Freehold Royalties Ltd. (OTCPK:FRHLF) Q2 2022 Earnings Conference Call August 10, 2022 9:00 AM ET
Company Representatives
David Spyker – Chief Executive Officer
Dave Hendry – Chief Financial Officer
Rob King – Vice President of Business Development
Conference Call Participants
Aaron Bilkoski – TD Securities Inc.
Chris Jones – Haywood Securities Inc.
Operator
Good morning ladies and gentlemen! Welcome to the Second Quarter Results Conference Call.
I would now like to turn the meeting over to Mr. David Spyker. Please go ahead, sir.
David Spyker
Yes, good morning everyone and thank you for joining us today. Joining me on the call this morning are Dave Hendry, our CFO; and Rob King, our Vice President of Business Development.
Over the last two years, Freehold has expanded its asset base into the premier basins across North America, providing the company with a high-quality inventory that will underpin our dividend and further our ability to reinvest in the business for years to come. Our low leverage and high-margin business model means that Freehold can generate material returns for our shareholders in all cycles of the commodity, with the added benefit in the current inflationary environment of having returns that are sheltered from compressing profit margins if operating and capital costs continue to increase.
You know key highlights as part of our news release yesterday include, we posted our third consecutive quarter of records funds from operations at $84 million or $0.56 per share. This represents an 81% increase on a per share measure versus the same period last year and a 17% improvement versus the previous quarter.
Driving funds from operations is a structural shift in Freehold’s business to higher return U.S. reduction, with U.S. realized pricing 19% higher on a per BOE basis versus the price we received in Canada during the same period. With the enhanced scale of our portfolio and confidence in the long term performance of our asset base, we are increasing our monthly payout 13% to $0.09 a share from $0.08 per share.
Freehold has been able to grow our dividend over 500% since the lows of COVID in 2020, with yesterday’s increase the sixth consecutive – the sixth revision over that period. The ability to ramp up Freehold’s dividend is a direct result of the portfolio reinvestment we have executed, the strength in commodity pricing and the flexibility we have maintained with our balance sheet. Looking forward into 2023, the company’s dividend remains as sustainable as ever, backstopped by a strong suite of payers from a higher returning portfolio.
From a guidance perspective, we are maintaining our full year production guidance of 13,750 to 14,750 BOE a day. Production in the second quarter averaged 13,453 BOE a day. Volumes were up 21% versus the same period last year and slightly down quarter-over-quarter. Excluding the acquisition work and now it’s subsequent to the quarter; our productions for the year would be coming in at the lower end of our guidance range. This is driven primarily by timing delays in getting new wells on production by our U.S. operators.
Our base asset performance, our new well performance and our drilling inventory are meeting or beating our expectations at time of acquisition. Drilling activity levels have exceeded expectations with on-production timing disrupted by supply chain and completion crew availability challenges, particularly in the U.S. We continue to expect production growth through the second half of this year and into 2023, supported by the drilling activity we are seeing year-to-date and in Q2 ‘22 in particular.
The acquisition work in the Midland and Eagle Ford basin that I will talk about in a minute will close in the third quarter and bring our annualized production back into the midpoint of our guidance range.
On the Canadian side, Canadian production was down 1% quarter-over-quarter with spring break-up impacting activity levels. Our drilling activity to-date is targeting the Viking, Sparky and Clearwater oil in addition to gas focused drilling in the Deep Basin. Given our third party capital spending assumptions, we expect Canada production to remain flat or modestly grow through the balance of 2022.
The activity on our royalty lands remains robust. Currently we are 24 rigs active on are U.S. assets and 11 rigs on our Canadian assets. Subsequent to quarter end, we entered into two definitive agreements to acquire high quality mineral title and royalty assets in the Midland basin and Eagle Ford basin. On August 4 we closed the Midland asset transaction for $123 million.
This Howard County Midland Transaction positions us in an emerging section of the Midland basin, with development underpinned by an exciting public operator with significant near term growth targets. We are forecasting greater than 20% growth in production associated with this transaction into 2023.
The Eagle Ford transaction is expected to close in September and will layer in a low volatility production profile, driven primarily by a diversified group of large public payers. This transaction further complements our current production base in the Eagle Ford, which is backstopped by an investment grade producer with multiple years of future development.
I’ll now pass the call to Dave Hendry just to walk through some of the financial highlights.
Dave Hendry
Thanks Dave and good morning everyone. As commodity prices improved over the quarter, Freehold continued to deliver on the core financial aspects of its return proposition, providing a meaningful dividend, while also providing investors with a lower risk investments. As noted by Dave, Freehold generated record funds from operations for the third straight quarter of $84 million or $0.56 per share. Broad increases in energy pricing, alongside the larger proportion of revenue derived from our higher priced U.S. volumes contributed to the increase.
Dividends declared for Q2, 2022 totaled $36 million or $0.24 per share. This represented 150% increase versus the same period in 2021. Freeholds dividend payout ratio for Q2, 2022 was 43% versus 33% during the same period in 2021. We expect to continue to position our pay out at 60% of forecasted funds from operations. Accordingly, we’ve increased our monthly dividend to $0.09 per share.
Freehold’s average realized U.S. crude oil price was $138.70 per barrel during Q2, 2022, up 75% versus the same period in 2021. While Freehold’s average realized U.S. natural gas price was $7.79 per MCF, up 114% versus the same period in 2021. In Canada, Freehold’s average realized crude oil price was $128.30 per barrel during Q2, 2022, up 85% versus the same period in 2021. Freehold realized a natural gas price of $6.30 per MCF for the second quarter, up 159% versus the same period in 2021.
Cash cost in the second quarter totaled $8.38 per BOE, up over both Q1, 2021 and the previous quarter. However, I would like to point out that this includes the yearly cash payment for our employee award plan and the DFU cash redemption per retired director. These share based compensation payments totaled $4.77 per BOE. Excluding these charges, cash costs for the quarter amounted to $3.61 per BOE, down from $3.70 per BOE in the previous quarter.
For Q2, 2022 Freehold reported current income taxes in Canada of $9 million and $3 million in the United States, driven by strong commodity pricing and production volumes. Current tax rates realized in Q2 2022 as a percentage of funds from operations can be used to estimate cash taxes for the remainder of the year.
Net debt totaled $33 million at quarter end, representing 0.1x net debt to 12 month trailing funds from operations. Freeholds net debt declined $68 million year-to-date and $30 million quarter-over-quarter, including the diversified Mainland asset transaction of $19 million, which was closed and paid on June 28, 2022. Inclusive of the two transactions announced in early July, Freehold expects to remain well below our upper ceiling of our net debt to funds from operations of 1.5x.
Now, back to Dave for his final remarks.
David Spyker
Thanks Dave. So Freehold remains focused on executing our strategy of continuing to enhance our North American asset base, providing growing shareholder returns and maintaining low leverage. With the acquisitions announced year-to-date, we have added to our high quality portfolio, enhancing our funds flow profile and enabling Freehold to increase our dividend payout by 13%. We are enthusiastic for the remainder of the year and will remain focused on the execution of our strategy moving forward.
I’ll now turn it over to questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] The first question is from Aaron Bilkoski. Please go ahead, your line is open.
Aaron Bilkoski
Good morning guys. My question is about the U.S. asset acquisition that you made to-date. When you look back on these deals, at least the ones you’ve closed, how have they performed relative to your expectations and specifically I’m thinking about operational metrics like number of wells drilled, wells brought on stream, and the production volumes themselves?
A – David Spyker
Hey! Good morning Aaron. Thanks for the questions. So we’re constantly reviewing the acquisition investments that we’ve made and using this look back work to calibrate our modeling and evaluation work going forward. So if we look at the three major U.S. transactions that closed in 2021, you know the diversified royalty asset package that closed in January last year in the Eagle Ford asset in late September and the Midland asset in October, yeah so with the bulk of it closing nine months ago and representing these three deals, about $290 million U.S. we’ve already recovered 30% of the purchase price as revenue from those investments.
So we’re super pleased with this. You know Rob’s going to just give you a little bit more color on the specifics and how it feeds into what we’re seeing going forward.
Rob King
Thanks Dave. Hi Aaron! So on the volume side across those three transactions that Dave mentioned, you know we’ve seen our cumulative volume relative to – our actual cumulative volume relative to our expectations at the time of these three acquisitions, basically being in line. You know when we dig a little bit more into that, you know we’re seeing the gross well activity on the lands in these three transactions, you know largely again across all three, you know basically in line.
You know where we did see some differences is on the net – you know your division of the actual net and the forecast net wells that are brought in line. So we’ve seen at least on the November 2020 deal and the September, or I should say October Midland deal, you know the net wells have probably been a little softer than our expectations with lower NOI wells being brought on, which speaks to some of the softer first half production in our U.S. assets from those two acquisitions.
On our larger Eagle Ford deal, which is about you know by value, you know 65% of the purchases that we did in the U.S. over the last two years, you know that is actually exceeding our expectations on the number of net wells that have been drilled.
Aaron Bilkoski
Thank you for that. I guess I have a follow-up question. I’m curious about the activity levels that underpin your 2022 guidance. I don’t know the best way to ask this, but I guess how many net wells in the U.S. that you anticipate will come on stream in the back half of this year?
Rob King
Yeah, I mean what we have in our, what we call our net activity inventory at the end of Q2, and this is the pro forma of the three acquisitions, you know we have about 1.5 net drilled but uncompleted wells, and about 2.5 net permitted wells. So those you know four activity wells if you were to put what our average IP is across those – you know those which we see about 700 BOEs a day, IP 365 from our U.S. assets. You know that’s 1.5 net wells.
Net DUC’s would be about 1,000 barrels a day productive capacity, you know the 2.5 net permits would be just shy of 2,000 barrels a day of productive capacity. Now we’re not suggesting that’s what’s coming on in the second half of this year. You know that’s – we’ve probably seen that there’s a bit of gapping – the average is about five months you know when the well is spud and brought online on our U.S. assets, but that’s probably been moving a little bit higher over the last few months.
But pro forma of the three acquisitions that we made, you know we need somewhere between 3 and 3.5 net wells to maintain, to hold our production flat. So that helps to calibrate a little bit about where – how those four activity wells match into our forecast.
Aaron Bilkoski
Perfect! That’s helpful color. Thanks guys.
Operator
Thank you. The next question is from Chris Jones. Please go ahead. Your line is open.
Chris Jones
Maybe a question for Rob. I know you guys had some direct gas exposure in the U.S. with royalties in the Haynesville, but you know gas with minor percentage of royalty sales, and recently we’ve seen several U.S. operators shift asset mix to focus more on gas. Just wondering if you guys are looking at expanding your gas exposure. The DUC county rig activity in the Haynesville is growing, which typically indicates growth that’s coming, our LC growth. I understand there may be some limitations on basin supply given current capacity, but it feels there is interest in adding new capacity, so just curious on your thoughts there.
Rob King
Yeah, I mean Haynesville – this is Rob speaking. Haynesville is definitely a basin that we’re doing our homework on. You know to-date you’re right, we don’t have a lot – more of our exposure is certainly in the Eagle Ford and in the Midland and you know pro forma in the three acquisitions that we made, you know that would be close to 90% of our U.S. production will be in those two basins. You know we do have some exposure to the Haynesville as well as to Appalachia with the November 2020 transaction that we did. But I would say Haynesville is a basin that we’re getting up to speed on and would love to look at the right opportunity to add something in that, but you know it’s on the count.
Chris Jones
Okay, that’s very helpful. Thank you. Just for my follow-up, you know are we seeing an end to the debate over dividend versus buybacks or is the best way to return capital to shareholders still sort of considered of importance?
A – Dave Hendry
Yes, it’s Dave Hendry here. Good morning, Chris. We don’t have any plans to do share buybacks in the near term. We continue to always evaluate what’s in the best interest of shareholders, but at this point you know our expectation with continuing accretion on our acquisition is to deploy that through increasing our dividend and maintaining a payout ratio with a longer term pricing forecast in that 60% range.
Chris Jones
Great! Thank you.
Dave Hendry
My pleasure.
Operator
Thank you. There are no further questions registered at this time. I will now turn the call back to Mr. Spyker.
David Spyker
Thanks again everyone for your participation today. I’d say we remain pretty excited about what’s going on at Freehold. We’re looking forward to getting this new acquisitions rolled into our business and our numbers and looking forward to continue the strong execution of our business plan. So thank you and thanks again for your time today.
Operator
Thank you. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.
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