Freehold Royalties Ltd
TSX:FRU
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Freehold Royalties Ltd
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Good morning, ladies and gentlemen. Welcome to Freehold Royalties' Fourth Quarter Results Conference Call. I would like to turn the meeting over to Mr. David Spyker. Please go ahead.
Good morning. Thank you for joining us today.
On the call with me from Freehold are David Hendry, our CFO; Rob King, our Vice President of Business Development; and Ian Hantke, our VP of Diversified Royalties.
2022 was a year of records for us. This result as a significant work that was done over the last 3 years to establish Freehold as a premier North American energy royalty company. Our expansion and optimization efforts have resulted in a new look Freehold, with the scale and asset base that will enable sustainable, long-term value creation for our shareholders. By targeting plays across North America, our asset base, development inventory and revenue generation is underpinned by exceptionally high-quality payors in many of the top-tier operating areas across Canada and the U.S.
Freehold's fourth quarter and full year 2022 results reflect this quality. In 2022, we set a number of records. We had record revenue of $393 million that was up 88% over 2021 and more than 170% increase over the 5-year average of the company, highlighting the bigger, better nature of Freehold. Our portfolio is well balanced with revenue from Canada accounting for approximately 60% of the total and the U.S. contributing the remainder.
Oil and NGLs represented 82% of revenue for the year. We had record funds from operations in 2022 of $317 million or $2.10 a share. This compares to $190 million or $1.39 a share in 2021 and is a 153% improvement versus the 5-year average for Freehold. We had record realized pricing of $75.14 a BOE. That was up 57% compared to the previous year. We continue to highlight the pricing advantage that our U.S. strategy has provided. Freehold realized $90.64 a BOE within our U.S. portfolio last year versus $68.12 a BOE in Canada, a 33% improvement. The higher pricing in our U.S. portfolio is driven by the ability to sell our product closer to market, thus reducing the impact of transportation and Canadian egress bottlenecks.
We had record production in 2022, 14,101 BOE a day, an increase of 19% over 2021. Our Canadian volumes averaged just over 9,700 BOE a day and were approximately flat year-over-year without completing a major acquisition in Canada. U.S. volumes averaged just under 4,400 BOE a day, up over 100% due to acquisition activity, paired with an increase in third-party drilling activity. For Q4, volumes averaged a record 15,041 BOE day up 7% versus the previous quarter.
We are forecasting 2023 production to average between 14,500 and 15,500 BOE a day and we are taking a cautious stance given the sharp pullback in natural gas pricing and the volatility in oil pricing, which is currently off 20% compared to the 2022 average price. As with 2022, we can expect to see production rate volatility in our portfolio with seasonal impacts in Canada and the multi-pad drilling impacts in the U.S. with a number of our operators drilling 10 to 20 wells on a pad with sequential drilling, completion and tie-in activities as opposed to activities in parallel that we would see elsewhere in our portfolio.
We had a record year of dividend payments, $142 million or $0.94 a share, an increase of 128% over 2021. Freehold's dividend payout ratio was, on average, 45% for 2022, an increase from 33% in 2021. We took a measured approach to dividend increases throughout the past 2 years. At current scrip pricing, we expect dividend levels will be above a 60% payout ratio in 2022, and we're comfortable with that. Further dividend increases will be in lockstep with an increase in production or a fundamental shift in our underlying commodity price assumptions.
We reiterate that we believe we can pay the dividend at much lower commodity prices and third-party development assumptions, with the work over the past 5 years in enhancing our payor and asset quality, improving the overall sustainability of the company.
We had a record year of drilling in 2022 with 1,057 gross wells drilled on our acreage, a record for Freehold and a 61% increase over 2021. Almost half of the gross drilling was on Freehold's mineral title lands including over 80% of U.S. gross wells drilled on mineral title land.
In Canada, we saw drilling in oil-weighted areas such as the Viking, Clearwater and Cardium in addition to liquids-rich gas-weighted targets in the Deep Basin and Spirit River. 503 gross locations were drilled on Freehold's Canadian land, a 14% increase over 2021. We estimate approximately $1 billion in industry capital was deployed on our lands by our Canadian payors.
In the U.S., operators focused drilling on light oil prospects in the Permian and Eagle Ford with 90% of the activity occurring within these 2 basins. Development of Freehold's U.S. lands was led by a diverse group of disciplined, investment-grade public companies and growth-oriented public and private operators. We estimate approximately $3 billion of industry capital was deployed in our lands by our U.S. drillers last year.
Through the second half of 2022, Freehold consistently had between 30 and 35 rigs running on our royalty lands with a good balance between our U.S. and Canadian portfolios. We expect oil targeted drilling activities to remain relatively strong, though we are approaching gas prospects with caution. Our business development team remained busy in 2022, completing $190 million in value-enhancing acquisitions, expanding our royalty positions in the Permian and Eagle Ford basins in the U.S. and in the Clearwater in Canada.
Looking forward, we continue to see good opportunities both within Canada and the U.S., although Freehold will remain very disciplined in its portfolio investment strategy in terms of players and focus areas, patiently looking to invest in areas that will continue to strengthen our portfolio and provide value to our shareholders.
On the leasing front, Freehold executed 83 new leases with 30 distinct counterparties, a level that we've not seen since 2018, 2019. Areas of activity included Southeast Saskatchewan and Mannville heavy oil with operators weighted to junior private entities with a near-term growth objective. We've also been successful in leasing some of our mineral title lands in the U.S.
Cash costs for 2022 totaled $519 a BOE, up 40% versus the same period in 2021. The majority of the increase was associated with higher interest rates.
Our net debt exited the year at $128 million or 0.4x net debt to trailing funds from operations. This was achieved while acquiring $190 million of value-adding acquisitions and increasing our dividend twice in 2022. At current commodity price levels and our limited cost exposure, funds flow generation remains robust, allowing for debt to be paid down while maintaining our dividend.
Early in 2023, we announced the release of our sustainability report, highlighting the company's focus on responsibly growing and enhancing our business through environmental, social and governance initiatives. Freehold strives to generate shareholder value by maintaining a strong balance sheet, focusing on the long-term sustainability of our business, and partnering with high-quality operators across North America, who are aligned with our views on the importance of sustainability and ESG performance.
So in closing, 2022 represented a very successful year for the company, as we move forward with a measured advancement of our North American strategy. I would like to thank our Board of Directors, our shareholders, employees and all those who have supported Freehold through 2022.
We will now take any questions. Thank you.
[Operator Instructions] And the first question is from Luke Davis from RBC.
Just wondering if you can speak a little bit to your alternative royalty business. What types of opportunities you're looking for it? And just generally, what that market looks like currently?
Yes. That sounds good, Luke. We're going to turn that over to Ian Hantke, he's looking after that for us. So Ian?
Yes, we're tackling a diversified strategy, much in a similar way or early day approach to the U.S. expansion was we're trying to be patient and examine a bunch of the opportunities and just get up the learning curve before we put too much capital to work. We have a number of opportunities that we're looking at. Some have traction, some we're just sort of in the space to get a better understanding of where Freehold can fit. Most of the conversations we're having are focusing around sort of base and industrial mines and minerals, renewable power and renewable fuel and some amount of critical minerals, but not a huge amount.
So we've got some existing potash royalties. We're looking to -- we like those assets. We're looking to grow our position there, but I think that's going to be probably a slow and measured approach. Those are typically smaller assets that we will have to pick up 1 at a time. But yes, I would say we're just trying to make sure that we're looking at opportunities that sort of add to the stability of Freehold and make sure we sort of compete for capital with oil and gas opportunities and sort of, I guess, stay out of the way of the base business as we look for interesting things to examine.
I think, Luke, our thinking has certainly evolved over the past year. I think we originally thought we might be able to find a niche in wind and solar, but those are opportunities certainly can compete for oil and gas returns. And so that's why Ian and his team have kind of diverted onto some of these other types of opportunities that he talked about. And we think that there's some pretty good opportunities within that scope.
That's helpful. Curious what kind of a return threshold or hurdle rate or something that you guys generally look at when you're evaluating the stuff?
It would have to be in that mid to high teens even into the 20% range, Luke, just to make sure that we're getting those returns in a new type of business for us.
Yes, makes sense. Maybe just 1 more for me, broadly on M&A. What are you guys currently seeing in Canada and U.S.? And do you think there's as much opportunity as you saw through 2022?
It's Rob here. So in Q4, we had about 20 opportunities that we screened. We did -- looked at some. We're -- bid on a couple of those, not successful, sort of still continuing a pretty very disciplined approach that we're taking with the acquisition opportunities. It was probably, I'd sort of say, a slower start to 2023, maybe not surprising, just given the volatility and the significant degradation on the natural gas side.
We've seen a number of potential sellers just sort of pull back and relook and redecide when they may look to monetize. That being said, there are several things that we're looking at. In Canada, I think we're still focused on the Clearwater. We actually just closed a couple of weeks ago, a small $1 million tuck-in in Figure Lake and in active dialogue with several producers. So yes, still active, but remaining disciplined.
The next question is from Travis Wood from National Bank Financial.
Maybe just to follow on M&A. Could you provide any commentary around kind of the aggregate deal value that your activity, maybe specifically those 20 deals through Q4 would have added up to and kind of more interestingly, just across the year itself? And then I have just 1 follow-up.
Yes. So in Q4, those 20 opportunities that we reviewed, that would be about -- it was USD 250 million and CAD 300 million in terms of the deals that we looked at in Q4. '22, it was closer to over 100 opportunities that we reviewed. So it was over $5 billion. of U.S. opportunities and $700 million of Canadian opportunities.
Okay. Interesting. Just on the assets that you purchased kind of thinking over the last 12, 18 months, any surprises that you're seeing through now that you've had a good full year of operations, a busy second half of the year as well. Any surprises as you look back on performance and -- versus your initial expectations and specifically thinking of the Eagle Ford performance against the Permian specifically?
Yes. I think it's actually been -- it's nice having a full year of 2022 to see the performance of our '21 acquisitions. Obviously, we are very active with almost 30 -- almost $400 million worth of deals that we added to our portfolio in 2021. So we had a chance to have a full year and sort of see how they've done, and we've been really pleased with the performance. It's 1 where we've already generated $165 million of revenue on $367 million of acquisition capital. So that's about 45% of our investment that's been returned in less than 2 years.
And I think relative to our acquisition assumptions on those three 2021 deals, I think gross drilling has been basically in line where I think we're -- there's about a 1% difference in the gross wells that have been drilled on our lands. And so that sort of is quite validating, though, the capital is certainly being deployed onto our lands in the levels that we had anticipated. So it's a checkmark there.
Well productivity has been equally in line. We forecasted about 800 barrels a day of IP 180 on our -- on those U.S. deals and the actual has been about 790. So call it, 1% off on those -- on the type curve. So again, been positively pleased that that's been in line. What we have seen is the net wells have been lower. And that's sort of a reflection of some lower net royalty interest wells that have been brought on. And that's sort of the timing issue that we discussed in the mid part of 2022.
And I think it's 1 -- we would have been a lot more concerned if the gross drilling wasn't in line, so that would have been more of the reflection that capital wasn't being deployed on our lands. The net drilling is that transitory timing issue and some of the things that we're continuing to manage with our production forecast on the U.S. side.
Eagle Ford, it's 1 where when we think back to like how did we -- when we paid for that deal, I think 1 of the important things is that we didn't pay for a lot of upside on that transaction. We sort of paid for 5 years of development. And I think what we've observed with the key royalty payor there, Marathon, where they probably had some well productivity declines relative to what we saw in prior years, but they're still keeping pace, and it's still keeping largely flat production coming from Marathon's assets that we have with them in the Eagle Ford.
And the next question is from Matthew from iA Capital Markets. Please state your last name.
It's Weekes. I'm just wondering, it sounds like there's a little bit of sort of conservatism maybe in the guidance range for 2020. I'm just wondering if you could walk through maybe some of the broad points or kind of drivers into the cadence of production growth as you look to the year ahead?
Yes. I think I can. It's Dave here. When we look at that, and if we just look, first off, at the pullback in gas prices. And so -- the thing with the gas in the portfolio, it can add a lot of production. It doesn't add a lot of cash flow. And so what we see is that with some pullback in gas drilling, and we do see some of the rig counts slowing down a little bit. That will have an impact on our volumes, especially where we've been seeing some gas drilling in Canada is where that would have the bigger impact.
On the oil side, again that -- we're not seeing a slowdown on the U.S. side. You get a little bit more worried on the Canadian side where it's a little bit more impacted by the differentials and so just taking a cautious approach. When we look at the guidance that our drillers are giving, what we're seeing for guidance as people release their year-end results and guidance that there is a little bit more of a cautionary tone and we reflect that in our business.
And so that's how we're approaching it. We don't want to get ahead of our skis. And like we saw last year, the portfolio can be volatile. Canada can be -- is probably a little bit smoother, but impacted by much more weather-related events, whether it's breakup or cold weather snaps. But the U.S., just because of the nature of the drilling, we see a very much more sawtooth production profile, depending on when a number of these pads are brought on. And so that's been reflected in how we think of guidance.
And just to build a little bit further what Rob was talking about on the net wells, we've got a wide range of net royalty interests in the U.S., and we can't predict where that drilling is going to occur. So we look at it more from an average net royalty interest across the portfolio. If we get some of those higher NRI spacing and it's drilled, then we'll get ahead of some of the numbers. If we're on some of the lower ones, then that impacts our view.
So it's just a little bit much more volatile portfolio given both the combination of how U.S. lands are developed and then just Canadian history.
Okay. That's helpful. And so it sounds like kind of some of the headwinds are on the gas side and just thinking about your overall weighting to oil and kind of most of the drilling being more oil-weighted. Would you say there's a degree of kind of protection from the lower gas prices there and then potentially as well as we see kind of differentials narrowing on the heavy oil side in Canada a little bit. Would you say these factors kind of might provide a little bit of support in the context of commodity price volatility?
Yes, I think that, that's fair, especially on the Canadian side, with the differentials. On the U.S. side, we're starting to hear some chatter that maybe some of those U.S. rigs are going to get deployed on to the oil side, but we certainly haven't factored that into how we're thinking of the business yet. Bottom, rigs are still competitive in the U.S. And so operators are hesitant to give up a rig. And so we just have to see how that all plays out.
The next question is from Christopher Jones from Haywood Securities.
Just to add to Luke and [indiscernible] question there on M&A. How do you think about balancing incremental M&A relative to dividend increases, given the opportunity set to transact, does it make sense to sort of accelerate M&A and perhaps slow down on any potential dividend increases? Or maybe just kind of talk to that a little bit.
Yes. I think where we're with the dividend at $0.09 a share, that's the right level for us with where we see commodity prices and scrip pricing. And so we'll be in that -- I'm sure we'll have a strict handle on the payout ratio in 2023. And so we think that, that's the right level right now. And in the interim, we'll continue to pay down debt and see if there's opportunities that we can add to the portfolio like Rob had indicated. You're starting to see a little bit of a slowdown in the opportunity set going into Q1 in the U.S.
On the Canadian side, probably a little bit more dialogue that we're having with people with respect to royalty financing type opportunities, again, given the higher interest rates and a bit of volatility in the commodity prices, but we're in no rush. And we look at a lot of stuff and pretty selective on what we want to bring into the portfolio.
So think of dividend holding where it's at, excess cash used to pay down debt and patiently bide your time looking for the right opportunity.
Okay. And then just on the Howard County, Midland asset, volumes are up 50% since close. Is that above what you guys were internally forecasting? And how do you see that trending this year?
Yes. It certainly is above like Q4 production that we saw from those assets was what, 900 barrels a day. Our acquisition analysis had 550 barrels a day. Some of that was just higher net royalty interest wells coming online. So that's a little bit of the positive aspect where you can get some higher NRI wells that are drilled sooner when we had predicted that there'd be lower NRI wells that would have been turned in line. So it's -- that may mean revert a little bit within -- in 2023 and beyond, but the key operator under our Howard County assets is still aggressively allocating capital to that place.
So I think we're encouraged that it's going to be in line with what our expectations were at the time of the acquisition.
The next question is from Jamie Kubik from CIBC.
Maybe you answered a little bit already. But can you talk a bit about the production guidance range you provided for 2023? And maybe what sort of net well count would cause you to hit the low end versus the high end in those scenarios? And then maybe secondly, can you outline how you expect Canada and the U.S. to individually contribute this year?
So on our -- on some of the ranges there on the net wells, Jeremy, it was 1 where -- on the -- sorry, Jamie, on the -- on the Canadian side, we sort of had a range of, call it, 15 to 20 on the net wells with the midpoint of the range kind of pointing to where that, say, 15,000 barrels a day for the overall production. US side, it was sort of about 3 to 4 net wells is what we had forecasted in that range.
In terms of contribution between the 2, I don't -- actually don't have that number at hand right now. I mean I think what we're sort of expecting to see on a year-over-year basis is basically flat Canadian volumes, flat to maybe slightly down on a BOE basis, just because of some of the gas challenges that Dave was talking about. And then on the U.S. side, we're probably sort of seeing like low single-digit growth on a year-over-year basis. So that's kind of what the overall portfolio is. So obviously don't have at hand the '23 split between the countries.
Okay. That's helpful. And then maybe a tack-on question here related to some of the M&A comments that you've made, but I know Freehold's focus on the U.S. side has been really oil-weighted basins, but would you look at being opportunistic in some of the gas-weighted basins given the pullback in pricing to start this year? Or is oil more of the focus for Freehold?
I mean, I think we're always going to be opportunistic. Returns drive -- really drive what we're focusing on. That's kind of equal comment. That's why we're indifferent between allocating our capital in Canada versus allocating our capital in the U.S. We just look for the highest and best return and that's equally true for the commodity. I think 1 thing we've observed is just we may be able to get the best of all worlds by focusing on the Permian, where not only can we get not gas opportunities, because we still get the oil opportunities.
So I think we're -- it's not that we haven't looked at natural gas opportunities in basins like the Haynesville and we continue to look at those. But I think where we've just had more traction and are seeing a greater opportunity set is in -- or is in the Texas place.
[Operator Instructions] There are no further questions registered at this time, I'd like to turn the meeting back over to David Spyker.
Great. Thank you, everyone, for joining today. Some great questions and some good dialogue. Exciting year in 2022 for us and really looking forward to 2023. It was a number of ideas and initiatives that we have going on. We're looking for another successful year. So thank you all.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.