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. Fourth Quarter and 2017 Year-End Conference Call. Please be advised that certain statements on this call constitute forward-looking statements. These statements relate to future events or our expectations for future performance. All statements, other than statements 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.
Good morning and thank you for joining us. On the call from Freehold are Darren Gunderson, our CFO; and myself. We will summarize 2017 results, and then we'll be happy to answer your questions. The fourth quarter saw commodity price momentum, and we entered 2018 maintaining some of this strength. We achieved a number of objectives, both operationally and financially. Operationally, 2017 production volumes averaged 12,350 BOEs a day, a 1% growth rate versus 2016. This came despite Freehold selling 800 BOEs a day of working interest production through 2017. Royalty production for 2017 averaged 10,963 BOEs a day, a 10% growth over 2016. Royalties as a percentage of production and operating income totaled 89% and 96%, respectively, both record highs for Freehold. Looking into 2018, we remain committed to growing our production base on a per-share measure through leasing out our undeveloped mineral title, adding barrels through our audit function and through value-adding acquisitions. Our royalty base continues to attract capital. In total, 464 or 22.3 net wells were drilled on our royalty lands over the year, a 65% increase versus 2016. The majority of the spending on our lands continues to be focused on oil targets, with approximately 60% of the drilling in Southeast Saskatchewan and in Central Alberta Saskatchewan Viking play. We have also seen an uptick in activity associated with the Shaunavon in Southwest Saskatchewan and liquids-rich natural gas targets in the Deep Basin. Overall, we estimate $760 million was spent on our royalty lands in 2017. This compares to $475 million in 2016. Looking into 2018, we're forecasting reduced activity on the natural gas side. However, we are forecasting 25 net locations to be drilled on our royalty lands in 2018, a slight uptick in activity versus 2017. On the leasing side, we completed 100 new lease agreements in 2017, which compared to 30 in 2016. We continue to see success in leasing out of our undeveloped land.Late in the year, Freehold closed the acquisition of a new 2% gross overriding royalty for the Cardium on 166,000 gross acres of land in the greater Pembina area. The purchase price of the GORR was $52 million, plus the assignment of -- by Freehold of certain minor working interest assets. The royalty assets are forecast to generate approximately 3.6 to 3.8 in operating income and approximately 210 BOEs a day 74% light oil in 2018. The Cardium acquisition provides greater than 20 years of drilling inventory. Freehold funded the acquisition with debt available through our credit facility, with year-end net debt to funds from operations exiting 2017 at 0.6x. In line with our debt thresholds of 0.5x to 1.5x net debt to funds from operations. Subsequent to quarter-end, Freehold closed a noncore working interest disposition of a nonoperated Cardium unit for $8 million. As part of the transaction, Freehold retained a 4% core on the same interest. 2017 average productions and funds from associated -- and funds associated with the asset was 180 BOEs a day and $2.1 million, respectively. The disposition further strengthens our royalty focus with capital savings transferred to either debt payments, acquisitions or our dividend. On the acquisition side, Freehold completed 2 transactions subsequent to quarter-end. The first transaction was a $7 million royalty deal in the prospective East Shale Duvernay Basin. As part of the transaction, Freehold acquired a 1% GORR on 113,920 acres of royalty lands. The asset is operated by an active operator with multiple years of drilling inventory. The second transaction Freehold closed on March 7, 2018 involved the acquisition of 2 low-decline, oil-weighted assets. Freehold acquired a lessor 0.2% interest in the prospective Weyburn unit. Freehold believes there are multiple years of upside with extension of existing CO2 enhanced oil recovery scheme and future infill drilling. In addition, Freehold acquired a created 1.9% GORR in the long-life Mitsue Gilwood Sand Unit #1. Freehold forecasts further opportunities through waterflood optimization, well reactivations and infill drilling. The purchase price associated with these transactions was $24 million, plus some minor working interest wells. The purchase assets are forecast to produce 110 BOEs a day. 100% of this is oil and have a $2.6 million net operating income based on strip pricing for 2018. We see the transactions as further mitigating Freehold's corporate decline. We purchased these royalty assets at just over 9x cash flow. Including the previously mentioned transactions and incorporating our estimates for third-party activity and leasing strengths, we are forecasting our 2018 production range from 11,750 to 12,250 BOEs a day. We will update this forecast through the year. I will now pass the call to Darren to walk through our financials.
Thanks, Tom. Good morning, everyone. Financially, we achieved a number of objectives. During 2017, Freehold generated funds from operations of $123.8 million or $1.05 per share. Better-than-expected production and pricing through the fourth quarter resulted in funds from operations outpacing our expectations. Revenue from oil and NGL production represented 83% of total revenue in 2017. Freehold declared dividends of $68.5 million or $0.58 per share in 2017, implying a 55% basic payout ratio and 58% adjusted payout ratio. Consistent with our strategy of targeting an adjusted payout ratio of 60% to 80%, we're increasing our annual dividend by 5% from $0.60 to $0.63 per share. At this new dividend level, and based on our 2018 guidance, our adjusted payout is 61%, safely at the low end of our target. We plan to use excess free cash flow over and above our dividend to fund future acquisitions and pay down debt. Of our $124 million funds from operations for the year, we generated $50 million in free cash flow over and above our dividends and capital expenditures, which we applied to our debt. Freehold closed the year with net debt of $68 million, representing 0.6x net debt to funds from operations. And this reflects a $52 million acquisition we completed late in the year with our existing credit facility. We forecast 0.4x net debt to funds from operations at year-end 2018, reinforcing our conservative strategy. Now back to Tom for his final remarks.
Thanks, Darren. In closing, we've executed key aspects of our strategy during and subsequent to our year-end. We continue to position Freehold in some of the highest netback plays in Western Canada, which will continue to see development. With our dividend increase, our payout is still comfortably at the low end of our guided thresholds, and we will allocate excess free cash flow after dividends to accretive acquisitions or to pay down debt. The working interest dispositions are in line with our commitment to enhance our royalty focus. To summarize, we had strong growth in our royalty production, near-record drilling, and we purchased a quality royalty acquisition with significant running room. Overall, Freehold offers investors a low-risk, attractive investment in oil and gas. I will now pass it over to the moderator for questions.
[Operator Instructions] The first question is from Travis Wood of National Bank Financial.
Can you expand on the entrance into the emerging East Shale Duvernay play, and just in terms of what you're anticipating for activity and what type of running room is ahead through the remainder this year and ideally into 2019 as well?
Travis, thank you for that question. We're pretty excited about getting a position in the Duvernay. Obviously, it is a lot of sections of land. We feel that the operator is well funded, and that there will be development. We don't know exactly what the pace of development will be on these lands because that's up to the operator. But we feel that there will likely be a number of wells, maybe 5 to 10 wells a year, drilled on these lands at the beginning.
The next question is from Shailender Randhawa of RBC Capital Markets.
Tom, so I've got a few questions. So just to go back to the Duvernay GORR, just any more color on which part of the fairway the lands are in, and what you saw from a technical perspective in terms of your evaluation? And then the second question, you raised the dividend. Is that sort of set in stone now in your mind for the remainder of the year? Like are you moving to a more infrequent review of the rate? And then lastly, if you could just comment on where you think the decline rate stands, just net of the recent transactions that you've completed.
Okay, great. Thanks, Shailender, for the questions. As far as the East Shale Basin, this is the area that's very close to Three Hills or Huxley. This basin has seen wells that have produced over 400 barrels a day. We believe it's in the very sweet spot as far as shale quality. Your second question on the dividend, we do review it with our board quarterly. So that is our -- a potential adjustment to the dividend could be a maximum of likely, once every quarter. But however, we haven't changed it for a year. That's more likely, the pace is every 6 months to a year that we'd change it.
Okay. And then lastly just a decline rate...
Yes. The decline, we feel our base decline is around 17% overall. And it is shallowing. So as it moves into next year, it is a few percentage points below that.
[Operator Instructions] The next question is from Jeremy McCrea of Raymond James.
Just on your 25 net wells that you're expecting for next year, can you give a little bit more breakdown of where those wells are coming from? And just on the second question here as well too, the new leases that you have signed, can you maybe give a bit more detail in terms of maybe where the -- just if there's -- what the biggest ones are like in terms of size and potential multi-year [drillers], if there was any?
Thanks, Jeremy. The -- as far as what we're forecasting for drilling for the year, it doesn't change very much year-over-year. We are seeing 60% of the activity on our lands within the Southeast Saskatchewan, Mississippian and Bakken plays as well as in the Viking play. We are forecasting our top driller to have about 8 wells in the Viking as well as the second one in the Shaunavon and the Viking in the Southeast Saskatchewan in the 5 net range. So -- and then we have a balance of our other operators drilling on our lands as well. We have seen, obviously, we had 20 -- nearly 23 net wells drilled last year. And we're hoping a slight uptick this year into that 25 range, and most of that is oil drilling.
Okay. And then just for the new leases. I like it because it looks like those modern new leases. Any of them multi-year, long -- like sizable commitments, I guess? Like anything to pay attention to or to keep monitoring, I guess?
Most of our leases are in Southeast -- new leases are in Southeast Saskatchewan. Typically, they are about 2-years leases. We have had some in the leases in the Duvernay, and they are typically 2 to 3 years.
There are no further questions registered at this time. I would now like to return the meeting back over to Mr. Mullane. Please proceed, sir.
Well, thank you very much for attending our conference call. We believe we had another strong quarter and year, and we continue to offer investors a low-risk, attractive investment in oil and gas. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.