Topaz Energy Corp

TSX:TPZ

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Topaz Energy Corp. Second Quarter 2022 Results Conference Call.

[Operator Instructions] Thank you.

Mr. Scott Kirker, you may begin your conference.

[W. Kirker, executive]

Thank you, Michelle. And welcome, everyone, to our discussion of Topaz Energy's results for the 3 and 6 months ended June 30, 2022 and 2021.

I am Scott Kirker and I'm the General Counsel of Topaz.

Before we get started, I refer you to the advisories on forward-looking statements contained in the news release as well as the advisories contained in the Topaz annual information form and its MD&A available on SEDAR and on the Topaz website. I also draw your attention to the material factors and assumptions in those advisories.

I'm here with Marty Staples, Topaz President and Chief Executive Officer; and Cheree Stephenson, Vice President, Finance, and Chief Financial Officer. They will start by speaking to some of the highlights in the last quarter and the year so far. After their remarks, we'll be open for questions.

Marty, Cheree, go ahead.

[Marty Staples, executive]

Thanks, Scott. Good morning and thank you, everyone, for attending the Q2 Conference Call for Topaz Energy.

Topaz continues to execute on its unique business strategy which generates high-margin inflation-protected income streams. Q2 marks our eighth consecutive quarter of royalty production and cash flow growth. Q2 results was -- represent 4x and 1.7x cash flow and average royalty production since Q3 2020, when Topaz completed its IPO.

We're pleased to provide our fourth quarter -- our fourth dividend increase, 40% to date, to $0.28 per share, which represents a 5.5% dividend yield at our current share price. The dividend increase reflects a balanced approach, where we still plan to allocate the majority of our excess free cash flow to acquisition growth in conjunction with modest, sustainable increases to our dividend.

During the quarter, Topaz generated record cash flow of $95.4 million, 29% higher than Q1 2022 and 156% higher than Q2 2021. Cash flow per share of $0.67 grew 26% from Q1 2022 and was 109% higher than Q2 2021. In Q2, we allocated 39% of cash flow to shareholder dividends, invested 15% in cash royalty acquisitions, incurred $1.3 million in capital expenditures and reduced net debt by over $42 million.

Average second quarter royalty production of 16,676 BOE per day grew 3% from prior quarter and 36% from prior year. Approximately half of the Q2 production increase is attributed to the Keystone acquisition, which closed April 29, 2022, while the remainder is attributed to operator development, which as expected was partially restricted due to spring breakup conditions. Total liquids royalty production grew 8% from Q1 2022, driven by crude oil production attributed to the Keystone Royalty acquisition.

In the second quarter, working interest operators on our royalty acreage spud 102 gross wells. And 112 gross wells were brought on production, which represents a 26% decrease from the first quarter, when 137 gross wells were spud, which is attributed to the expected spring breakup access limitations. In addition, a total of 67 gross wells have been reactivated to date in 2022 in response to the strong commodity price environment. These wells were not producing at the time Topaz acquired the respective royalty interest.

To date in 2022, 14 new leases have been executed across our fee mineral acreage. And 23 gross wells have been spud or licensed, including 3 targeted -- targeting helium. Based on our planned operator drilling activity, we expect to have 20 to 24 rigs active on our royalty acreage during the third quarter, following spring breakup conditions. We estimate our primary partners will invest $1.5 billion of annual capital development, which excludes incremental activity on our Keystone and Reserve Royalty acquisitions.

Our infrastructure assets realized 100% utilization during Q2; and generated $16.2 million in processing revenue and other income, 4% higher than Q1 2022 and 20% higher than Q2 2021. Our infrastructure business provides strong dividend support. In Q2, our infrastructure revenue represents 43% of our second quarter dividend. Our infrastructure contracts provide over 80% fixed revenue and include contractual inflation protection measures.

During the second quarter, we invested $99.6 million in acquisitions, which includes $85 million for the acquisition of Keystone Royalty Corp., paid through the issued -- issuance of 4.2 million Topaz shares. Keystone provided 500,000 gross acres of predominantly undeveloped land, which includes 300,000 fee mineral acres, as well as royalty production of approximately 450 BOE per day. We also completed $14.6 million in tuck-in royalty acquisitions in Q2, which includes 129,000 gross acres of predominantly undeveloped land, supported by $20 million of operator drilling commitment. The royalty ranges from 2% to 5%; and is located through the Charlie Lake, Clearwater and Central Alberta resource plays, which provides further strategic alignment with Tamarack Valley.

Topaz exited Q2 with $151 million of net debt, which represents 0.4x debt -- net debt-to-annualized cash flow. We currently have $485 million of available credit capacity. And together with our estimated 2022 excess free cash flow of over $170 million, we believe we have significant capital to continue to execute our acquisition and dividend growth strategy.

We've updated our 2022 guidance estimates to incorporate year-to-date financial results. Using fixed prices of $5 AECO and $90 WTI for the second half of the year, our EBITDA guidance has increased 8%. And we estimate we'll generate over $170 million of excess free cash flow in 2022 and exit the year with 0.2x net debt-to-cash flow before incremental acquisitions.

Our increased dividend of $0.28 per share represents a 46% payout ratio on our updated guidance. Our long-term payout ratio is targeted between 60% to 90%. However, we believe the reinvestment of our excess free cash flow into additional growth opportunities provides enhanced long-term shareholder value, and we plan to continue to increase the dividend alongside this growth.

During the past few months, we've opportunistically layered on some hedging which is focused on [ protecting summer gas volatility ] and protecting acquisition metrics at higher commodity pricing. For the next 12 months, we have 30% of our estimated natural gas production hedged at a weighted average of $5.71 per Mcf and 11% of our total liquids production hedged at an average price of CAD 105 per barrel. When you combine our stable infrastructure income and our moderate hedging, our 2022 is fully covered even at low -- ultra low commodity pricing.

We are on track to publish our 2021 sustainability report early fall, where we'll demonstrate our sector-leading ESG foundation.

Happy to answer any questions at this time.

[Operator]

[Operator Instructions] Your first question comes from Josef Schachter, Schachter Energy Research.

[Josef Schachter, analyst]

Scott, Marty and Cheree, congratulations on the quarter and increasing the dividend. I just want to get a feel, Marty, on how the deal flow looks to you. How many data rooms are open compared to other quarters [ where you ] kind of give us some guidance of the activity that you're looking at? And are there any potential of any bigger deals in the second half of the year for Topaz?

[Marty Staples, executive]

Yes. Thanks for the questions. We -- typically, through the summer, it's been quiet historically in the basin, but that hasn't been the case this year. In fact, I think this has been one of the busier years in the sector we've seen. Data rooms are continuing to pile up. We know that there's a bunch of different mandates in play right now both on the royalty and infrastructure side where we are kind of engaged in those data rooms. And I think the biggest thing that we've seen lately is the reduction in equity prices has made our business even more appealing to a lot of the operators out there right now. I think equity is a tough thing for operators [ to access debt ]. I mean we've got interest rates going up [ federally ] today in the U.S. again, so a lot of uncertainty there, which actually makes Topaz a good spot for investors [ in ] E&P companies to call right now, so yes. We continue to be active through the summer. And the good news is we're active. The bad news is nobody is taking summer holidays.

[Josef Schachter, analyst]

And in terms of the mix, [ it's ] infrastructure that's been harder to do. Do you see more of that product coming along so that you might have a bigger piece of that, yes, before the end of this year?

[Marty Staples, executive]

Yes. So 2 things kind of happened with infrastructure. We are working with a few different companies that have been in the M&A space right now. And we hope to have some more narrative to put out there later into the year, but I think, as always, infrastructure deals just take a little bit longer. There is some larger packages available right now and we're trying to see how we fit into those. And keep in mind our strategy right now is to take non-oppositions, not go in and try and nameplate the facility. So that doesn't limit us necessarily, but it does -- we look for partners to kind of align with [ to help ] facilitate some of these acquisitions. So yes, I would say it's a pretty healthy balance between the two. I think royalties over the last 2 years and -- have been kind of front and center for us. And we'll continue to be active on the royalty space, but we're not ignoring any infrastructure component either. And I think you'll see a couple smaller acquisitions made through this quarter in the infrastructure side, some expansion dollars go to work on the infrastructure side. And then we might be able to kind of pin down 1 or 2 of these larger projects as well. So really active on both sides.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now turn it back to Mr. Staples. Please go ahead.

[Marty Staples, executive]

Okay, well, thanks, everybody. And look forward to talking to you next quarter.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.