? And then I guess the second piece of that would just be, it is fairly sizable. So I was wondering if you can kind of frame out how you came to that $500 million. Any kind of details there would be helpful.
Sure, Luke. It's Dave Hendry here. Yes. No, we have absolutely no immediate plans to utilize the shelf. This was merely about being prepared. So the shelf just gives us added flexibility. Should a future opportunity come along, we want to make sure that we're adding the best value being able to communicate it in the best way. So this is purely about being preparedness. As far as on the size of it, it's -- what we did is we looked at what peers were putting out from the last shelf prospectus over the last year or so. And what we found was about a medium of those was about 25%. So we took a look at our market cap, 25% and that sort of rounded to around that $500 million mark. And then we looked at deal opportunities. We want to make sure that it's a reasonable side because it's going to be out there for that shelf period of 25 months. And so that's -- that was the logic on how we came around $500 million.
Got you. Makes sense. Maybe just another one for you, Dave. Just around hedging. I mean things are pretty good now, activities picking up, margins are high. But the industry is pretty notorious for kind of overestimating pricing. So wondering if you have any updated thoughts on hedging and how that might look over the next couple of years?
Yes. So as far as on hedging, it's something we do discuss regularly with our Board as far as whether we want to apply it. Right now, I mean, with our dividend -- or sorry, our net debt to fund flows projections where we're looking around that more 0.5x is relatively, let's call it, conservative on the leverage. And so hedging doesn't really have a lot of logic to it for protecting that one. As far as protecting the dividend side, are you still seeing, let's call it, a backward-dated position of the hedging. And so at this point, we're comfortable with not having a hedging position, but we continue to evaluate it every single quarter with the Board.
We will take the next question.
Travis Wood.
I have 2 questions for you. The first, could you give us some color around the strength of pricing you're seeing, I think, specifically in the U.S. on the liquid side as well as the natural gas side. And then I'll have one more as well.
Okay. So you’re going to keep Dave Hendry busy.
Yes, exactly. So yes, we -- just to help provide a little bit more detail, I guess, one of the changes that we made to our MD&A and financial statement disclosure was providing data both on a Canada and a U.S. basis. And so for -- it's always we're -- I'm just pointing out to the 9 months, just providing a little bit more of a smooth pricing scenario rather than looking in a particular quarter. And where you can see on a crude basis, our realized pricing in the U.S. on oil is about $10 higher. So I mean you take a look at it and saying over the last 9 months, we were getting about $68 net on oil versus in the U.S. we're at $78. And similarly, on a gas basis, where the -- our natural gas realized pricing was $3.90 relative to CAD 2.60. So you're seeing a $1 delta. And in the third quarter, that was -- that natural gas delta was even wider, where it was $1.40 improvement on that. So we're seeing great realizations in the U.S. And so our production in the third quarter was about 60% weighted to the U.S. and obviously with the Eagle Ford deal that weighting will go up and you'll continue to see that torque of the improved realizations on our U.S. products. And if you look at on a net oil equivalent basis, blended together. So for the first 9 months of the year, you're looking at almost $52 a barrel in the U.S. relative to $42. So it's noticeably improvement in the U.S. And so that's why we're projecting funds flow to improve proportionately better the weighted average percentage of production in the U.S.
That's great color. And then one more, just around activity, I mean, guidance for the tail end of this year into 2022 hedged higher. We've seen the resilience in pricing continue. Around the services side, I think you mentioned 20 rigs. Has that picked up subsequent to the quarter? And how should we think about kind of the pie chart of U.S., Canada from rig activity through at least the tail end of this year, I guess?
Travis, it's Rob King speaking. On the -- this is the latest update. This is up until a couple of days ago. We actually have increased from those 20 rigs across the U.S. and Canada lands to 24 rigs. So now there's 17 running on -- in the U.S., 11 are in the Midland and the other splits are sort of scattered between the Eagle Ford, Bakken and Appalachia. In Canada, we've seen an increase to 7 rigs running on our lands. So even split between Alberta and Saskatchewan. Viking and Cardium are definitely the most active plays with 4 rigs, Alberta 4 rigs, just the Viking and Cardium are definitely the most active right now for us. So almost every time we update our rig activity, we're sort of seeing an increase ever since sometime early September time frame. So it does give us some pretty solid confidence about what we're going to see in the balance of Q4 and into '22.
[Operator Instructions] We will take the next question.
Jeremy McCrea. [Technical Difficulty]
Did we lose you, Jeremy?
I'm sorry. I'm unable to hear anyone. [Operator Instructions] Hearing no response, we will have to go to the next question.
Elias Foscolos.
I've got a question on the guidance. I appreciate the production guidance. I'm trying to tie in as to what the commodity price guidance, where that kind of relates to things. I mean directly with commodity price guidance, I guess I would be expecting some sort of fund flow or cash flow guidance, but there isn't any there. So can you frame as to what I'm supposed to get out of the commodity price guidance for Q4 and '22?
Yes. Basically, is, what we're doing -- first of all, we'll start with the production guidance. So just recognizing the significant evolution of the portfolio throughout the year. Just trying to tie all the bits and pieces together of the acquisition work that's been done and give you some insight into our view of what Q4 shapes up to and then continuing that forward into next year. This is really -- it's tying all these -- all the acquisition work together. For the production or for the pricing guidance, we're just giving you what we're using in our modeling for pricing, part of it when we talk about the dividend, that pricing there and the midpoint of guidance for us triangulate around kind of a 50% payout on pricing, and that's all we're trying to do. Just let the analysts and investors kind of see what we're using in our numbers as we're thinking through our business strategy and plans.
Okay. So I can use that in a sense for the dividend and what I would say the amount of cushion off of that is to redeploy capital, I guess, would that be correct?
Yes. And the way we're looking at managing the dividend is that we think that, that level about pricing continues to triangulate around that 50%. We still see considerable opportunity for acquisitions in front of us right now. And so we think of that level of dividend, we can pay down debt and get ourselves comfortably the 0.5x debt to cash flow and still leave opportunity available money to invest on the acquisition front. So we're just trying to strike that balance and kind of lay that out a little bit more clearly for our readers.
Okay. I appreciate that. And maybe a bit more of a high-level question. Given the current commodity prices that are out there and the current drilling activity that you're seeing, absent of acquisitions, how do you see production on your current stream of assets. Would it be holding relatively flat? What I'm really trying to get at is are we at a point now where we've got something that's flat, slightly growing, slightly declining, leaving you the ability to add upside through acquisitions?
Yes. That's a good question, Elias. And how we've modeled it right now, we see ourselves essentially flat for the next 3 years. So we don't have to deploy capital into acquisitions to maintain that stable production profile. So that's a significant difference from historically what we've had to do with the company and this reflects how we've really repositioned and restructured the asset base in the last 9 months. And so what that's allowed us to do is we could be pretty selective on the bid level that we're proceeding with on assets and then the exact type of assets that we want to bring into our portfolio. And so we've got a lot more horsepower to run our business with the increased funds flow. And with the production profile where we're at, we've got a lot more ability to really drive the value and the location of where we're adding to the portfolio.
Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Spyker.
Thank you for everyone that participated today. Once again, we're very excited with the quarter. We're very excited about going forward. So thank you all, and we'll -- please don't hesitate to call if anyone has further questions. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.