Earnings Call: Q1 2019

May 8, 2019

Good morning, ladies and gentlemen, and welcome to the Freehold Royalties Limited First Quarter twenty nineteen Conference Call. Please be advised that certain statements on this call constitute forward looking information. These 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 Milane, Chief Executive Officer of Freehold. Please go ahead, sir. Thank you, and good morning, and thanks for joining us. Also joining me from Freehold are David Speicher, our Chief Operating Officer Bob Lamond, our Vice President, Asset Development Alan Whitby, our Interim Chief Financial Officer and myself. We will summarize our first quarter results, and then we'll be happy to answer questions. Some quarterly highlights we want to expand upon include: on the operations front, Q1 twenty nineteen, royalty production averaged 10,139 BOEs a day, down 9% versus Q1 twenty eighteen and two percent versus the previous quarter. The variance in royalty volumes year over year was driven by a combination of natural declines, reduced audit function additions, weather related shut ins and lower third party drilling during the 2018. Royalty interest accounted for 95% of production and 99% of operating income in Q1 twenty nineteen. On the working interest side, we expect to remain active in further dispositions through the remainder of the year. We also expect to shut in some natural gas working interest volumes through the summer months with the expectation that pricing will not justify returns. We continue to forecast 2019 royalty production between nine thousand nine hundred and ten thousand three hundred BOEs a day. And given the level of activity on our lands through the past two quarters, we believe royalty production should stabilize. Frugal saw continued strength in activity on our royalty lands over the quarter. In total, we had 147 or 7.3 net wells drilled on our royalty lands during the period, down 38% on a gross measure but up 14% on a net measure versus the same period in 2008 and flat versus the previous quarter. Our average royalty rate on nonunit wells totaled 6.4% versus 4.1% in the same period last year. Activity through the first three months of twenty nineteen was primarily focused on Saskatchewan oil prospects, including Viking at Dotsland, Mississippi and Place in Southeast Saskatchewan and Shaunavon in Southwest Saskatchewan, representing 32% of the total gross wells drilled. Together, Saskatchewan and Viking locations represented greater than 65% of our gross nonunit drilling in the quarter. Developing plays remain active with four East Shale Basin Duvernay and two Northern Alberta Clearwater wells drilled on our acreage. We are currently forecasting 20 net wells as part of our 2019 guidance unveiled in March, and we feel we're off to a good start to the first quarter. On the leasing side, we completed 20 new agreements over the quarter with much of the focus on our oil perspective labs in Southeast Saskatchewan and in Viking. We're typically seeing lease rates between 1216% as part of these agreements. On our dividend, with improving commodity prices through the quarter, our funds from operations improved materially relative to Q4 twenty eighteen. Dividends represented 64% of funds from operations for the quarter. This compares to 101% during the previous quarter. We will continue to evaluate our dividend quarterly, but given the volatility associated with Canadian Energy, particularly associated with pricing, we have chosen to remain to maintain our dividend at current levels. Through 2019, we are forecasting a payout of approximately 60% versus our previous guidance of 76%. We have set a dividend strategy of between 6080% of funds from operations for 2019. So we remain at the lower end of this range. I will now pass the call to Alan to walk through our financials. Thanks, Tom. Good morning, everyone. This quarter, we continued to position Freehold with strong financial flexibility and as a lower risk investment. During the 2019, Freehold generated funds from operations of $29,300,000 or $0.25 per share. Revenue from oil and NGL production represented 81% of total revenue for Q1. As a result of our acquisition program over the last two years, we have added higher quality oil barrels, improving our netback. Freehold reported a loss in the first quarter, driven by a $14,100,000 nonrecurring impairment charge, partly offset by a $3,800,000 deferred tax recovery, all related to the conversion of a production volume royalty contract into a gross overriding royalty. We anticipate this first quarter loss to be fully recovered within the next two quarters. Freehold declared dividends of $18,700,000 or $0.01 $5.03 $25 per share in Q1, implying a 64% payout ratio. As part of our Q1 twenty nineteen results, we updated our West Texas Intermediate and Edmonton oil price assumptions for the balance of 2019. As a result, we are forecasting a payout of approximately 60% at the low end of our payout range for the year. Freehold closed the quarter with net debt of $78,000,000 representing 0.7x net debt to funds from operations. Net debt decreased 13% versus the same period last year, reflecting free cash flow over and above our dividend and acquisitions in the interim. For year end 2019, based on our forecast and without additional acquisitions, we forecast net debt to funds from operations of approximately 0.3x. Subsequent to the quarter end, we extended our $180,000,000 credit facility to mature 05/31/2022, one year further. One additional item of note. Freehold received a proposal letter from the Canada Revenue Agency where the CRA stated that it intends to reassess Freehold's deduction of certain noncapital losses and noncapital loss carryforwards in the tax returns filed for 2015. Freehold will vigorously defend its tax filing position and believe it is without merit. No provisions have been made in the financial statements relating to this proposal letter. Now back to Tom for his final remarks. Thanks, Alan. In closing, we executed on our strategy in Q1. We continue to position Freehold in some of the highest netback plays in Western Canada that will continue to see development. This is evidenced by strong drilling on our royalty lands in Q1. With the improvement in commodity prices, our payout is still comfortably at the low end of our guided thresholds. In the near term, we will 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. I'll now pass it on to the moderator for questions. Thank you. We will now take questions from the telephone If you have a question and you are using a speakerphone, please lift the handset before making your selection. We have a question from Amir Arif. Just a couple of quick questions for you, Tom. So just first of all, just the valuations in the space have come down. And so you would think that would increase producers' willingness to do some deals. But at the same time, there's more producers who are trying to live within cash flow. So I'm just curious how those two opposing forces are result in terms of your outlook on the acquisition market for royalties right now. Thanks, Amir, for the question. When we look at the, I don't fiscal prudence of producers, I think that's a good sign for producers. Producers are also trying to develop their lambs and live within cash flow. One of the means that we can help producers to develop their lands is with a royalty. We see that there's still quite a few people that are challenged that like to drill showcase their lands more. And so we are seeing a number of producers that are looking to do royalty deals. We didn't do any substantial deals in Q1, but there is pretty good deal flow out there. Okay. And just a second question on that CRA proposal letter that came in. For now, it's just for 2015. Is there any concern or chance of that increasing to other years post 2015? Or is it just specific to that one year? No, we expect the loss carryforwards to impact later years. The reassessment will be 2015 with no impact on 2016 or 2017. Going forward, if the letter turns into reassessment, it would affect the loss carryforwards, which we use to reduce tax to nominal or zero amounts in forward years. So we're at an early stage on that point. We haven't hit reassessment yet. We expect that, that would only occur later in the year. And the exposure that we'd have would be a reduction of our tax pools of approximately $160,000,000 Okay. Sounds good. And then one final question, if I may. Just I know, Tom, you mentioned the use of free cash flow for debt reduction or acquisitions dividends. How would you rank those today in the current environment in terms of where you'd like to be using that free cash? Well, we thanks, Sameer, for that question. Right now, we like where our dividend is. It's at the low end of our payout threshold, our payout targets. So when we look at the next use of proceeds, do believe that we will execute on our on acquisitions through the year. And so we believe that we will use our excess free cash flow towards acquisitions during the year. Timing is something that we can't predict, but we think there's plenty out there that we should be able to transact and use that excess free cash flow towards acquisitions. By default, we pay down our debt. And only if our debt is down, I guess, to zero or something is starting to build cash would we consider buybacks, etcetera. It all depends at the level we trade at at the time as well. We have a question from Dennis Wong from Canaccord Genuity. Just the first one here that I have is just on PPAs and compliance. You said revenues and volumes associated with that were lower this quarter. Just kind of curious as to how you're thinking about that on a go forward basis. Should we expect that to decline continuously or kind of level out here? How are you guys forecasting and focusing on that component as well? Yes. Thanks, Dennis, for that question. I think you're referring to our audit and compliance barrels and revenue that we typically get during the quarter through our audit function. We typically have a higher as you noticed in previous years, we had higher reported audit and compliance production numbers or PPAs. We believe that's probably in the 100 to 200 range a year going forward on a barrels per day on compliance. That's quite a bit lower than it was in previous years because we haven't done a major acquisition that had lots of title land. Okay. So we should be expecting, just as we get further away from a historical transaction, that, that should be a little bit defined? Yes, a little smaller, yes. But we're thinking 100 to 200 BOEs a day. Okay. Perfect. The second question that I have is just on H2 CapEx and kind of how you guys are going to maybe try and up your net wells potentially drilled or you can take a larger share of second half CapEx as producers start or continue kind of drilling for the remainder of this year. Dennis, it's Dave Spiker. I'll take your question there. Dennis, we've had a lot more dialogue recently with operators. You're trying to position ourselves to compete for drilling dollars. And a lot things that we're looking at is if we look at our lands where we see that the drilling activity is a little bit less than offsetting lands, that we'll have those discussions with the operators to see if we can put some well specific royalty incentives in place in exchange for drilling commitments. It is very early on in the process, but the discussions have been quite constructive. And really, we see it as just a willingness from both parties' part to understand each other's business objectives. And we think that there is we are going to see some additional net wells out of that this year and into next year as well. It's been quite constructive. Okay. Perfect. And then are there certain areas that you believe producers are focusing in on that you want to maybe potentially think about further incenting incremental activity? I think that our focus area really is on the light oil areas in Southeast Saskatchewan. That's where we see the biggest opportunity right now. And with a lot of older leases in there with royalties in that 20% plus range, if we can just draw those back a little bit, then we can compete with other lands and we compete with Crown opportunities. Okay. Perfect. And then final question here, and I'll turn it over after this is how should we be thinking about the remaining working interest reduction that you guys have? And how you're going to manage around that either further dispositions or around the remaining production and so forth? Yes. So on the dispositions, Dennis, Dave here again. We are going to remarketing the remaining assets outside of the Anderson assets. And so there will be a package that's coming out on the street this quarter. And the goal is to have those a good chunk of those sold before year end. We have no further question registered at this time. Would like to turn back the meeting over to you, Mr. Malane. Well, thank you, everybody, for joining us on this conference call. We had a quarter that was in line. We believe that our drilling activity was above basin average because of our light oil targets. We believe that we are an investment that in oil and gas that it has a lower risk, and we continue to have a long term auction value with the many prospects that we have in our lands. Thank you. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.