Earnings Call: Q2 2019

Aug 2, 2019

Good morning, ladies and gentlemen. Welcome to the Freehold Royalties Limited Second Quarter twenty nineteen Conference Call. Please be advised that certain statements on this call constitute forward looking information. These statements relate to future events or our expectations for future performance. 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 Tom Lane, Chief Executive Officer. Please go ahead. Thank you, and good morning. Thanks for joining us. With me from Freehold are Alan Withy, our Chief Financial Officer Matt Donahue, our Manager of Investor Relations and Capital Markets and myself. We will summarize our second quarter results, and then we'll be happy to answer questions. Some quarterly highlights we wanted to expand upon include: On the operations front, Q2 twenty nineteen royalty production averaged 10,311 BOEs a day, up 2% versus the previous quarter. The increase in royalty volumes quarter over quarter was driven by strong activity levels during the first half of the year, particularly within the Alberta and Saskatchewan Viking and our liquids rich portfolio. Royalty interest accounted for 97% of production and 100% of operating income in Q2. Reflecting acquisition activity, which we will detail, we have increased our 2019 royalty production forecast from a range of nine thousand nine hundred ten thousand three hundred BOEs a day to 10,000 to 10,500 BOEs a day. We remain cautiously optimistic concerning activity levels through the remainder of the year with the expectation our royalty portfolio will continue to outperform the Western Canadian sedimentary basin activity levels. Utilizing our free cash flow and the flexibility within our balance sheet, Freehold closed a $30,000,000 acquisition of gross overriding royalty during the quarter. The transaction comes with drilling commitment on the part of the vendor on certain light and medium oil reservoirs in Central And Northern Alberta and Southwest Saskatchewan. At the time of closing, the royalty was producing two fifteen BUs a day with 94 of production being liquids. Funds from operations in 2019 under actual and strip pricing associated with the acquired assets is estimated at $3,800,000 Subsequent to quarter end, Freehold closed a $9,800,000 acquisition of certain royalty assets located in North Dakota, United States. As part of the transaction, USD $05,000,000 a acquisition deposit was paid in June 2019. Production and funds from operations in 2020 associated with the acquired assets is forecast to be approximately 200 BOEs a day and $2,300,000 respectively. This represents our first royalty acquisition outside of Canada. Frion has been looking at royalty opportunities in The United States for several years. And in the past two years, we have significantly improved our U. S. Knowledge base and developed our U. S. Entry strategy. We will initially focus on royalty opportunities in the Williston Basin, which is an extension of the Bakken 3 Forks place found on our existing royalty acreage in Southeast Saskatchewan. Our ability to understand the geology and play types make for a comfortable transition as we continue to build our expertise in doing business in The United States. Within Canada, Freehold saw continued strength in activity on our royalty lands during the 2019. In total, we had two seventy four wells, 10.2 net wells drilled in our royalty lands during the period. Of these, 127 or 2.9 net wells were drilled in the 2019. This represents a 34% improvement on a net measure and a 15% decrease on a gross measure over the same period in 2018. Typically, the second quarter represents a period of slower drilling activity. However, activity in our royalty lands outpaced expectations, particularly when compared to the same period in 2018. Together, Saskatchewan and Manitoba drilling represented approximately 51% of our gross drilling on the in the 2019. Alberta activity has again been concentrated in the Viking And East Central Alberta as well as in the Cardium and West Alberta. Moderate activity continues for Mandel oil plays throughout the basin. We continue to see activity emerging in the Duvernay and Clearwater with 12 gross wells drilled between these two plays in the 2019. Also, our top payers continue to represent some of the most well capitalized upstream companies in Canada. We are currently forecasting 20 net wells as part of our 2019 guidance. And while we are well ahead of our forecast year to date, we would like to see activity levels through the third quarter before making any revisions to this estimate. Both the Canadian Association of Oil Well Drilling Contractors and Petroleum Services Association of Canada are forecasting material reductions in drilling activity in 2019, greater than a 25% drop in drilling year over year. We are not seeing that on our lands. Dividends represented 62% of funds from operations for the quarter. This compares to 64% during the previous period and 101% during the Q4 twenty eighteen. We will continue to elevate our dividend evaluate our dividend quarterly, but given the volatility associated with the Canadian energy industry, particularly activity levels and the outlook for light heavy differentials, we have chosen to maintain our dividend at current levels. Through 2019, we're forecasting a payout of approximately 60% to 65% versus our previous guidance of 60%, reflecting a weakened outlook for crude oil. We have set a dividend payout range of between 6080% of funds from operations for 2019, so we remain at the low end of this range. I will now pass the call to Alan to walk through the financials. Thank you, Tom. Good morning, everyone. This quarter, we continued to demonstrate strong financial flexibility at Freehold. During the 2019, Freehold generated funds from operations of $30,100,000 or $0.25 per share. Revenue from oil and NGL production increased to 93% of total revenue in Q2 twenty nineteen. A retreat in natural gas prices during the quarter, along with a focus towards more activity within oil plays, impacted this weighting, a weighting that has become more valuable over the last two years. Continuing a multiyear trend, Freehold's royalty production amounted to 97% of total production and 100% of operating income in the second quarter. That's up from 95% of total production and 99% of operating income in Q1 twenty nineteen. Freehold declared dividends of $18,700,000 or $0.01 $5.03 $25 per share in Q2 twenty nineteen, implying a 62% payout ratio one within the targeted payout range Tom mentioned earlier. In conjunction with our Q2 twenty nineteen results, we updated our WTI and Edmonton oil price assumptions for the full year of 2019, along with the 60% to 65% payout ratio expectation at the low end of our targeted payout range. Freehold closed the quarter with net debt of just over $98,000,000 representing 0.9x net debt to funds from operations. The net debt figure increased just over $20,000,000 versus the prior quarter, reflecting acquisition activity closed late in the quarter, partially offset by free cash flow generated in excess of dividends paid during the period. For year end 2019, based on our forecast and including The United States expansion closed subsequent to the quarter end, we forecast net debt to funds from operations of approximately 0.8 times. Net income for Freehold in the second quarter was $3,400,000 or $03 per share. As discussed in our call last quarter, Freehold received a proposal letter from Canada Revenue Agency or CRA, where CRA stated that it intends to reassess and deny Freehold's deduction of certain noncapital losses claimed and carried forward in the tax return filed for the year end December 3135. Freehold is and will continue to vigorously defend its tax filing position. However, it anticipates the proceedings with CRA could take considerable time to resolve. We firmly believe Freehold will be successful defending its position, and therefore, any amounts paid to CRA should be refunded plus interest. No provisions have been made in the financial statements relating to the proposal letter. Now I'll turn it back to Tom for his final remarks. Thanks, Alan. In closing, we executed on our strategy in Q2 twenty nineteen. We were able to grow our royalty production organically quarter over quarter. We provided a sustainable dividend to our unitholders. We executed on our acquisition strategy utilizing free cash flow while unveiling our first U. S. Royalty transaction. We reiterate to our shareholders that the move to The U. S. Will be measured with the goal of improving the quality of our royalty portfolio. We see the Williston Basin as providing a strong near term opportunity set for our shareholders. Looking forward, we will continue to strive to maximize value for our shareholders by investing our free cash flow in the form of dividends, value enhancing acquisitions and or paying down our debt. Overall, Freehold offers investors a lower risk oil and gas investment vehicle with upside oil prices, and we feel we've furthered this during the quarter. I'll now pass it over to the moderator for questions. Our first question is from Dennis Fong with Canaccord Genuity. The first one that I have is just on The U. S. Royalty acquisition and kind of your view therein. How do you guys see the build out of essentially your U. S. Business now that you've kind of done your first foray into the North Dakota Bakken? And how should we think about the pace of acquisition growth, especially if you're able to complete transactions at a 3.5 to 4.5x cash flow rate and show that and on assets that show production growth over time? And I've got a follow-up. Thanks. Hi, Dennis. Good morning. This is Tom. Thank you for the questions. First of all, when you look at our U. S. Royalty acquisition strategy, we're just looking to add assets that improve the quality of our existing portfolio. We look in Canada and in The U. S. To find those. We do believe right now that there is plenty of opportunity on both sides of the border, but we are we have been looking at The U. S. For some time, and we'll continue to look the Williston Basin area, primarily on our in our first go into The U. S. As far as the pace, I mean, we just use excess free cash flow, as you know, Dennis, to buy acquisitions, and we've used a little bit of our balance sheet as well. And don't expect every deal that we have is 3.5x to 4.5x cash flow. It all depends on the upside and the pace of drilling on lands, as you know. So that cash flow range can range as low as this to double this as well for quality assets, which have lots of drilling opportunity. As far as so we'll just allocate cash to the best opportunities that we see coming. Some could be in the Williston Basin and some could be in Canada. Okay, perfect. And just quickly as a follow-up in terms of using a little bit of your balance sheet to potentially fund transactions. What are kind of if you wouldn't mind reminding us as to what kind of the debt targets that you would like to stay within to kind of potentially pursue some of these potential acquisitions? Yes. Our debt as you know, Dennis, our debt targets will be less than 1.5x debt to cash flow. We won't push it right to that limit. We'll stay comfortably underneath that as we have done in the past. Okay, perfect. And then last one here is just in terms of looking at the activity levels in Canada, I was just curious as to how the initiatives that you were indicating and that you're pursuing to drive more committed wells and capital on your land, how that's kind of faring along? Yes. I mean this is a long term process for us, Dennis, to energize our land. We're working with producers. If producers can commit to drilling wells, we might offer a small break in the royalties to encourage development. Okay, thanks. Thank you. Our next question is from Amir Arif with Cormark Securities. Please go ahead. Thanks. Good morning, guys. Just a quick question for you, Tom. Can you just give us a little more color about the opportunities you do see Basin just in terms of like the fragmented nature of any royalty opportunities that are there splits between mineral versus cores that you see and just the maturity of the play in general, just as you contrast that to what you've seen in the Canadian side? Yes. Thanks, Hamir, for that question. When in Canada, there's more Crown land than there is free mineral title land, freehold land, probably eighty-twenty. It's flipped in The U. S. So as far as opportunities, most of the opportunities in the Williston Basin are mineral title. As far as fragmentation of land, usually, we look at land that's already been kind of got the drilling spacing units in order and stuff like that. So usually, there's already a lot of the hard work is done, and we kind of come in just before the drilling starts. Okay. And then for this specific acquisition, is that the royalty for all the zones? Or is it just the Bakken versus the 3 Forks? Is there any split on Yes. It would be all zones, but the target here is 3 Forks Bakken. Okay. And then just a final question on the Canadian acquisition, the $30,000,000 acquisition with the drilling commitments. Did those drilling commitments, based on your projections, does that hold production and or cash flow flat as you move out a year? Yes. This it grows or is slightly or is flat in the near term. Okay. Okay. And the reserve life to that production? Many, many, many years. I actually do not know that, but the reserve life index would be over ten years for sure. Okay. Sounds great. Thank you. Thank you. Our next question is from Jeremy McRae with Raymond James. Please go ahead. Hey guys, it's a couple of questions on these acquisitions here as well too. The first question is just more of a high level, like what do you guys and how do you guys approach acquisitions in today's market versus what you guys would have done a couple of years ago when you look at acquisitions? Like has your hurdle rate for acquisitions changed? Like what exactly are is or do you think there's different more important things with acquisitions nowadays? Maybe if you can just kind of go along those lines. Yes. Thanks, Jeremy, for the question. I mean as far as when we look at acquisitions, we try with every acquisition, want to improve the quality of our assets. So that's number one. Number two is the where we've traded down, everything's traded down. So we have to everything has to be accretive. So we do demand a higher rate of return for our assets. I think we I'd a couple of years ago, we'd say high single digits, low double digits. Today, it's low double digit rate of return after tax is what we look for. Okay. And then And also a quality counterparties as well. We've always wanted quality counterparties, but we're just more attuned to that in in this day and age. Okay. Is there something is are you more inclined to have royalties on future inventory or more inclined to have near term cash flow? And just with the follow-up, are you able to give any kind of indication of how many locations these royalty rates may apply to that aren't kind of producing now? Okay. Yes, I guess when we look at we've done several deals where it's mostly raw land and we've and they're usually typically small deals, but usually they have drilling activity forecast in the near term, not like four or five years down the road. So it's something that has near term cash flow projected. Some of the assets we have bought that has I mean, these ones in The States has good cash flow today because that's why we have such a low multiple on the deal. So it's a balance. It's all driven by net asset value and the quality of the asset. Okay. And are you able to provide any kind of future locations that you see on these acquisitions? Yes. There's always yes. Well, I mean, I guess, we when we do a bottoms up analysis, there's always future locations that we put on the acquisitions. Okay. As far as the Canadian $30,000,000 royalty we just put in, we do have a 100 well commitment. And if that isn't met, then the royalty percentage goes from 1.7% to 2.7%. So that's how you incur well, if they don't drill 100 wells, it's a good deal for us. If they do drill 100 wells, it's a good deal for us too. Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to you, Mr. Nguyen. Yes. Well, thank you very much. It is thank you, everybody, for joining us on the call. We're excited about our acquisitions that we did in Q2. We generated increase in production on a per share basis, organic growth quarter over quarter. We're pretty excited about that in this environment. Thanks for the call, and everybody have a great weekend. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.