Earnings Call: Q3 2020

Nov 10, 2020

Good afternoon, ladies and gentlemen. Welcome to the Third Quarter Results Conference Call. I would now like to turn the meeting over to David Spiker. Please go ahead. Yes. Good everyone, and thank you for joining us. With me on the call from Freehold are David Henry, our CFO Rob King, our Vice President, Business Development and Matt Donahue, our Manager of Investor Relations and Capital Markets. Before we get into the highlights for the quarter, and it was a really good quarter for us, we wanted to note that alongside the government and public health officials, we are actively monitoring COVID-nineteen and following the latest guidance. The health and safety of our by directing all employees who work from home initially. Now the word of public health measures in June, our return to office task force worked diligently to develop office safety protocols in alignment with government and public health guidelines. We were able to reopen our office in July with a reduced staff on the all the latest. We want to thank our shareholders for their ongoing support. So despite these ongoing concerns associated with COVID-nineteen and the prevailing commodity price, Freehold continues to deliver strong focused on sustainability of our providing consistent income source for our shareholders while reducing the overall risk profile by reducing leverage and positioning our royalty land ahead of the drill. We continue to highlight that during these periods of weaknesses, our strong margin and simple business model stand the test of time. Operationally, production on our royalty lands averaged 9,096 BOE a day, essentially flat previous quarter and down approximately 10% versus the same period last year. Shutting in production on our royalty lands averaged about 5% during Q2 'three, an improvement from 9% in the previous quarter, and we exited the quarter with only about 3% shut ins. Through the remainder of the year and in 2021, we see volumes stabilizing in our core South West Dakota. During the third quarter with 32 wells drilled. We caught the previous quarter and no drilling activity after excluding adjustments as producers responded to weaker crude oil prices. For the first nine months of twenty twenty, we had two sixty one wells drilled on our royalty land, slightly higher than our initial expectations. What we're seeing is activity continue to be focused on our core Viking play at Dogland, but we also saw increased drilling in core plays in Southeast Saskatchewan, Western Saskatchewan heavy oil, Cardium oil in West Central Alberta, and in liquids rich natural gas in the Deep Basin. We believe that with the lower volatility within the crude oil price environment and the stronger natural gas pricing through the winter months, producers will continue to remain active on our royalty lands into breakup of 2021. Given the backdrop for shut in volumes and uncertainty around the pace of third party drilling, pre hold announced early in Q2 its previously released 2020 guidance was no longer applicable. We are continuing to suspend 2020 guidance at this time with the expectation that we will resume 2021 guidance as more information is unveiled on spending levels associated with some of our top drillers. We expect to provide the next update to investors as part of our Q4 twenty twenty results, which will be released in March 2021. As part of our Q3 results, we are increasing our monthly dividend by 33% from $0.15 to $02 per share starting in January 2021 for shareholders on record as of 12/31/2020. At the revised monthly dividend level, Freehold's funds from operations are forecast to be at the low end of the annual payout range of 60% to 80%. With two months remaining in the year, it is our expectation that dividend levels will be at the low end of our payout range for 2020 as well. While increasing the dividend, we continue to maintain the strength of our balance sheet and will continue to pursue value enhancing acquisitions. At current commodity prices and the revised dividend levels, we expect to pay down approximately $2,000,000 to $2,500,000 in debt per month with leverage remaining below 1.5 net debt to funds from operations. I'll now pass the call to Dave Hendrie to walk through some of the financial highlights. Thanks, Dave, and good afternoon, everyone. Financially, as crude oil prices stabilize and natural gas prices improve, Freehold continues to deliver on the core aspects of its return proposition, a meaningful dividend while providing investors with a lower risk investment, differentiating itself from traditional oil and gas E and P companies. In the third quarter, Freehold generated 23,100,000.0 in royalty and other revenue, up 56% versus Q2 twenty twenty, reflecting improved liquids and natural gas pricing, lower cash costs and stable production volumes. Our royalty portfolio generated an operating netback of $27.2 per BOE during the third quarter, up 61% when compared to Q2 twenty twenty. Funds from operations for Q3 twenty twenty totaled $19,900,000 or $0.17 per share, up 8789%, respectively, versus Q2 twenty twenty. Our payout on a dividend paid basis was 27% in the 2020, down from 92% during Q2 twenty twenty. We target freehold payout to remain at the lower end of our outlined range of 60% to 80% for 2020, with our year to date payout at 67%. As previously mentioned, we increased our monthly dividend for 2021 from $0.15 per share to $02 per share, reflecting an improved and less volatile crude oil price environment and positive momentum associated with third party capital on our royalty lands, while still remaining cautious and measured. Cash costs for the quarter totaled $3.7 per BOE, an all time low for freehold. This was down noticeably from $4.79 per BOE in Q2 twenty twenty. The decrease versus Q2 reflects both lower operating and financing charges. The reduction in cash cost was most materially impacted by the disposition of working interest production during the previous quarter with the forecasted impact on operating costs expected to be approximately $0.35 per BOE. Freehold closed the quarter with $14,400,000 reduction in net debt from Q2 twenty twenty. Net debt totaled $81,700,000 at 09/30/2020, representing a 1x net debt to the funds from operations. The decrease in net debt quarter over quarter reflects stronger funds from operations. With oil prices likely to remain range bound for the remainder of 2020 and into the 2021, we expect our long term debt to EBITDA ratio to comfortably remain covenant compliant. Freehold's prudent strategy of maintaining long term debt to cash flow below 1.5x and a dividend payout range of 60% to 80% of funds from operations, providing cushion for potential volatility that may pick up in commodities. Updating our Canada Revenue Agency reassessments, amounts are consistent with those recorded last quarter. Freehold's corporate income tax filings for 2015, 2018 and 2019 were reassessed by the CRA in 2021. Pursuant to these of noncapital losses by freehold were denied, resulting in reassessed taxes, interest and penalties totaling $29,300,000 in addition to a denial of 129,900,000 of carryforward noncapital losses. Freehold has filed its objection of the reassessment, which required deposits totaling $14,700,000 to be paid to the CRA during the third quarter. 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 were filed correctly and that it expects to be successful in its objection to these reassessments, and therefore, the deposits paid to the CRA should be refunded with interest. Freehold anticipates that proceeding through the CRA will take approximately one year to resolve. Furthermore, the payment of these deposits does not impact prehold earnings or funds from operations or net debt. Now back to Dave for his final remarks. Thanks, David. So looking forward, we expect the next three to six months to remain challenging for the industry, although improving sharply from the oil price lows of Q2. Setting ourselves apart, Freehold provides investors relative stability as royalties represent a higher margin business. We continue to maintain flexibility in our balance sheet while maintaining sustainability in our dividend. At current share price levels, we feel the return proposition is an attractive entry point for investors. With today's increase to our twenty twenty one monthly dividend, we highlight how the royalty model is sustainable through all commodity cycles as we have demonstrated since we went public in 1996, nearly twenty five years ago. We continue to execute on the core aspects of our strategy moving forward with the goal of maximizing returns for our shareholders. In addition, we would also like to encourage all people to take a moment tomorrow to remember some of the sacrifices made by our Canadian heroes through remembrance day ceremonies. While many of us may not be able to attend in person given some of the restrictions associated with COVID nineteen, we think it is important for people to take a moment to recognize some of the tremendous sacrifices Canadian soldiers have made to provide us with the incredible freedom and quality of life we maintain in Canada today. We would now entertain any questions that you may have. Thank you. We will now take questions from the telephone lines. You. And the first question is from Jeremy McRae. Please go ahead. Your line is now open. Yeah. Hi, guys. Can you give me an indication of how many new leases lease agreements you've signed here for the quarter or looking to sign? And have you noticed any increase in activity on some of your gas weighted lands here? I'm thinking maybe Edson or in some of those other areas there. Yeah. Thanks, Jeremy. It's it's Rob speaking here. Maybe I'll answer your first your question first or the second question first. In terms of gas oriented drilling, we've seen a little bit of activity in the deep basin with a couple of the the producers that that that we're close with. I think that's you know, I'd say it's probably not been the key focus of our activity. It's it's really continued to be in the Viking, in the Cardium, in in the Southeast Saskatchewan, and we're beginning to see more activity in Clearwater. Those are certainly the the, I would say, the the big four that continue to be the most dominant in the portfolio. But, you know, some some of those Cardium locations are obviously have a have a fair amount of a fair amount of gas in them as well. So whether it's the the gas economics or the liquids economics that are driving it, you know, unclear, but they are being know, unfortunately, they are being drilled. And as listed new leases, let me get that. Out of hand here. It was a modest, a modest amount in terms of what we were able to, you know, secure in terms of new leases, certainly from a dollar amount, in terms of the lease the lease bonus revenue. Yeah. I I was just more just trying to see, you know, how much activity has really started to pick up as guys start to come approach and say we're getting comfortable with drilling again. Let's look to find these new leases or these lands over here. That's that's that's just generally how that's changed. Sure. Maybe I'll answer it a bit of a different way in terms of actual drilling because where we've seen activity pick up in q four here, you know, we're now on pace halfway through q four. We have about 50% more drilling on our lands relative to q three. Same areas are still the dominant areas of of activity, Viking, Sparky, Cardium, or kind of the the big three followed by it's followed by Southeast Saskatchewan. We've talked to another Clearwater players where they're, you know, they're they're, you know, two in particular talked about ten, fifteen wells in the winter drilling program here. So I think we certainly are seeing signs of activity picking up in terms of drilling. Okay. No. That's good. Thank you. Thank you. The next question is from Zai. Please go ahead. Your line is now open. Hey, folks. Great quarter. Just wondering, why not institute an NCIB? Just given PrairieSky has been doing something similar, and it seems like there's not many acquisitions going on. Yes. I think our perspective on the NCIB is that our preferred method of returning value to shareholders is through the dividend, which was our first priority. I wanna continue to manage our balance sheet is is second priority. And and I think that we're actually seeing quite a a good number of opportunities that are out right now. We do long term view that we think by allocating some some capital by key acquisitions, then we think that's a better allocation of capital than NCIB at this point in time. Certainly, every opportunity that we look at, we compare it to an NCIB. But right now, we think that there's opportunities to do business out there that would make our company better. Totally understand. Thanks for that color. Just wondering, as we get past OPEC and you have more line of sight on COVID, would you be targeting a 60% to 80% payout ratio on the dividend? Because the the 2¢ increase was good, but just just thinking about it longer term. Yeah. I've got definitely. You know, our our strategy is is still that 50 to 80% payout. We're looking at here as more of a bit of a measured dividend increase. You know, we still have a conservative view on commodity prices. You know, we're not a 100% sure, you know, how COVID is gonna play out despite some of the optimism this week with the with the Pfizer announcement. So we really need to see how that plays out. We need to see how our quarter plays out, and we're gonna reevaluate in q one, you know, once we have a little bit more confidence that the environment ahead of us is is stabilized and is sustainable. So the the target is still there, 60% to 80%. You know, how we ramp up to that through a measured approach is is how we're gonna handle that. So Alright. Thanks. That that's all for me. The next question is from Luke Davis. Just a few quick ones for me related to the last caller. How are you thinking about setting the dividend just from a modeling perspective? Are you typically kind of targeting the lower end at 60% and then thinking about the balance, the 80, as kind of a volatility cushion? Or how should we be thinking about that going forward? I think that's a fair comment, Luke. Definitely, for now, given the just the rapidly evolving business environment that's a little bit more comfortable operating at that bottom end, low end of of the payout range. It provides ourselves a little bit of of cushion in in case we do see a retracement of commodity prices again. But but also, we think that, you know, there's a good opportunity to to make some small smaller dividends that I mean, smaller acquisitions that enhance our portfolio. So wanted to see a little bit of room there as well. So it's a balance of a number of factors that are driving us initially to sit in that lower end as we just watch how the environment unfolds. Right. Makes sense. And then I guess following that, any change in terms of how you're thinking about hedging, just particularly when you see commodity pricing that sort of appears more constructive, and I would say more so on the gas side? Yes. We have not historically hedged, and it's not an area of focus right now. It means that the the prices are still volatile enough in either direction that, you know, we don't think that, you know, hedging is is the right thing for us right now. And and by the nature of our our conservative business model and and the high net asset we achieved, you know, hedging is not as a key part of our portfolio that would be, say, for a traditional E and P producer where, you know, we've got a a really good stable production base. It doesn't have an operating cost component to it and doesn't have a capital draw associated with it. So broad hedging is not a priority right now. Right. Makes sense. And then I guess final one for me. Just can you maybe frame out what you've seen in the acquisition markets to date? Any kind of changes in recent months? And can you kind of frame out how we should be thinking about that going forward? Let me just turn that over to Rob because he's got and his team have been been really looking at a lot a lot of opportunities in the last little bid here, and maybe just give some color on on what you're seeing. In terms of of since our last update in August, we've certainly seen an uptick on both sides of the border as it relates to potential transactions. These are both marketed processes, but also proactive conversations that that that we've been having. You know, in the on the Canadian side, a lot more achieved gaps on the on the manufactured decor opportunities and probably a lot more receptivity as it relates to proactive conversations with a number of of counterparties, particularly on the private side. So a fair fair amount of dialogue. I think the there's still still a fair bit of spread that's that's that's definitely out there. But, you know, with every with every month, we're we're we're optimistic that that that that spread will narrow. In The US side, lot of opportunities are are coming across our debts. I'd say, you know, more more more packages that are also, you know, fairly attractive that have a pretty interesting mix of near term production, tangible upside, and future upside. And, you know, that's not just a Bakken comment. You know, we've really been expanding our efforts and our and our our capabilities to be looking outside of North Dakota and have been and have been doing looking at a number of opportunities that that are in other basins that are, seeing capital being actively, allocated, in this current commodity price environment, and that's that's, that's providing some encouraging, opportunities for that we're actually looking at. Right. Makes sense. And then I guess final one, I can appreciate this might be a little bit more sensitive. But when you speak to spreads, can you maybe provide some broader ranges in terms of where the market is sitting and around where you'd like to execute transactions at? Maybe I'll just kind of talk more from one of the key tenants that Dave talked about that when we're looking at acquisitions, it really has to be accretive to our free cash flow yield. And so if I kinda use our free cash flow yield in that 15 ish percent range, plus or minus, depending on the depending on the day, it has to be superior to that. And so I think that's you you you it's a bit of a data point to kind of point to in terms of where where we need to see acquisitions to, to to to be attractive and be, competitive, you know, for us, and they're probably a little bit, a little bit inside that right now. No. It makes sense. Thanks very much, guys. Appreciate it. Thank you. There are no further questions registered at this time. I'll turn the meeting back over to Mr. Spiker. Okay. Well, thanks, everyone, for attending the call this afternoon, and thank you for your interest in our story, interest in our company and for the value proposition that we offer. So we good had quarter, and we look forward to talking you guys again throughout the coming weeks. Thank you, and good night. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.