Earnings Call: Q4 2020

Mar 5, 2021

Good morning, ladies and gentlemen, and welcome to the Freehold Royalties Limited twenty twenty Fourth Quarter and Year End twenty twenty Conference Call. Please be advised that certain statements on this call constitute forward looking information. All statements other than those of historical facts may be forward looking and we caution the listener. I will now pass the call over to David Spyker, Chief Executive Officer of Freehold. Please go ahead, sir. Thank you, and good morning, and thanks, everyone, for joining us. We had a great quarter, we're looking forward to sharing it with you this morning. On the call with me today are Dave Hendrie, our CFO Rob King, our VP, Business Development and Matt Donahue, our Manager, Investor Relations and Capital Markets. 2020 was a significant year for Freehold. We undertook a number of key initiatives to underpin the long term sustainability of our business and really to reinforce Freehold's identity as a lower risk income vehicle for our shareholders. And this was accomplished despite the challenging backdrop of COVID-nineteen and the sharp decline in oil prices. To start this morning, I would like to talk about the dividend increase and then we'll focus on the excellent operational performance that we've had. In conjunction with projecting a 10% to 15% production growth over 2020, we will be increasing our dividend by 50% from $02 per share to $03 per share starting in April to shareholders of record on March 31. This healthy dividend increase represents a measured approach in moving the dividend upward toward our long term 60% to 80% payout ratio objective. The stepwise approach takes into consideration that despite the improvement in the commodity price outlook, there still remains a tenuous supply demand balance with uncertainty on the resolve of OPEC plus to manage the pace of bringing incremental production to market and uncertainty on the ultimate pace and sustainability of demand recovery as COVID-nineteen vaccination initiatives are well underway. We also see this as an opportunity to delever our balance sheet with free cash flow after dividends being directed to further reduce our debt, retaining financial flexibility to do further high quality acquisition work. Our team worked hard last year to identify acquisition opportunities in the bottom of the price cycle. In November, we announced the acquisition of that diversified U. S. Royalty package, and that really solidified our position as the only publicly traded North American focused oil and gas royalty company. The CAD74 million acquisition closed in early January of this year and provided us with exposure to 400,000 gross drilling unit acres of mineral title land and overriding royalty interest across 12 basins and eight states, predominantly weighted towards the activity rich Permian and Eagle Ford basins. The acquisition not only added twelve fifty BOE a day of production for 2021 and projected $12,000,000 in funds from operations, but it has significantly increased the quality and the depth of opportunities available to us to further enhance our U. S. Portfolio as we seek to continually position the company in areas that we believe will attract capital through all commodity price cycles. With near term focus on taking some debt off our balance sheet, we want to position ourselves to be able to do meaningful acquisition work in the future. We were able to take advantage of some of the deal exposure that we saw in Q1 and complete two tuck in acquisitions, adding additional exposure to the Bakken and Permian Basins. These deals totaled about $4,700,000 and closed earlier this week. They're estimated to add 75 barrels a day of production in 2021 and will provide additional production growth into next year. We continue to integrate all these U. S. Transactions into our portfolio with volumes and funds flow in line or above expectations when we did the transactions. We really feel that the groundwork that we set in 2020 has positioned us for an exciting 2021 as we return to growth, projecting a 10% to 15% increase production year over year. With commodity price outlook improving as 2020 progressed, we had a resurgence in drilling on our lands with 111 gross, 4.9 net wells drilled in Q4. That was more than double our Q3 drilling activity and a 5% increase from the activity we had in Q4 twenty nineteen. So the increase in drilling activity was also accompanied by production recovering in Q4, up 5% over Q3 volumes and averaging 95.63 boed day in the quarter. So this strong drilling and production momentum has continued into 2021 and along with the closing of our U. S. Royalty acquisitions, we're increasing our 2021 production guidance to a range of 10,500 to 11,000 BOE a day. This represents a solid 10% to 15% increase over our 2020 average of 96.05 a day. We have considerable optimism heading into 2021 and we'll continue to focus on positioning Freehold to be a premier royalty company with a strong balance sheet, a sustainable dividend and prospects for growth in top tier oil and gas operating areas. I'll now pass the call to Dave Hendrie to walk through some of the financial highlights. Thanks, Dave, and good morning, everyone. Financially, as commodity prices improved over the quarter, Freehold continued to deliver on the core aspects of its return proposition, providing a meaningful dividend while providing investors with a lower risk investment, differentiating itself from traditional oil and gas E and P companies. Royalty and other revenue totaled CAD90 million for 2020, down 36% versus the same period last year. In the fourth quarter, Prehold generated CAD25.8 million in royalty and other revenue, up 11% versus Q3 twenty twenty, reflecting improved liquids and natural gas pricing and growing production volumes. For 2020, funds from operations totaled CAD72.9 million, a 38% decline versus 2019, reflecting weakness in crude oil prices associated with the COVID-nineteen pandemic. Funds from operations for Q4 twenty twenty totaled CAD22.1 million or $0.19 per share, up 11% versus the previous quarter. Freehold's dividend payout totaled 54% for 2020 versus 63% during 2019. The dividend payout was below our outlined range of 60% to 80%, reflecting better than forecast production and commodity prices during the 2020. Our payout on a dividend paid basis was 24% in Q4 twenty twenty, down from 61% during Q4 twenty nineteen. As previously mentioned, we increased our monthly dividend for 2021 from CAD0.02 per share to CAD0.03 per share, reflecting a measured response to an improved commodity price outlook and expected increase in third party spending on our royalty land in 2021. For 2020, cash costs totaled $4.63 per BOE, down 13% year over year and represented an all time low for Freehold. This strong result reflected reduced G and A, financing and operating cost charges. Over the year, we executed upon a number of cost saving measures, which have improved our netback and profitability. Cash costs for the fourth quarter totaled $4.11 per BOE, down 19% versus the same period last year. Our twenty twenty one U. S. Acquisitions are expected to only add a marginal amount of G and A, which should continue to improve our corporate cost base and netback. Net debt totaled $65,800,000 at 12/31/2020, representing 0.9 times net debt to funds rolled from operations and a $15,900,000 reduction from Q3 twenty twenty. The decrease in net debt quarter over quarter reflected stronger funds rolled from operations alongside a lower dividend payout. Freehold's prudent strategy of maintaining long term debt to funds rolled from operations below 1.5x alongside a longer term dividend payout target range of 60% to 80% of funds flow from operations provides cushion for potential volatility in commodities. Debt only increased slightly early in the year as the majority of our recent U. S. Acquisition was financed by the very successful subscription receipt issuance in December 2020 As the acquisition didn't close until early January twenty twenty one, the subscription receipts were reported as a current liability at year end before their conversion to equity in January. Regarding the Canada Revenue Agency reassessment, amounts are consistent with those reported last quarter. Regal's corporate income tax filings for 2015, 2018 and 2019 were reassessed by the CRA in 2020. Pursuant to these reassessments, deductions of $92,600,000 of noncapital losses by Freehold were denied, resulting in reassessed taxes, interest and penalties totaling 29,300,000.0 in addition to a denial of $129,900,000 of carryforward noncapital losses. Freehold has filed its objection of the reassessment, which required a deposit of totaling $14,700,000 that has been paid to the CRA during the third quarter. For the 2020 tax year, Freehold estimated it has sufficient other tax pool deductions and doesn't expect to utilize reassessed noncapital losses, and on this basis does not expect a reassessment of its 2020 Canadian corporate income tax filing. Freehold has received legal advice that it should be entitled to deduct the noncapital losses, and as such, management remains of the opinion that all tax filings to date have been filed correctly, and it expects to be successful in its objection of these reassessments, and therefore, the deposits paid to the CRA should be refunded with interest. Freehold anticipates the proceeding through the CRA could take approximately one year to resolve. Furthermore, the payment of these deposits does not currently impact Freehold's earnings or funds flow from operations or net debt. Now back to Dave Spiker for his final remarks. Thanks, Dave. So yes, looking forward, we are very enthusiastic about the next twelve months of operations. We've witnessed a steady trending up of capital and production volumes on our lands, both in Canada and The U. S. And at current commodity price levels, our high royalty margins offer significant option value to provide returns to our shareholders. With today's increase to our twenty twenty one monthly dividend, we highlight this is the second time in the past four months that we've revised our 2021 payout upwards. And the royalty acquisition that we announced in November was a key milestone for Freehold and it marked the first material transaction within The U. S. We see the deal as both enhancing the growth profile of the company while providing further sustainability of our dividend, which has been reiterated by the highlights of yesterday's results. So moving forward, we'll continue to provide significant free cash flow for our shareholders with a focus on maximizing return either through further increases to our dividend, through value enhancing acquisitions or reducing our leverage. I'll now pass the call to the operator for questions. Thank you. We will now take questions from the telephone lines. Our session. First question is from Jeremy McRae. Please go ahead. Hi, guys. This question is actually more for David here just with almost you being in that position now for a year and somewhat high level as well too. How are you guys looking at leverage post COVID now? Just in terms of is it more focused to repay debt almost to nothing? Is it more dividend increase used for? I just wanted to kind of understand how you're viewing leverage differently nowadays. And then just as a follow-up question, just with The U. S. Acquisition, how do you see those going forward here? What does the company look like five years from now in terms of the amount of U. S. Activity? And then just given your comfort here now that you've seen a good couple of months of activity on those lines? Thanks, Jeremy. First off, we've a pretty simple business model. It costs about $15,000,000 per year to run our business. And then after that, we generate a lot of free cash flow. And there's three places that we can allocate that. We can allocate it to dividends, we can allocate it to paying down debt or we can allocate it to acquisitions. And so right now, what we've elected is that $43,000,000 in that cash flow is going to be paid to dividends. As Dave mentioned, we've got $66,000,000 in net debt at year end. And what we'd like to do is just allocate some free cash flow just to further reduce that debt level. And really what we want to do is free up capacity to do meaningful acquisition work going forward. And Jeremy, the years that I've been here, I've never seen so much opportunity for deal flow. Stepping down into The U. S. Has really opened up a lot of opportunities for us. And we've identified a number of areas in the Permian, in the Eagle Ford, in the Bakken, where we think that are just really core assets that if we can add those into our portfolio, it's going to give us long term line of sight additional drilling and production growth from those assets. So we see this as an opportunity to if we can delever a little bit to free up some cash to continue to add quality acreage to our portfolio. And that's having a solid rock solid portfolio is what's going to give us that sustainability long term. I don't think we really have a target as far as how much acquisition work we do in Canada versus The U. S. It's really opportunity driven. And but so we see opportunities on both sides of the border, both on the oil side and gas side. But we do see this with the amount of deal flow we're seeing, we want to be able to participate that just really to build up the underlying quality of the assets that we have in the company. Okay. And just how do you like how are you guys competing against others, some of The U. S. Royalty companies? Like is there like do guys have a bit of a unique edge that or what like maybe some of the constraints some of U. S. Guys are facing? Like how are you able to win some of these deals? Yes. I think we're competitive. We've shown that we're competitive down there. And I think that one of the reasons that we can be competitive is that we've got a really, really strong technical team here that's focused on acquisition work. Every deal we look at, we look from a grounds up, bottoms up basis. And so I think that we can compete just from a technical perspective of how we see those lands getting developed. We can be a little more confident in some of the development activity going forward projected on those lands. So I think that, that's our just technical work and quality of evaluation work. The following question is from Aaron Bukowski. Hey, good morning, guys. Good morning, Aaron. How are you doing? Good, thanks. So in the MD and A, you talked about retaining financial flexibility to pursue M and A and consideration for setting the dividend below the 60% payout range. And if I look in the presentation on Page four of your slide deck, you talk about 50% of free cash flow being available for M and A. I guess my question is, does this mark a subtle change in the payout policy? Should we be thinking about a payout ratio of 60% of free cash flow net of, say, minor tuck in acquisitions? And I ask because it's my impression that 60% of free cash flow went to equity holders in the form of the dividend and the remaining 40% was used for M and A or debt reduction? Yes. The objective of the 60% to 80% payout ratio remains intact. It's just the pace of which we're going to get there. And so we're taking a measured approach to that. I think we see an opportunity, first off, we've talked about just to free up pay down a little bit more debt and focus on acquisition work. One of the things that we're looking at is reviewing our dividends quarterly, we can look at get some comfort in where commodity prices are, get some comfort in what we see on the horizon for acquisitions, just make sure that our debt is in check and then make another measured move. So it's a measured approach that we want to take rather than a quick ramp up and then be exposing ourselves to potential to reduce the dividend if the business changes again quickly. So the strategy remains intact. We're going to work our way up to the 60% to 80% payout ratio. We have been seeing for a while now that we think that we're going to be on the lower end of payout ratio given the opportunity set that we see in front of us to continue to make the company better. Thanks. And just poking a little bit further on that. So if the dividend will be reviewed in Q1, you'll have spent half the year with the payout ratio that's significantly below your target range. Do you foresee Freehold paying out 60% of free cash flow in 2021? And I asked you just to get to that point, it would imply a large, arguably unsustainable increase later in the year. Yes, I don't think we really are looking at it as a kind of having to catch up. We're looking at more run rate dividend. And so that dividend is going to move up as we feel it's appropriate. But we're not going to look back and say what we have to do to increase it to the balance out 60% for a year. It's more a run rate going forward and as Okay. I have a couple more questions, if that's okay. On one hand, you're talking about sort of a measured approach to the dividend because of potential oil price risk as you talk about supply and demand balance continues to be tenuous. Yet on the other hand, you're pretty excited about acquisitions and you aren't hedging future production, which I guess leads to two questions. Firstly, I'm curious in general terms what price deck you're using to sort of evaluate and underwrite future M and A opportunities. Are you finding attractive opportunities at $50 WTI or are you using something closer to the strip? Yes. I think it's been a bit of a challenge with the price moving so rapidly. I don't sure any of us anticipated the move yesterday by OPEC plus and subsequent price jump there. But when we're looking at acquisitions, our first foray is what does it look like on strip pricing. And then from there, we back it down and with the $55 flat pricing tested there, tested at $50 and see what makes sense. And one of the things that we've done a lot of acquisition work look back and it's a testament to the quality of technical work. We've always nailed production profile that comes out and the drilling activity. We're pretty good at that. But I think like most of us in the past, we're it's hard to predict price. And so when we do our acquisition work, we're being a little bit more conservative on the price decks that we're using. And we think that there's still ability to do some very high quality acquisitions at a very attractive rate of returns at pricing well below strip pricing right now. Thanks. Guess that leads me to my next question. It's on hedging. So right now, you can lock in WTI over, I guess, through 2022 with somewhere around $60 Has your view on hedging at the corporate level changed at all since you've, I guess, taken over since this commodity price sort of rally has taken place? No, we don't the beauty of our business, Aaron, is that we have no capital obligation. So it costs us about $15,000,000 to run our business. After that, it's just pure free cash flow. So it's not as if we have to fund a drilling program or to maintain our production or have a risk of being put on notice by somebody to do a drilling or have some operational unexpected operational costs. So we think that our business as it is because we don't have those capital costs isn't a business that we need to hedge. And that's one of the reasons that shareholders participate in the business is that ability to participate in commodity price moves, knowing that there's no capital commitments in the company. So we think that with the dividend policy of paying out 60% of our cash flows at 80%, that we've got flexibility in there to run our business very effectively without having to hedge. Okay. And one final question for me. If we think about sort of the production added from new wells into in 2021, roughly what portion of that do think is going to be coming from Canada? What portion will be coming from The United States? Let me have Rob King answer that question. He's much more familiar with exactly where your ballgame is. Yes. Hi, Aaron. So on the production forecast, we have 10,500 to 11,000 BOEs a day forecasted now for 2021. Of that, about twelve fifty is from The U. S. That's an increase from when we announced our U. S. Acquisition in November. We had about eleven fifty barrels a day expected for 'twenty one. So a combination of better commodity pricing as well as bit more active rig activity has caused us to have a more constructive view on near term production growth in our on our U. S. Assets. On the Canadian side, we've embedded in about just a little bit over 15, one-five, net wells in Canada. So that would sort of add in the range of about 700 barrels a day, 900 barrels a day of new production within Canada. Please go ahead. Hi folks. Congrats on the quarter. The U. S. Royalty acquisition I thought was very well timed, especially given where prices are today. I was wondering why you decided to use so much equity in the acquisition, not just the revolver, maybe break the payments into milestones or something like that? Hi, Dave. It's Dave Hendrick here. We like to keep our capital structure flexible. And at the time, we obviously weren't expecting prices to be where they are today. With that said, our target always is to maintain debt level below 1.5 times FFO. And so even where you can see where it is at year end is we're at the one times level currently. And so we look at acquisitions and we want to be mindful about the flexibility. And because if you do it all on debt as well, that sort of limits your flexibility going forward. So it's about looking at it And the issuing equity, we reviewed it. It was accretive and allowed us to execute a deal and not overburden the balance sheet with debt, which is sort of against what we hear back from our investors as far as they like something with a management profile. So we balanced that out and decided to issue equity. But you may have noted as well is that the acquisition was around $74,000,000 and the equity raise was about $60,000,000 So we did layer in a good portion of debt with that deal anyways. Further to Dave's point there is that at the time strip pricing in late November when we did that deal, it didn't have oil above $50 until late twenty twenty eight. So the environment has significantly changed. And so think if we knew where prices were going to go to where they are today, then maybe we would have took on a little bit more debt. But at the time, we thought that was a prudent approach, and we're happy that we were able get that deal in the door during that price cycle. Got you. And I mean just I remember hearing a 15% sort of IRR or mid double digit sort of IRR target or hurdle for acquisitions. But just given what the other color I mentioned earlier, just about using $50 or something more conservative than today's prices, I'd imagine the space has become way more competitive in terms of acquisitions now. Are you still sort of targeting that return? Or are you looking at on an accretion metric sort of perspective? Just tell me a little bit more about how you're thinking about U. S. Or acquisitions going forward. Yes. It's Rob speaking. So that's still that's probably be, I would argue, at the lower end of our return expectations when we're thinking about opportunities that we're adding to our portfolio. Just to put it in context for the two small tuck in transactions that we added in so far in Q1, just under $5,000,000 Those each had IRRs down north of 20 and free cash flow yields that were north of 20%. So we're still able be transacting on opportunities in this current commodity price environment. Agreed, competition, but there's also a lot of opportunities. When I think about the number of transactions our team reviewed in January and February, we looked at about a dozen opportunities, transacted on two of them. We're looking at right now in the hopper, there's north of 15 opportunities that we're looking at. So there's a lot there is certainly a lot of competition, but there's a lot of opportunities as well. Right. Thanks for that. And then just lastly, you be breaking out The U. S. And Canadian production now that the acquisition is closed? Yes, I would anticipate we would be breaking out U. S. Versus Canadian production. We certainly provided that in our guidance for this year, and that will be the intent going forward. All right. Thanks. That's all the questions for me. Thank you. We have no further questions registered at this time. I would now like to turn the meeting back over to Mr. Spiker. Yes. Thank you, everybody, for participating this morning. I just want to reiterate how happy we are with the quarter and our optimism for the year ahead. So thanks for your participation today. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.