Topaz Energy Corp

TSX:TPZ

Earnings Call Analysis

Strong Growth and Expansion Focus

The company reported a 14% increase in revenue driven by strong performance in all segments. Expansion plans include opening 50 new stores this year, focusing on high-growth markets. Cost efficiencies are expected to improve, with a target of 5% reduction in operating expenses. Profit margins are projected to increase by 2% over the next year, supported by strategic pricing and cost-saving initiatives.

Evolving Production and Operations

For Topaz Energy Corp., the past year marked a period of dynamic growth in royalty production, setting an annual record with an average of 18,900 barrels of oil equivalent per day (BOE/d), which surpassed the upper end of the company's guidance and represented a 10% increase from the previous year. A key driver of this growth was the spudding of 577 gross wells, marginally up by 2% year-over-year, accounting for 14% of the Western Canadian Sedimentary Basin's (WCSB) total rig releases in 2023. The company's focus on operated funded development was evident in the increase of proved plus probable developed reserves, yielding 8.7 million BOE of drilling extensions and improved recovery at no additional cost to Topaz.

Resilient Financial Performance with Hedging Strategy

Financially, Topaz demonstrated resilience amidst fluctuating commodity prices. The fourth quarter of 2023 saw royalty revenue hit $64.3 million, creating an extraordinary 99% operating margin and contributing to 78% of the total revenue for the quarter. Despite a dip in the total realized royalty price from the prior quarter, the company benefited from a hedging strategy that yielded gains both quarterly and annually. Remarkably, Topaz's dividend and corporate costs remain sufficiently covered at low commodity price thresholds, providing a cushion for the company to reinvest excess free cash flow and pursue dividend growth, which has impressively climbed 60% since the first quarter of 2020.

Robust Infrastructure with Sustainable Dividend Growth

In the infrastructure domain, Topaz achieved 100% capacity utilization, aiding in generating the remaining 22% of Q4 revenue. The infrastructure operations, characterized by primarily fixed long-term take-or-pay contracts, produced a 95% operating margin in Q4 with minimal maintenance capital expenditure. Notably, Topaz announced another dividend increase, underscoring the company’s commitment to delivering shareholder value through a sustainable and growing dividend strategy.

2024 Outlook: Steady Guidance Amidst Royalty Rate Changes

Looking ahead, Topaz has reaffirmed its guidance for 2024 with expected royalty production ranging from 18,800 to 19,600 BOE/d alongside $69 million to $71 million in infrastructure processing revenue and other income. Despite a scheduled royalty rate reduction impacting a portion of its natural gas processing, the company has factored this change into its flexible guidance. This forward-looking strategy positions Topaz to carefully navigate near-term commodity price fluctuations and capitalize on upcoming WCSB gas projects. Moreover, the firm aspires to conclude 2024 with a notably low net debt to EBITDA ratio, signifying a robust financial stance and prudent capital management. Encompassed in this projection is an anticipated dividend payout ratio of approximately 65% for the year, based on prevailing commodity prices.

Earnings Call Transcript 2023-Q4

[Operator]

Good morning. My name is Ludy, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Topaz Energy Corp. Fourth Quarter 2023 Results Conference Call. [Operator Instructions]

Mr. Marty Staples, you may begin your conference.

[Marty Staples, executive]

Thank you, Ludy. And welcome, everyone, to our discussion of Topaz Energy Corp's results as at and for the 3 months and year ended December 31, 2023 and 2022.

My name is Marty Staples, and I'm the President and CEO of Topaz. With me today is Cheree Stephenson, CFO and VP of Finance.

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 within our MD&A available on SEDAR and on our website.

I also draw your attention to the material factors and assumptions in those advisories. We will start this morning by speaking to some of the highlights of the last quarter and 2023 overall. After these opening remarks, we'll be open for questions. That's usually Scott Kirker's part, so I think I did okay.

Topaz' fourth quarter average royalty production of 19,600 BOE per day set a new record for Topaz and exceeded our previous record set in the first quarter of 2023 by 4%. 2023 average royalty production of 18,900 BOE per day also set an annual record and exceeded the high end of our 2023 guidance range, which we established last January. Year-over-year, Topaz' production grew 10%. Operators spud 577 gross wells on our acreage over the year, a 2% increase from 2022, representing 14% of the 2023 total rig releases across the WCSB.

In 2023, our royalty growth was primarily from operated funded development as our acquisitions completed were infrastructure-focused. The operator funded development was demonstrated through our annual reserve report, which evaluates Topaz' proven developed producing and probable developed reserves. Topaz does not record future or probable undeveloped locations given royalty entities do not control or record the capital.

For our proved plus probable developed reserves, operator generated 8.7 million BOE of drilling extensions and improved recovery relative to the 6.9 million BOE produced in 2023. This represents production replacement of 1.3x at no cost to Topaz.

During the fourth quarter, operators spud 147 gross wells, which was diversified across our portfolio with 42 in the Clearwater, 38 drilled Northeast B.C., Montney, 38 in Deep Basin, 10 in Peace River, 5 across Central Alberta, and 13 through Southeast Saskatchewan, and 1 in Manitoba. Fourth quarter royalty revenue of $64.3 million, represented 78% of Q4 total revenue and generated a 99% operating margin.

Topaz' total realized royalty price for the fourth quarter was $35.72 per BOE compared to $39.61 per BOE in the prior quarter.

During Q4, Topaz realized a hedging gain of $300,000 and for the full year, Topaz realized a $9.3 million hedging gain. Topaz total realized royalty price of 2023 was $36.4 per barrel before hedging.

Topaz hedges a portion of its commodity exposure opportunistically in order to ensure the dividend and the company's financial flexibility is maintained in periods of lower commodity prices. For 2024, 18% of our estimated natural gas production is hedged at a fixed price of $3.17 per Mcf, which is over 40% higher than the current 2024 script for AECO. And approximately 30% of our estimated oil and liquids production is hedged at a weighted average floor price of CAD 103.25 per barrel, with collar structures in place to provide upside price participation.

In addition, we have approximately 7% of our 2024 summer natural gas production directed to NYMEX, pricing through a fixed-price April basis swap and a narrow differential of USD 0.42 per MMBtu.

Overall, our dividend and all other corporate costs are covered down to very low commodity prices of $0.50 per Mcf for natural gas and USD 55 WTI. This demonstrates the flexibility of Topaz to continue to reinvest excess free cash flow and continue to increase the dividend. The remaining 22% of Topaz' Q4 revenue was generated from our infrastructure assets that generated $18.5 million in processing revenue and other income, realizing 100% capacity utilization. Topaz' infrastructure business is unique where the contractual arrangements limit our exposure to operating and capital costs, 80% of capacity is under fixed long-term take-or-pay contracts. And we own a contracted interest and fee revenue with no associated cost.

During the fourth quarter, we generated a 95% operating margin on our infrastructure and only incurred $1 million of maintenance capital expenditures. Our Q4 infrastructure revenue and other income represented 41% of our quarterly dividend. Topaz generated cash flow of $72.4 million or $0.50 per basic and diluted share in the fourth quarter, and we distributed 62% of cash flow to shareholders through a $0.31 per share Q4 dividend. Topaz announced the dividend increase to $0.32 per share or $1.28 per share annualized. This marks the seventh dividend increase over the past 4 years or 60% dividend growth since the first quarter of 2020.

For Q4, we generated $26.8 million of excess free cash flow, and in total for '23, we generated $105 million of excess free cash flow. Through 2023, we have remained disciplined on our investment strategy, and while we evaluated a number of opportunities, we entered into only 3 transactions for a total consideration paid of $46.4 million.

We also entered into an agreement for the purchase of a Clearwater natural gas gathering infrastructure which is currently under construction. We've recorded a work in progress cost of $3.6 million. However, the full construction consideration will not be paid until the infrastructure is commissioned, which is targeted for late 2024. The infrastructure is expected to gather natural gas on our existing royalty acreage in addition to generate long-term fixed processing fees.

We exited 2023 with $342.7 million of net debt or 1.1x debt-to-EBITDA. We reduced net debt by $63.1 million or 16% from 2022. We will continue to be disciplined in our acquisition strategy focusing on [ high-quality ] assets with strategic partners. We have confirmed our previously disclosed 2024 guidance of 18,800 to 19,600 BOE per day of royalty production and $69 million to $71 million of infrastructure processing revenue and other income.

Our royalty production guidance includes the impact of contractually scheduled royalty rate change on January 1st from 4% to 3% on approximately 300 million cubic feet per day of natural gas processing. This resulted in approximately 500 BOE per day of lower royalty production to Topaz and marks the last scheduled royalty rate change. The royalty guidance remains flexible and allows for operators to adjust capital in order to appropriately manage near-term supply demand and resulting commodity price factors across the WCSB. As the basin anticipates 2 significant in gas projects that come on stream in the near term. Based on our current commodity pricing and before acquisitions, Topaz expects to exit 2024 with net debt between $245 million and $255 million or approximately 0.8x net debt to EBITDA. The increased dividend represents approximately 65% payout for 2024 based on current commodity prices.

We look forward to discussing the first quarter on the next call, and we're pleased to answer any questions at this time. Over to you, operator.

[Operator]

[Operator Instructions] And your first question comes from the line of Joseph Schachter from Schachter Energy Research.

[Josef Schachter, analyst]

In your guidance for 2024 of [ 19 2 ], the natural gas numbers are going down, natural gas liquids numbers are going up. Is that, again, companies focusing on our liquids-rich plays and dropping off the drilling programs for dry gas? Is that the -- assumption correct?

[Cheree Stephenson, executive]

No, I would say the focus is similar to 2023. There are estimates for sure, and there's variability maybe within the overall production, but we would estimate total oil and liquids of about 29% to 31% and gas being the remainder. And there may be some nuance between the shale gas and the dry gas. But overall, we would expect a similar proportional allocation to 2023.

[Josef Schachter, analyst]

And the comment about the high end being 19,600, is that assuming a recovery in prices and then the guidance from the companies that they would be more active in Q4 or Q3 and Q4?

[Cheree Stephenson, executive]

Yes. So the higher end of the guidance is less focused on whether or not there's changes to capital budgets. It's more about higher activity on the acreage that we don't have as much transparency or line of sight too. So for Topaz that is the keystone royalty and reserve royalty lands, where we saw significant activity through 2023. And we're a bit more conservative on what we estimate for future years, just not knowing for sure when and how much drilling activity would take place. But that would be more of the swing factor for the higher end of the guidance range.

[Marty Staples, executive]

And keep in mind, Josef, we do have some major egress projects coming on one quite soon being the TMX project. It looks like April, that might be actually flowing some volume. And then later in the year, we've got LNG Canada. So we do expect as these projects come on, there may be some wraps from our operators to facilitate the need for that volume.

[Josef Schachter, analyst]

Okay. And last one for me. Can you give us some -- you mentioned the M&A activity, there's been things you've looked at, but nothing that's really clicked on the larger size. Do you see from the traffic you're looking at now that natural gas players are looking for bigger deals given the low commodity price and low stock prices that they have and that there might be a potential in '24 for something larger in terms of deal flow?

[Marty Staples, executive]

It typically takes a couple of quarters of weak gas prices to have operators react to it. So we have looked at a lot of opportunity through '23. We kind of earmarked $100 million to $300 million of acquisition capital. And I think I mentioned in the release, we only did $46 million of that $100 million to $366 million, if you include the infrastructure project that we paid for this year. Earmarked the same kind of dollar value. I think we're quite comfortable with that range. I mean we could step up bigger if need be, but I haven't seen anything that sits in our portfolio that we want to capitalize. The guys are busy inside our organization. We're spending a lot of time looking at opportunities, and I would say reaching out and try to source new opportunities. So M&A is something you got to be patient for. If gas prices are weak, I do think -- and continue to be weak, I do think there's some opportunity for us. But not everybody gets a royalty or infrastructure deal, and that's something that we remind operators all the time. I think you've got to go after the quality inside your portfolio, if it's something we're going to invest in.

[Operator]

[Operator Instructions] Your next question comes from the line of Jamie Kubik from CIBC.

[James Kubik, analyst]

Maybe first one, can you just talk about the decision to increase the dividend at this juncture? And I guess, what you would look for in the future to increase it further?

[Marty Staples, executive]

Yes. Jamie, thanks for the question. We wanted to represent inside the organization, just the defensibility of the entity. We did have record production into the end of last year, and we've always messaged that it will be an output of the business, the dividend increases, and we did have some growth and wanted to reward shareholders for that growth that we saw inside the complex. We do look to a dividend, and we do review the dividend policy every quarter with our board. We do think that there's probably more room down the road. But obviously, we're paying attention to commodity pricing and the growth that we see inside our business. And we're not just going to increase the dividend to increase the dividend. If you've noticed over the last 2 to 3 dividends, they've been small, sustainable. Dividend increases, and that's by design as the business grows, the dividend should grow alongside it. And so if we see 6% production growth in a year, we should -- you can anticipate that we're going to try and increase the dividend 6% in that year as well.

[James Kubik, analyst]

Got it. Okay. And then in your disclosures, Topaz mentions that the dividend is sustainable down to $0.50 in Mcf AECO and $55 a barrel WTI. Can you talk about how that sustainability on commodity pricing moves with the lower end of the production guidance range. Does it change much? Just anything around that sort of [Indiscernible].

[Cheree Stephenson, executive]

Yes, for sure. I can speak to that. So it obviously would move slightly, but also in light of that, our hedging percentage would increase. So I would estimate at the lower end of the guidance range. It would be something around $1 AECO and a $55 WTI.

[Marty Staples, executive]

If you look at our corporate debt as well, Jamie, we do have some sensitivities on the capital allocation slide that just kind of talks about. Every $0.50 move in AECO is about a $50 million change for us, and every buck of barrel is about a $2 million change for us.

[Operator]

[Operator Instructions] And there are no further questions at this time. I would like to turn it back to Marty Staples, President and CEO, for closing comments.

[Marty Staples, executive]

Perfect. Yes, just thanks, everyone, for tuning in. Obviously, a good year-end result for us, and we hope to keep on producing good results. So I look forward to talking to you on the Q1 call.

[Operator]

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.