Freehold Royalties Ltd. (OTCPK:FRHLF) Q3 2022 Earnings Conference Call November 9, 2022 9:00 AM ET
Company Participants
David Spyker – Chief Executive Officer
Dave Hendry – Chief Financial Officer
Rob King – Vice President, Business Development
Conference Call Participants
Luke Davis – RBC
Patrick O’Rourke – ATB Capital
Jamie Kubik – CIBC
Jeremy McCrea – Raymond James
Operator
Good morning, ladies and gentlemen. Welcome to the Third Quarter Results Conference Call. I would now like to turn the meeting over to Mr. David Spyker. Please go ahead.
David Spyker
Good morning, everyone and thank you for joining us this morning. On the call from Freehold with me are Dave Hendry, our CFO; and Rob King, our VP of Business Development.
We are really excited about the third quarter. For the third quarter, we delivered record production of 14,219 BOE a day, driving revenues of $98 million and funds from operations of $81 million or $0.54 per share. After 2 years of upward momentum in crude oil prices, Q3 2022 represented a 15% retreat in West Texas intermediate oil price. This oil price retreat contributed to a $2 million reduction in funds from operations quarter-over-quarter. Through the quarter, Freehold was able to complete greater than $160 million in value-enhancing royalty transactions adding to both our U.S. and Canadian portfolios. We also increased our dividend for the sixth time in the past nine quarters and we maintain flexibility within our balance sheet.
Some of the highlights from yesterday’s news release include, as I mentioned already, the record production with volumes averaging 14,219 BOE a day for the quarter, up 6% versus the previous quarter, and up 26% versus the same period in 2021. Our Canadian portfolio was not impacted by the seasonal slowdown associated with lower Q2 drilling with Canadian production flat quarter-over-quarter. U.S. production was up 24% quarter-over-quarter as new wells were brought on production, and the acquisition work announced it was our Q2 results closed in August.
Looking forward, we continue to see strong third-party development on our royalty lands with 30 to 35 rigs consistently drilling on our lands in Q3. We are reiterating our 2022 production guidance range of 13,750 to 14,750 BOE a day. The $160 million in value-enhancing acquisitions expanded our royalty positions in the Permian and Eagle Ford in the U.S. as well as a Clearwater in Canada.
The Permian and Eagle Ford transactions have been incorporated into our portfolio already with early drilling results in line or ahead of expectations. These transactions are expected to provide a strong growth wedge for our royalty portfolio going into 2023. In Canada, we completed a royalty transaction for Clearwater assets. In total, this deal adds greater than 300,000 gross acres to Freehold’s inventory, tripling the company’s previous Clearwater land position. This $18.4 million deal includes a drilling commitment with a strategic partner who has a track record of development success within the play. This transaction aligns nicely with the drilling momentum we are seeing in the Clearwater oil play. We have had 26 wells drilled on our Clearwater acreage in Q3 with early success in our Southern Clearwater acreage, including Figure Lake, where we’re seeing initial oil production rates for the first 30 days or approximately 240 barrels a day per well on a gross basis.
Overall, we achieved record gross drilling results within our North American portfolio with 304 gross wells drilled on royalty lands over the quarter. For the first 9 months of 2022, more than 760 gross locations have been drilled with robust activity associated with both our Canadian and U.S. portfolios setting up for what we expect will be a record level of gross drilling on Freehold’s lands in 2022. In Canada, we have seen activity focused on oil-weighted areas in Southeast Saskatchewan, the Viking, Cardium and the previously mentioned Clearwater play. We’ve also had strong drilling results in the Deep Basin and Spirit River with 8 wells drilled and a number of those wells in the top 15 well results in August and September. We expect this to be a strong growth driver through the remainder of the year and into 2023 with activity expected to continue on Freehold lands.
In the U.S., development is focused on light oil prospects in the Permian and Eagle Ford basins. Drilling was driven by a diverse group of disciplined investment-grade companies, where we’ve also seen an increase in the share of activity coming from a more active group of smaller public and private operators. Freehold achieve near-record financial returns for the quarter as the company generated $81 million or $0.54 per share in funds from operations. This represents a 67% increase on a per share measure versus the same period last year and only $2 million below the funds flow record set in Q2 2022.
A key highlight associated with the advancement of our North American strategy has been the stronger pricing we received associated with our U.S. production. Our U.S. realized pricing was $92.15 a BOE on 4,653 BOE a day of production, while our Canadian pricing was $65.63 a BOE on 9,566 BOE a day of production. This is a 40% premium on one-third of our production and really highlights the benefit of our diversification to North American pricing points, which has enhanced the sustainability of our return profile. We benefit from lower transportation and quality differentials on the oil side and specifically for Q3, the strength in NYMEX pricing when AECO gas pricing was weaker as it related to egress constraints associated with maintenance on pipeline systems in Canada.
Cash costs in the second quarter totaled $362 a BOE, down 57% versus the same period in 2021. This decrease was driven by increased production volumes and reduced stock-based comp payouts. Given the low cost intensity of royalties, as we expand our North American portfolio, we believe we are positioned to add production at very low costs. The transactions that we’ve completed year-to-date were funded by utilizing our existing credit facility. Q3 2022 net debt exited the period at approximately $160 million or 0.5x net debt to trailing funds from operations. Note that this includes acquiring over $160 million of value-adding acquisitions in the quarter, while paying down $33 million in debt.
At current commodity price levels, cash flow generation remains robust, allowing for debt to be paid down over and above our dividend with Freehold committed to maintaining flexibility through our balance sheet. Dividends declared for Q3 totaled $39 million or $0.26 a share. This represents a 102% increase versus the same period in 2021. Freehold’s dividend payout ratio for Q3 2022 was 47% versus 35% during the same period in 2021.
We increased our dividend 13% to $0.09 a share from $0.08 a share, paid on September 15. And our dividend planning is based on a longer-term price view of $75 per barrel West Texas intermediate oil price, a CAD4 an Mcf gas price and a $5 an Mcf gas price. This view reflects that the volatility that we’re seeing in commodity pricing and positions us within our stated payout guidance of approximately 60% into 2023. We will continue to monitor our dividend quarterly, allocating returns with an objective of maximizing shareholder value. We continue to see high-quality acquisitions opportunities across North America. With that patient and disciplined M&A work will continue to be a key component of our go-forward strategy.
In closing, Freehold remains focused on executing our strategy of continuing to enhance our North American asset base, providing growing shareholder returns and maintaining low leverage. The acquisitions announced during the quarter have made a material improvement in the scale and quality of Freehold’s portfolio.
Thank you. And we will now take questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] The first question is from Luke Davis with RBC. Please go ahead.
Luke Davis
Hi, good morning, guys. Wondering if you can just frame out your volume growth expectations for Q4, split by the U.S. and Canada and just provide some details on key plays, key operators, key drivers that sort of thing? And to the extent that you can frame that out just directionally for 2023, that would be helpful as well?
Rob King
Sure. Hi, Luke, it’s Rob King here. So for Q4, in terms of overall volumes, we’re sort of targeting in and around that 15,000 plus or minus, for the quarter. And that’s really, call it, two-thirds in Canada, one-third in the U.S. in terms of how that volume contributes to that 15,000 type level. Some of the key players on the U.S. side are clearly going to be in the Eagle Ford. Marathon actually is really bringing on 40% of the wells that they – we expect to have turned in line in 2022, actually in September, October, November time frame. So we are expecting some strong production from our Eagle Ford assets. And I think the other is going to be the new transaction that we closed in August in Howard County in the Midland Basin. And that’s – one of the key operators there has been very actively completing a number of the DUCs that they had on that asset. So between those two, that’s a material part of our Q4 volume growth on the U.S. side. In Canada, we’re seeing some really strong gas drilling in the Deep Basin. And so that’s probably where the most significant amount of the volume growth that we’re going to see in Canada. 2023, I think we’re a little early to be talking about 2023. I think it’s one where we’re still waiting to sort of understand a bit from our key payers in terms of what their capital programs are going to be. But if we’re directionally call it, like right now, Canada, call it, flat in terms of what we would sort of see that over the next year in the U.S. would be modestly growing.
Luke Davis
That’s helpful. Thanks.
Operator
Thank you. [Operator Instructions] The next question is from Patrick O’Rourke with ATB Capital. Please go ahead.
Patrick O’Rourke
Hi, good morning, guys. Thank you for taking my question. I guess I just would like to know kind of your views in terms of the current dividend payout ratio. Now that you’ve sort of rightsized it over the last couple of years, how you think about the timing and scaling of future dividend growth? And then I guess it’s probably somewhat inextricably linked to the view on the outlook for M&A and balance sheet management here. So perhaps if you could tie in how you think about all these sort of three factors working together going forward?
David Spyker
Yes, Dave Spyker here. So really how we’re thinking of the dividend is we want to run a dividend at approximately 60% payout based again on that longer-term pricing strategy that we see. And that longer-term pricing strategy really aligns with what we’re seeing on the forward curve right now. And so when we review the – our dividend again in – with our Q4 results, we will be looking at what is pricing shaping up to be. I mean there is a lot of moving parts on commodity. Right now, we see the volatility in it. We want to keep our balance sheet strong. So a key part of that is continuing to pay down debt to keep ourselves flexible for M&A acquisition type opportunity. So like I mentioned, we do see a lot of deal flow right now. Rob and I were in Houston last week and continue to see quality opportunities available today, and it doesn’t sound like the pipeline of opportunity is slowing down any. So, part of our strategy is to be able to invest the other 40% of our funds from operation to really grow our business and enhance it along the same lines that we have been focused on over the last 2 years.
Patrick O’Rourke
Thank you.
Operator
Thank you. The next question is from Jamie Kubik with CIBC. Please go ahead.
Jamie Kubik
Yes, good morning guys. Thanks for taking my question. Just a question on your U.S. asset base, Rob, you are mentioning around a third of the volumes in the U.S. for Q4 from 15,000 BOEs a day, so about 5,000 BOEs a day out of the U.S. Can you just talk a little bit about how many net wells you need to see drilled to maintain volumes at that level in 2023? And what level of drilling cadence would see that asset base grow? Thanks.
Rob King
Yes. So, in terms of the number of net wells that we need to sort of see a flat scenario, it’s about, call it, 3.5 net wells. It’s a – that obviously is an estimate because it’s – there is obviously no shortage of different type curves that are embedded within that. Just to kind of give a context, obviously, so far in 2022, we have had close to 400 gross wells drilled on our U.S. lands, about two net wells. So, a lot of type curves are embedded within that. But we see an average of 700 barrels to 800 barrels a day on IP 365 is what our typical U.S. well is in our portfolio. To sort of put that 3.5 net wells in context, when we look at what our net activity these wells are. So, that’s a combination of the drilled and uncompleted wells and the permits that are on our lands. At the end of Q3, we had over four of those net activity wells. I think one of the other parts that kind of gives us some confidence and gets us excited is also seeing that the net DUCs have increased quarter-over-quarter, which again sort of builds in that confidence of how we can sort of see those volumes materialize in Q4 and into the first half of next year.
Jamie Kubik
Okay. So, the four net wells activity wells that you mentioned there, did I get that right, first of all? And then I guess, how – over what timeframe would you expect those to start to hit the profile? I know that there is extended timeframes in the U.S.
Rob King
Yes. I mean that’s the – yes, the four activity wells are – they are almost call it, equally split between DUCs and permits. And DUCs, those can come on anywhere between one month and four months. And the permits are kind of 6 months to 12 months between when a permit is filed and when it’s turned in line. So, it’s a much wider range on the permit side and a tighter range typically on the DUC front.
Jamie Kubik
Got it. Okay. That’s great color. Thanks guys.
Operator
Thank you. The next question is from Jeremy McCrea with Raymond James. Please go ahead.
Jeremy McCrea
Yes. I have a couple of quick questions here. The one, can you give some actual numbers behind some of the statements that you guys were talking about. Just – I think it was Patrick was asking the question. Just on some of the M&A, what would be the dollar amount that you have looked at, say, this quarter versus last quarter versus this time last year? And then just for the Clearwater acquisition, can you give a little bit more details on that? How many wells are committed on the land? Were there any results to-date that we could kind of speculate on how much more follow-up wells there could be here if there is any success on these lands so far?
Rob King
Sure. It’s Rob speaking again. On the deals that we looked at in Q3, it’s just a little bit under on a value basis, about $2.5 billion. In terms of the number of opportunities, that’s about close to 40 opportunities came across our desk. In terms of what we actually dug into and reviewed, about a third of that in terms – by number. So, we took that 40 and probably looked at, call it, 12, 13 opportunities. And of that bid on about half and we are successful in closing the Clearwater transaction. In terms of make-up of those deals, 80% were focused in the U.S., 20% in Canada. So, we are still – the point being, we are still very actively looking at Canadian opportunities as well as U.S. opportunities. It’s just given the size and scope of the U.S. market. There tends to be a lot more opportunities to look at, but obviously demonstrating that our Clearwater transaction, Canadian opportunities is still something very much in our focus area. How that compares to activity we have seen so far this year, that’s 36 opportunities, as I mentioned. 90 opportunities we have reviewed over the course of ‘22. So, it’s sort of – the Q3 was consistent with what we have seen in prior quarters this year. I don’t have the stat for what Q3 of ‘21 would have looked like. But I think we have certainly seen increased activity year-over-year as prices have remained constructive that’s brought a number of sellers into the market. On the Clearwater side, it’s a 26-well commitment, that gross well commitment that we have with the operator. They have drilled two gross wells so far, but we don’t have any tangible results at this point. They certainly have a very active winter drilling program that we are pretty excited about.
Jeremy McCrea
Okay. Thank you, guys for that. Thank you.
Operator
Thank you. And there are no further questions registered at this time. So, I will turn the meeting back over to Mr. Spyker.
David Spyker
Thanks everyone for participating today. We are very enthusiastic for the remainder of the year, and we are going to remain focused on the execution of our strategy. So, thanks again and have a good day.
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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