Earnings Call: Q1 2020

May 6, 2020

Good morning, ladies and gentlemen, and welcome to the First Quarter Results Conference Call. I would like to turn today's meeting over to Tom Malay. Please go ahead, sir. Thank you very much. Please be advised that certain statements on this call constitute forward looking information. All statements as in those historical facts may be forward looking, and we caution a listener. Hi. Good morning, and thank you for joining us. With me on the call from Freehold are Dave DeFendry, our CFO, Bob Lamond, our asset consultant, VP, Bob King, our VP our VP business department, and Matt Donahue, our manager of investor relations in Capital Markets. Before we get into the highlights for the quarter, we wanted to note that alongside government and public health officials, we are actively monitoring COVID nineteen updates and following the latest guidance from Alberta Health Services and other provincial health departments. As we hold, we want to thank our health workers in Alberta, Saskatchewan, and across Canada for battling COVID nineteen. As the COVID nineteen pandemic evolve continue to evolve to evolve, we're always prioritizing the health and safety of our workforce by directing our employees to work from home since March 2. We appreciate the continued efforts of our staff during this time and want to thank our shareholders for their ongoing support. Operations in first quarter royalty production averaged 10,618 GB today, up 5% versus the same period in 02/2019, and up 3% quarter over quarter. Increases in volumes were reflected in the last third party drilling additions, strong production performance associated with recent acquisitions, and meaningful prior period adjustments partly relating to our auto function. Royalty liquid production averaged 5,900 73 BOE a day for the first quarter, up 7% versus the same period in 2019 and up 1% when compared to the previous quarter. Production from pre coal U. S. Royalty assets averaged 242 barrels a day on the first quarter, representing a 32% increase from the previous quarter. Royalty interest accounted for 96% of total production and a 100% of operating income. Had a solid start for the year on drilling point with a 175 gross, 52 net wells drilled on our royalty line over the period. That compares to a 186 gross, 4.5 net wells drilled during 2019 and a 147 gross, 7.3 net wells drilled on our land during the same period in 02/2019. Drilling continues to be focused between Saskatchewan and North and Manitoba, which together represented approximately 64% of the gross first quarter drilling, 75% on a net basis. So we'll continue to target oil prospects, specifically the license wells in West Central Saskatchewan and East Central Alberta. We grew up with sixty sixty five gross 3.3 net wells drilled during the quarter. Mississippi sub crop oil plays Southeast Saskatchewan and Southwest Manitoba saw 29 gross 1.3 net wells drilled. The various manhole oil plays across Saskatchewan and Alberta saw 17 gross and point eight net wells drilled. Not including 10 gross, point two net wells drilled on recently acquired Scorpio royalty lands in Central Alberta. And seven gross and three net wells on Clearwater royalty lands in Northern Alberta. In the quarter, 62% of the gross billing, 70% net, was on gross overriding royalty lands. 13% growth in the title land, 20% net. And 25% of the growth on those on unit interest for two and more than 2% net. Activity continued to be funded by the most stable operators in the industry. At the quarter end, Freehold announced that with continued weakness in crude oil prices due to the COVID nineteen pandemic and and a low tech rush of supply war, Freehold's board of directors revised a monthly dividend rate from 5 and a quarter cents to 1 and a half cents per common share to be paid on May 15 to shareholders on record on April 30. At the revised monthly dividend level, Freehold's funds from operations are forecasted to be dividend outflows for the major of two of twenty twenty and are targeting to be at the low end of our payout range of 6080%. Adjusting the dividend at this time concerns the strength of our balance sheet and enhancing optionality to pursue value enhancing propositions as they present themselves later in the year. We will also announce that due to uncertainty associated with underlying business environment, including the potential voluntary shuttles of production, regulatory and bonus production curtailments, high crude oil inventories and continued price volatility, previously released 2020 guidance is no longer applicable. We expect to provide the revised guidance updated at times of increased stability associated with commodity price environment in our loyalty payer capital programs. Lastly, on April 30, Freehold disposed of certain working interest properties with estimated production of 265 BUs today. Already agree that the future has agreed to assume decommissioning liability for approximately $3,700,000 on these properties. The holders agreed to pay 1,700,000.0 into escrow that will be released to the purchaser once the legal interest in the assets are satisfactory transfer. An additional 300,000.0 will be just deposited on the on behalf of the purchaser with various regulatory regulators and security deposits. I will pass the call to be able to walk through some of the financials. Thanks, Tom, and good morning, Financially, while we invert a significant retreat in global oil prices, which commenced in mid March, Freehold continues to pay a meaningful dividend, which we adjusted for the lower commodity price environment and to manage our debt levels. In the first quarter, Freehold generated 26,300,000.0 in royalty and other revenue, down 26% versus the same period in 2019, reflecting lower commodity prices, partially offset by higher production volumes. The total royalty revenue was comprised of 83% oil and NGL, which also reflected the decline in oil prices. Our royalty portfolio generated an operating netback of $25.22 per BOE in the first quarter, a 30% decline versus the same period in 2019. Points sold from operations for q one twenty twenty totaled $29.20200000.0, down 31% from q one twenty nineteen levels. Our payout totaled 92% in the 2020, up from 64% during the same period in 2019. At the revised dividend level, we target freehold payout to remain at the low end of our outlined range through the 2020 with the expectation to be greater than 100% for the 2020 given the expected commodity prices, differentials and shut in production volumes. We will generate approximately $11,000,000 in cash flow over our dividend in Q1 twenty twenty, which we allocated towards acquisition and paying down debt. We incurred a first quarter twenty twenty net loss of $9,000,000 compared with a 7,100,000.0 net loss recorded during the same period in 2019. The slightly higher net loss reflected lower volumes due to the retreat in oil prices later in the quarter as well as an impairment loss of 9,600,000.0 related to Bluehost's working interest properties recorded in the current quarter. This compares with a 14,100,000.0 impairment loss recorded during Q1 twenty nineteen related to the termination of a specific production volume royalty agreement. Cash cost for the quarter totaled $5.74 per BOE, down from $6.39 per BOE during the same period in 2019. The decrease year over year reflects reduced general and administrative charges, deferred payment of stock based compensation and increased production volumes. The first quarter typically represents a period of higher G and A for Freehold based on the seasonal nature of these expenditures. Freehold started the quarter with a $6,000,000 reduction in long term debt from year end twenty nineteen as cash flows exceeded acquisition spending. Net debt totaled $101,800,000 at 03/31/2020, representing 0.9 times net debt to fund sales from operations on a trailing twelve month basis. The increase in net debt quarter over quarter reflects the decline in oil prices, acquisition activity, a a decommissioning liability disposition, and the higher dividend payout. As the oil prices are likely to remain depressed through 2020, we expect our long term debt to EBITDA ratio to increase through 2020, but remain covenant compliant. Preval's prudent longer term debt strategy of maintaining long term debt to cash flow below 1.5 times and dividend payout range of 60 to 80% of funds flow from operations provides cushion for volatile prices like those currently being experienced. However, COVID nineteen pandemic has caused significant destruction of demand for oil, volatility in commodity prices, and uncertainty regarding the timing for recovery, which has made the preparation of financial forecast challenging. As a result, there may be adverse changes in cash flows or debt levels that are currently unforeseen. Now back to Tom for his final remarks. Looking forward, we expect the next three to six months to represent a challenging period for North American exploration production industry. Setting ourselves apart, we hope to provide investors a higher margin business as we do not pay typical costs associated with oil and gas operations and reclamation, enabling more returns to be transferred to our shareholders. So with our highest dividend level, we continue to maintain flexibility in our balance sheet while maintaining to sustainability in our dividend. At current share price levels, we feel the return proposition is an attractive entry point for investors and sustainable in the current commodity environment. In terms of how we expect to allocate free cash flow, our preference is to ensure stability of our sustainability of our dividend and having a clean balance sheet near term with the medium term outlook shifting value pre value creation via propositions to grow and improve our royalty portfolio. The ability to access capital with equity and debt remains challenged for many e and t producers. And we believe we can serve as a financing tool through the creation of new royalties in Canada and in The US. If we are unable to complete acquisitions with free cash flow, we expect to pay down debt. Thank you for joining us and we will now entertain any questions. Thank you. For those on the telephone, you may press 1 to ask a question at this time. You. We'll take our first question. Please go ahead, caller. Your line is open. Hi, good morning. It's Dennis on over at Canaccord. I've got two quick questions. The question is, I understand that you guys have pulled back your retention guidance. We're just hoping to find out in terms of how you guys look to do a lot of shut ins only to keep you. What are some of the initial indications that you received from the conversations from your loyalty payers? Hey, Ross. Hey, Dennis. Hey, Sean. Hi, Dennis. In terms of of shut ins as we look into q two, maybe just provide a a little bit of commentary around that. So when we've when we usually have, call it, thirty to sixty days where a full flapped or well has been shut in before it's booked. So we've actually been having a very regular and proactive discussions with our fee payers just to understand, you know, what they're thinking, how they're thinking, when they may be shutting in production. But, you anything we might be able to do to to mitigate that. So that's really kind of easy to run where a lot of our intelligence is as we as we look at what our production profile could look like through the the balance of 02/2020. We really saw very minimal shut ins in in March time frame. When I say minimal, it was it was sort of something much less than 5% and probably, you even even less than that. You know, our our dialogue with our key pairs would sort of point to somewhere in the five to 10% range of shut ins for for April. And, you know, our suspicion is if we get into May and June, that number's going to increase. And, you know, is it is it gonna it could double, you know, to the 20% range. That's sort of a a a a modeling assumption that we put in place. And then it'll be obviously highly sensitive in q three and q four as it relates to what the what the then current commodity prices will be. But that sort of gives a flavor of just how we're thinking about shut ins right now, Dennis. Great. My follow-up here as well is, I know you mentioned on your ATM yesterday that there was a wide pay to ask spread for royalty assets. How are you thinking about this in the context of obviously your current balance sheet strength? I know Tom just made that comment about any excess free cash flow getting put towards the balance sheet. And also kind of the potential to do these type of deals in this type of market, how are you addressing this, as well as what are you expecting as maybe near term tariff to narrow some good asset spread? Thanks. Mhmm. Yeah. Well, in terms of, you know, Tom Tom has his right in terms of the real priority order of our our free cash flow sort of getting that first, you know, balance sheet second, you know, and then third will be allocation towards the acquisition side of our of our portfolio. You know, in terms of how we're what we're what we're sort of we're optimistic in terms of what opportunities might might come about here. We have a a fair amount of dialogue, you know, particularly with convenience producers in terms of what what what might be possible and are continuing to look at a number of opportunities, you in the Bakken. It is you know, cash is is is is is capital's constraint for everyone, you know, right now. So it is one where we're being very careful. And I think our suspicion is our our acquisition activity will likely be more, you know, second half weighted rather than, things within second quarter as we continue to build our free cash flow position and monitor the level of leverage that we have. In terms of what narrows that bid ask spread, and I think a lot of it is is is a is a factor of time. It's a you know, the longer that prices are at the level that they're at, that that market therapy starts, you know, starts changing people's block patterns relatively quickly. Great. Thank you. I'll turn it back. Thank you. We'll now take our next caller. Please go ahead. Your line is open. Go ahead, Paulie. Your line is open. Please ensure the mute function on your telephone is pushed up. Oh, hi, Tom. This is Amir over at Walmart. Just a couple of quick questions for you. Just on your twenty twenty outlook, I know there's no formal guidance. And I was trying to follow on the strategy. But can you just give us a color if there are any growing segments on your land? And if there is none, where do you see production your if there are growing, taking place? Yeah. Amir, I'm just wondering if can repeat that question. It was a little rough for us to hear. Oh, sure. Yes. So just curious if there are any growing drone commitments commitments on your lands where people were some of your royalty companies have to grow on your lands based on the royalty agreements as well. And then if there are none or even based on that, where do you see production declining to by year end, please, still, on your end? Amir, that's, know, that I mean, that's a guidance question, really, and we're not giving guidance right now. I I think, Jay, when we look at what Rob has mentioned about shutting, and we think that, you know, it's only gonna be towards the end of the year before drilling starts taking off again. We we use strip prices as our indicator. So pretty difficult to see a lot of near term drilling, and it's very difficult to forecast. And we don't have we we don't have guaranteed commitments to drill. We do have, you know, some contracts where, you know, royalty changes we those are gonna happen, but those are more long term. Rob, do you have a plan? Yeah. Think I'm always following here. Our our Q1 net drilling of 6.2 net wells was, certainly ahead of expectations. So we started the year both from a production standpoint. Our our royalty production is the highest it's been in the last two years in in the first quarter. And we also have a number of net wells that were drilled in Q1. We certainly have that many wells drilled on Orion since March 17. So, that was one where we're anticipating near term drilling activity. The other aspect, you know, our decline rate on a corporate basis is 18%. So just in terms of how you're how you're modeling it, so it can be an 18% decline offset with, you know, a pretty robust Q1 production levels as well as robust Q1 drilling levels, so it really can help you calibrate your model. That's helpful. And just a second question on the dividends. I mean, companies are viewing the dividend cuts more as a temporary suspension or reduction in dividends. And so do you see your dividends increasing next year based on just the extent of how much the stock price is improving to next year or dividends only grow from here as production levels grow? We will continue to set our dividend along our 80% payout ratio target. And as you noticed in the last couple of years, we've been at the bottom end of that payout ratio, and we probably will continue to be that as we set the targets going forward. And as we see prices rebound, you know, we will take a look at strip prices and other factors instead of dividend. Thank you. We'll take our next caller. Please go ahead. Your line is open. Morning, Jamie Kievich from CIBC here. Most of my questions have been answered already, but I'm curious on this one, if you can offer any insight. I mean, a lot of freehold tax pools came through the acquisition of working interest properties over the years. And given the disposition at the end of Q1 there or at the April, sorry, do you foresee that we have any challenges to utilize the pools going forward given how small working interest volumes have become in the corporate profile? Andrew here. So we we didn't sell all of our working interest by any means. There's, you know, roughly around half of it. So as far as any challenge from the government or from CRA, we haven't we haven't heard anything back from them with regards to their challenge. The challenge we've already been told to not holding the forward disposition. We're we're working through this position is largely around managing the decommissioning on on some labor life working interest assets. And so the other portion of the working interest assets, we continue to operate them and it's one important part of the of the business. And so we're not expecting any change in our tax tools going forward. But, obviously, until we hear something back from C. A, it's hard for us to provide any further details on that. Okay. That's good. Thank you. Thank you. As a further reminder, please press star one if you would like to ask a question. At this time, there are no further telephone questions in the queue. Well, thank you very much for joining us on our call this morning. Stay healthy everyone. Thank you. Thank you. That will now conclude today's conference call. Thank you for your participation, ladies and gentlemen. You may now disconnect.