Freehold Royalties Ltd. (FRHLF) CEO David Spyker on Q4 2021 Results - Earnings Call Transcript

Freehold Royalties Ltd. (OTCPK:FRHLF) Q4 2021 Earnings Conference Call March 3, 2022 9:00 AM ET

Company Participants

David Spyker - President & Chief Executive Officer

Dave Hendry - Vice President, Finance & Chief Financial Officer

Rob King - Vice President, Business Development

Conference Call Participants

Luke Davis - RBC Dominion Securities Inc.

Aaron Bilkoski - TD Securities

Jamie Kubik - CIBC World Markets Inc.

Patrick O'Rourke - ATB Capital Markets

Operator

Good morning, ladies and gentlemen, and welcome to the fourth quarter results conference call.

I would now like to turn the meeting over to Mr. David Spyker. Please go ahead Mr. Spyker.

David Spyker

Good morning and thank you for attending. We're excited to share our Q4 2021 results with you this morning. Joining me today are Dave Hendry, our CFO; and Rob King, our Vice President, Business Development; and Matt Donohue, our Manager of Investor Relations and Capital Markets.

2021 was a transformational year for Freehold. So we completed $377 million in acquisitions and set record production levels at 14,005 BOE per day in Q4. We positioned our portfolio with the addition of royalty lands in the premier oil and gas basins across North America, including the Permian, Eagle Ford oil basins, Haynesville gas basin and the Clearwater oil play.

With this work, we have achieved the following; we delivered $69 million in funds from operations, our highest quarterly funds flow ever. This equates to $0.46 per share. We are increasing our dividend by 33% from $0.06 per share to $0.08 per share, which is $0.96 per share annualized and this commences with the April payment. We have increased the dividend every quarter in 2021 and this is the highest dividend level since 2015.

We have the most underlevered balance sheet of our Canadian royalty peers, exiting the year at 0.5 times net debt to trailing funds from operations. We are positioned to grow our royalty volumes through drilling on our existing land base. We had 250 wells drilled on our lands in Q4. We have nine to 12 rigs continuously active on our Canadian lands to start 2022.

We have had $1 million in lease bonus revenue so far this year, more than the last three years combined. We realized almost 1,000 BOE per day of production associated with our audit, compliance and royalty optimization drilling initiatives in 2021. These are the best acquisitions per se as they don't require capital.

With this all, we grew our Canadian production 4% from Q3 to Q4 2021 as a result of this robust drilling activity. We are very well-positioned in the Permian Oil Basin, an area which has set all-time high production levels in the past two consecutive months with half of the active US drilling rigs operating there. We have 17 rigs operating on our US lands currently with 45 new wells permitted in the last two weeks alone. And we are receiving premium pricing on our US assets.

We received $68 per BOE for our US royalty volumes in Q4 2021, compared to $53 per BOE for our Canadian royalty volumes, a 27% pricing premium due to proximity to US Gulf Coast. These are material shifts to our portfolio. And with our updated guidance we are projecting between $230 million and $250 million in funds from operations in 2022.

The dividend increase we announced strikes a balance between returning value to our shareholders, further strengthening our balance sheet and providing the flexibility to continue disciplined acquisition work. The opportunity to further build on the quality of our portfolio remains robust, and we view it as important to retain the flexibility to continue to evaluate and acquire assets that enhance our royalty portfolio.

I will now pass the call to Dave Hendry to walk through some of the financial highlights.

Dave Hendry

Thanks Dave, and good morning, 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.

Funds from operations for Q4 2021, totaled $68.8 million an all-time record for Freehold or $0.46 per share up 43% versus the previous quarter and 211% from the same period in 2020. For the year, funds from operations totaled $189.6 million or $1.39 per share which is up 129% year-on-year. The significant increase in funds from operations provided added financial strength and flexibility to how we manage our business.

Freehold's royalty revenue and funds flow both benefited from the strong upward momentum in crude oil and natural gas prices alongside growing production particularly in the US, which receives better pricing relative to our Canadian assets. Freehold's dividend payout totaled 35% for Q4 2021 versus 24% in Q4 2020.

As previously mentioned, we are increasing our monthly dividend from $0.06 per share to $0.08 per share reflecting our continued measured response to an improved commodity price outlook, better-than-anticipated production associated with increasing third-party spending on our royalty lands in 2021 which is expected to continue into 2022.

For Q4 2021, cash costs totaled $3.57 per BOE down meaningfully from $4.03 per BOE in Q4 2020. For the year, cash costs totaled $3.71 per BOE the lowest in Freehold's history and down 19% versus the previous year. We continue to drive efficiencies in this area alongside increasing production volumes.

Net debt totaled $101.2 million at December 31 representing 0.5 times net debt the 12-month trailing funds flow from operations. Overall, Freehold's net debt increased by $35 million versus the previous year. The increase in net debt reflected acquisitions completed over the year with stronger funds from operations also meaningfully contributing to the funding of these acquisitions.

Freehold's prudent strategy of maintaining long-term debt to funds flow well below 1.5 times alongside a longer-term dividend payout target starting at 60% of funds from operations provides protection to the business from commodity price volatility, while maintaining capacity to continue to grow through strategic and disciplined acquisition work.

In absence of additional acquisition work, Freehold has the optionality to potentially reduce net debt to zero by year end 2022 based on guidance estimates.

Freehold expanded its credit facilities with four Canadian banks in the fall of 2021 to $300 million with a permitted increase up to $375 million subject to lender's consent, which provides capacity and flexibility to potentially fund further accretive acquisitions during 2022.

Now back to Dave for his final remarks.

David Spyker

Thanks, Dave. So in closing, we remain enthusiastic about the next 12 months. There's been a steady trending up of capital spending and associated production growth on our royalty lands, both in Canada and the US. At current commodity price levels, our high margins offer significant option value to provide returns to our shareholders.

Today's increase in our monthly dividend means that we have increased our payout every quarter in 2021. And the acquisition work that we completed last year is expected to continue to provide both near and long-term value for our shareholders.

There's been a tremendous amount of work completed in the transformation of Freehold into a premier North American royalty company. I think you can see the fourth quarter has shown the full impact of the acquisition activity throughout the year resulting in these record-setting production and funds from operations for Freehold.

I would like to thank all our shareholders for their support, and also thank our Board and employees that contribute the ideas, the energy and the inspiration that has made an investment in Freehold of success.

Thank you all and we'll now take questions.

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. [Operator Instructions] We have a first question from Luke Davis. Please go ahead. Your line is open.

Luke Davis

Hey, thanks. Good morning, guys. Just on M&A. Wondering if you could provide some details on how the market develops just given the run in oil pricing here? Maybe what kind of opportunities you're seeing? And I imagine you're still focused on the US, but curious if you can comment just on both sides of the border?

Rob King

Good morning, Luke. It's Rob King speaking. So, I can provide a few comments in terms of what we're seeing right now. We started the -- start of January is really quiet on both sides of the border in terms of activity. But that will lasted a couple of weeks before things -- a number of opportunities, particularly in the US certainly coming across our desks, all over the size range from, call it, $10 million of value and less up to $500-plus million of value. So, I think one of the challenges that our team is having right now is how we allocate our time and allocate our capital to looking at these opportunities, because we've been -- we're fortunate to have a lot to look at.

In terms of what we're sort of seeing, in terms of bid-ask spread and what the market is looking like, because obviously the market has been incredibly dynamic in the last several weeks here. Just a few examples of activity in the US, in the last month, we've seen three transactions north of $1 billion of value. And the common thread between those mineral title opportunities was that they were done with the high-teens cash flow yields in them. So, it's still attractive -- a very attractive market, even in this commodity price environment where you are -- we are seeing, our peers think that ask spreads narrow.

I think for us, we've been – we haven't been testing the market to the same extent since our acquisition activity that you sort of see in our Q4 numbers right now. We're starting having some discussions and things are similarly pointing to metrics that would be in that range. I think we're seeing the strength in commodity price is bringing out a lot of sellers up, obviously, just from the sheer strength of it, but it's also has changed the development pace of the assets. So sellers might have looked to sell in the back half of 2022 or into 2023 are now seeing their portfolios mature that much faster. And our sort of – it provides that great mix of near-term development with future upside that buyers like us are looking for.

Luke Davis

Thanks. That was super helpful. And just curious, what you're generally using now for pricing when you're doing those evaluations?

Rob King

Yeah. It's – I mean, it's – that's a pretty dynamic process. I mean, it's multiple pricing scenarios as you'd guess. It's grounded in strip, but then it's strip minus running scenarios that – so look at strip for a one-year or two-year time period then moderating to a lower level or a lot of flat pricing scenarios. Yeah, it's – you're touching on one of the more challenging pieces of our valuation these days.

Luke Davis

Yeah. That makes sense. Thanks. And just one final one for me. Can you just give us an update on what's going on with the CRA process?

Dave Hendry

Hi, Luke, it's Dave Hendry here. Yes. We – first off, we still strongly believe our filing position is correct. Field Officer has been assigned. We've talked with them. We provided submissions to them justifying, why we believe our position is correct, and they're going through that – through those submissions as well as the rest of the material. I'm not expecting this to be quickly resolved probably see it maybe taking six months. I mean, it's hard to tell, CRA is going to take as much time as they want. And clearly, and they manage the process.

So with that, depending on where we are in that our next tax filing for the 2021 year, will be sort of midyear. And so if it's still outstanding and they haven't made a conclusion of their field process at that point there is a chance that most likely, we would get reassessed on our 2021, and then have to deposit probably another $10 million approximately until we wait for the appeal decision. But to finalize, we strongly believe our position is correct, and we're actively focusing on that.

Luke Davis

Yes. Helpful. Thank you. That's it for me.

Operator

Thank you. The next question is from Aaron Bilkoski from TD Securities. Please go ahead. Your line is open.

Aaron Bilkoski

Thanks. Good morning, guys. Would you be able to give me a sense of, what first year production rates would look like for your average US well relative to your average Canadian law?

David Spyker

Yeah, And, Rob can answer that. He's just pulling up his screen here right now.

Rob King

Yeah. We have a second question. I'll run this in the background while you –

Aaron Bilkoski

Sure. I guess, internally what leading indicators are you guys watching for future production additions? Are you guys seeing a ramp-up in licenses, or ramp-up in active rigs on your land? And I'd be curious to know, which plays are seeing the biggest rate of change?

Rob King

Yes. Maybe come back to your first question, I'll come to that question. So in terms of our average one-year production on our US wells, it's just 800 barrels a day is what we saw. This was a number that we ran back in our Investor Day in December. So this were contemplates wells on our US properties, as if we added them for the last four years 2017 to 2021. So yes, just under 800 barrels a day.

In terms of activity on our US assets, we've had a pretty consistent number of rigs over the last gosh four and five months now. So that 15% to 20% range. So that's kind of given us some confidence. I think what we're also tracking is just the number of permits that are on our lands. And as Dave said at the outset. In the last two weeks we've had 45 permits on our US lands and I think that was – you just put that in that 45 permit number into context. In the first two months we've had about 50 gross wells drilled in the US on our lands.

And so 45 permits is pretty exciting in – those on our – in the last two weeks on the spud side, half have been in the Eagle Ford with Marathon. The other half have been in the Permian, largely under Pioneer and also a handful of privates. Those permits that we talked about the 45, 35 were in Midland and the vast majority of those were under our lands that we acquired closing in October with most of that come from Pioneer.

10 were from Marathon in the Eagle Ford. And just to give you a little bit of a triangulation there's often in the Permian and the Eagle Ford about a two to three-month lag between permit to spud so we can – if you see those permits coming in February that sort of points to a Q2 spud time frame.

Aaron Bilkoski

Okay. Final question for me and I guess as a follow-up to one of Luke's question. I'd be curious to know what the size of the asset packages are that are crossing your desk? And if there's a sweet spot in terms of size for Freehold, either your ability to digest them or there's a sweet spot in terms of valuation?

Rob King

Yes. Maybe on your second point there is definitely the sweet spot valuation. That's far more important and relevant than the size. I mean everything we look at. If it doesn't make us better, we're not interested in adding it to our portfolio. And so that's in terms of size, it's a bad answer but it literally is all over the map in terms of – I'd probably say. it's almost a barbell. There's either – there's a number of opportunities in that $50 million and less.

And then what's interesting is the number of opportunities that are a couple of hundred and more. And I think that's – we're looking at both ends of the barbell. And there's obviously a heck of a lot more deals in that smaller range. But there is – there are more than three that are in that larger category that are currently on our desks.

Aaron Bilkoski

Do you find there's more competition for smaller deals or larger deals or it's tough to tell?

Rob King

I definitely agree with that comment in terms of more competition on the smaller ends and you can certainly see that with the marketers. The marketers know that they size the packages correct – air quotes correctly to try and get the most number of competitors looking at it. I think it's – but it's fair to say, there's a lot of opportunities and yes, there's a lot more competition we've observed in the US, but there's also a lot more opportunities.

Aaron Bilkoski

Thanks a lot guys.

Operator

Thank you. The next question is from Jamie Kubik. Please go ahead. Your line is open.

James Kubik

Good morning and thanks for taking my question. I've got two of them just quickly. So volumes on your Canadian assets really strong in Q4. How should we think about production volumes in 2022 on the Canadian side, given where producer activity is at? And also curious, if you can touch on how the US portfolio is trending currently? Thanks.

Rob King

On the Canadian side, I think our forecasting -- we think we're going to have about 20 net wells on our Canadian assets in 2022. And just to put that number into context that will -- we believe that will replace our decline rates in Canada. So Canada is kind of a flat to maybe modestly up. We've seen so far activity in Canada about 100 gross wells, drilled on our lands in the first two months, which is definitely on pace for that annualized 20 net wells.

A lot of that has been about 30 drillers make up those 100 wells 20 were with time in the Viking. Tamrac was very active in the Clearwater with a dozen wells on our lands and Tundra and some of the privates have also accelerated their activity we've observed in the last couple of months. Sorry, I don't know if that answers your Canada question. I know your US question. I just can't remember...

James Kubik

Yes. Sorry, I was just curious on how the production volumes are trending versus your guidance? I know you split out Canada about 9,300 barrels a day contributing in 2022 and the US contributing at 4,900. Just curious on what you're seeing so far because obviously the mix in Q4 was different than that?

Rob King

Yes. Yes I'd say it's sort of trending on pace. I mean I think we're we've put out our production guidance in November time frame. And I think our expectation for 2022 it will be at the high end of that range. The Eagle Ford is showing a lot of continued strength and probably even maybe a little bit ahead of where I think our expectations were. That's both a production comment, but also a cash flow comment we're even getting higher realized pricing than I think we had actually expected.

We're encouraging Marathon's 2022 capital guidance a few weeks back where their capital plans are supportive cooperative of the acquisition modeling that we had for their -- for our assets under Marathon. In the Eagle Ford they're actually talking about 15 redevelopment recompletion wells in the Eagle Ford. Obviously, all will be on our lands but we do not value any re-completions in our analysis. So that is some upside that we will see in 2022 that we weren't expecting.

James Kubik

Okay. And then maybe a follow-on question here. How should we think about the free cash flow priorities for the business? I mean should we think about the dividend being anchored at a lower commodity price level? I mean -- or should we think about Freehold likely increase in the dividend as the year goes on, if strip pricing or if commodity pricing outperforms your expectations? I know that you have WTI estimated $75 a barrel for 2022 and $4 on NYMEX clearly, a dynamic environment. But can you talk about how we should think about the dividend moving forward through 2022 and free cash flow priorities?

Dave Hendry

Hi Jamie, it's Dave Hendry again. Yes, I mean obviously, we just updated our dividend commodity prices incredibly volatile. So, it's very hard sort of know what that predictions are. We stuck with $75 WTI US, just because it's relatively consistent with a lot of our peers, as well as more of a moderated position. On top of that dividend that we just announced of $0.08 per share, the most meaningful contribution is acquisitions. So we're going to have to see how acquisitions play out this year to see what the ask numbers are and about, can we get some deals across the line that realize the returns that we're expecting. So that's the key focus.

And then we'll continue to monitor what commodity prices. We set that 60% target range for a reason. So, we'll continue to monitor that. And then -- and then we do have still $146 million of debt to pay down. So, we'll use that as a toggle. So we'll balance those three contributions like usual. So -- but as far as ultimately, do we change the dividend? We don't have a plan on updating the dividend in the next quarter, but we'll just evaluate and see how our acquisitions play along.

Jamie Kubik

Okay. That’s it from me. Thanks, guys.

Operator

Thank you. The next question is from Patrick O'Rourke. Please go ahead. Your line is open.

Patrick O'Rourke

Hi, good morning guys. Pretty comprehensive questions from the guys ahead of me there. I'll have to be a little bit quicker on the finger trigger there going forward. Just a couple of quick things though that, I don't think have been touched on and I'm curious too. In particular, you're showing some strength out of the Canadian asset here and I think that drove a bit of the outperformance on the quarter. I'm wondering, if you can comment now with pricing so strong in Canada and the progressive nature of royalty or Crown royalty curves here, how you're sort of competitively positioned on your Freehold lands?

David Spyker

Yes. Good question, Patrick. As far as the Crown royalty structure goes, there's still Crown royalty holidays that are in place early on. But when you come off those holidays, our royalty lands are very competitive. And so, right now we see drilling as active on the royalty lands, as I think we see in Crown lands across the portfolio. And so we see that continuing.

On a rig activity level there's certainly higher rigs in Canada, than we were this year last time. But we're still 60 rigs or so, under the long-term average in Canada, if we go back a few years. So we are seeing certainly increased activity. It hasn't recovered to more steady-state pre-pandemic levels and the same in the U.S.

So we're seeing the rigs really focusing in the most -- still the most cost-effective basins. Permian and Eagle Ford in the U.S., is really driving a lot of that drilling. And we did see a good up-tick in gas drilling in the Deep Basin in Q4. We expect to see that continue, but the oil plays are what's really being developed at a pretty good clip on our lands.

Patrick O'Rourke

Okay. Thanks. And considering, you guys are using a pretty conservative planning budget here with $75 WTI. Would Freehold consider an approach to hedging any of the production here?

David Spyker

Yeah. I don't -- we would talk about hedging before Patrick, maybe to backstop acquisition. But as far as hedging in general, it's not something that we're looking at. We do have the strongest balance sheet of royalty peers. And we're generating significant cash flow right now. So we think that we've got the balance with the dividend payment and the focus on managing our debt that we don't think that hedging is the right answer for us right now.

Patrick O'Rourke

Okay. Thank you.

Operator

Thank you. The next question is from Matthew Week. Please go ahead. Your line is open.

Unidentified Analyst

Hi. Good morning. I think all my questions have been answered at this point. So I'll just hop back in the queue. Thanks.

David Spyker

Thanks, Matthew.

Operator

Thank you. There are no further questions registered at this time. I will turn the call back to Mr. Spyker.

David Spyker

Okay. Thanks everyone for participating today. We had some great discussion. And so appreciate throwing those questions at us. And good luck to all. And we'll talk to you next quarter.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.