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Edited Transcript of FRU.TO earnings conference call or presentation 14-Nov-19 2:00pm GMT

Q3 2019 Freehold Royalties Ltd Earnings Call

CALGARY Dec 4, 2019 (Thomson StreetEvents) -- Edited Transcript of Freehold Royalties Ltd earnings conference call or presentation Thursday, November 14, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan G. Withey

Freehold Royalties Ltd. - Former Interim VP of Finance & CFO

* David Michael Spyker

Freehold Royalties Ltd. - COO

* Matt J. Donohue

Freehold Royalties Ltd. - Manager of IR & Capital Markets

* Robert E. Lamond

Freehold Royalties Ltd. - Vice-President of Asset Development

* Thomas J. Mullane

Freehold Royalties Ltd. - President, CEO & Director

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Conference Call Participants

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* Adam Gill

Eight Capital, Research Division - Principal

* Amir Arif

Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research

* Dennis Fong

Canaccord Genuity Corp., Research Division - Exploration and Production Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Freehold Royalties Ltd. third quarter conference call. Please be advised that certain statements on this call constitute forward-looking information. These statements relate to future events or are 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 Mullane, Chief Executive Officer of Freehold. Please go ahead, Mr. Mullane.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [2]

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Thank you, and good morning. Also joining me from Freehold are David Spyker, our Chief Operating Officer; Bob Lamond, our Vice President of Asset Development; Alan Withey, our Chief Financial Officer; Matt Donohue, our Manager, Investor Relations and Capital Markets; and myself, of course. We will summarize our third quarter results, and then we'll be happy to answer questions.

Some quarterly highlights include funds from operations totaled $28 million or $0.24 a share, down slightly from the previous quarter. The key drivers behind the variance included modest reductions in commodity prices and a slight decline in production volumes. Based on our share price at quarter end, we estimate our free cash flow yield approximately 12%. Dividends were 67% of funds from operations for the quarter. This compares to 62% in Q2 and 101% in Q4 2018.

At current commodity price levels and with our dividend at current levels, we continue to generate significant free cash flow. We will continue to elevate our payout -- evaluate our payout quarterly, but given the volatility associated with Canadian energy producers' activity levels, we have chosen to maintain our dividend at current levels. Through 2019, we are forecasting a payout of approximately 65%. We will unveil our 2020 guidance in March 2020 as part of our Q4 2019 results.

On the operations front, Q3 2019, royalty production averaged 10,149 BOEs a day, down 2% versus the previous quarter and the same period last year. The decrease in royalty volumes quarter-over-quarter was driven by reduced third-party drilling during the second quarter, which impacted volumes. The third quarter is typically the weakest period for production volumes and during the year as third-party activity is reduced during Canadian spring break-up. Oil volumes grew 4% year-over-year in the fourth -- and 4% quarter-over-quarter, indicating our oil portfolio strength. Royalty interest accounted for 97% of production and 100% of operating income in Q3 2019.

We completed a Canadian royalty transaction late in Q2 and our first U.S. royalty transaction during Q3 for USD 9.8 million. We expect volumes associated with our U.S. deal to ramp up into the year-end and into 2020, while we are happy that the development in production volumes associated with our Canadian acquisition completed in the previous quarter. Based on broader uncertainty in Canada-associated drilling activity, we are maintaining our 2019 production guidance of between 10,000 and 10,500 BOEs a day.

Within Canada, Freehold saw continued strength in activity on our royalty lands during the first 9 months of 2019. In total, we had 455 gross, 16.3 net wells drilled on our royalty lands during the period. Of these, 181 gross, 6.1 net wells were drilled during the third quarter of 2019. This represents a 3% improvement on a gross measure and a 3% decrease on a net measure over the same period in 2018. Together, Saskatchewan and Manitoba represented approximately 60% of our gross drilling in 2019, 77% on a net basis. Drilling continues to be weighted towards the Viking in west central Saskatchewan with 116 gross, 9.7 net wells drilled year-to-date. We're currently forecasting 20 net wells as part of our 2019 guidance. Both the Canadian Association of Oilwell Drilling Contractors and the Petroleum Services Association of Canada are forecasting material reductions in drilling activity in 2019, greater than 25% drop year-over-year, whereas drilling levels on our lands have been essentially flat.

I will now pass the call to Alan to walk through our financials.

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Alan G. Withey, Freehold Royalties Ltd. - Former Interim VP of Finance & CFO [3]

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Thank you, Tom, and good morning, everyone. This quarter, we continue to demonstrate strong financial flexibility at Freehold. As Tom mentioned, during the third quarter of 2019, Freehold generated funds from operations of $28 million or $0.24 per share. Revenue from oil and NGL production represented 92% of total revenue in the third quarter, up from 89% during the same period in 2018. Our re-treat in natural gas prices during the quarter, along with oil production and oil-weighted acquisition growth within our royalty portfolio, was the driver behind this increase.

Continuing a multi-year trend, Freehold's royalty production amounted to 97% of total production and all of the operating income in the third quarter, which is up from 93% of total production and 99% of operating income in the third quarter of 2018. Freehold declared dividends of $18.7 million or $0.1575 per share in the third quarter of 2019, implying a 67% payout ratio, well within the targeted payout range. As part of our results, we updated our WTI and Edmonton oil price assumptions and are estimating a 65% payout ratio expectation, which is at the low end of our targeted payout range for the full year of 2019.

Freehold closed the quarter with net debt of just over $105 million, representing onetime net debt to funds from operations. The net debt figure increased by just over $70 million versus the prior quarter, reflecting acquisition activity that was closed during the period. Acquisitions of just over $15 million, exclusively related to mineral titles acquired in North Dakota was funded by this debt and by free cash flow generated in excess of dividends paid during the period.

For year-end 2019, based on our forecast and assuming no additional acquisitions in the fourth quarter, we expect net debts to fund -- net debt to funds from operations to reduce towards 0.8x.

For the 3 and 9 months ended September 30, 2019, there is a modest amount of current income tax expense compared to 0 last year. This is due to Freehold's activities in the United States. Also related to tax, but in Canada, Freehold does not have an update related to the proposal letter received from Canada Revenue Agency, where CRA indicated its intention to reassess and deny approval of deduction of certain noncapital losses claimed and carried forward in the tax return filed in 2015. Freehold is vigorously defending its tax filing position. However, we anticipate that proceedings with CRA could take considerable time to resolve.

Now I'll turn it back to Tom for his final remarks.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [4]

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Thanks, Alan. In closing, we continue to execute the core aspects of our strategy. We completed our first U.S. royalty transaction over the quarter, utilizing free cash flow. 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 Williston Basin is providing strong opportunities for our shareholders. In addition, given the broader industry weakness, we are very happy on how activity levels have maintained themselves in our land, a testament to the quality of the underlying royalty portfolio. We expect the better-than-forecast activity levels and acquisitions completed earlier in the year, our volumes will remain steady into year-end.

Looking forward, we remain focused on maximizing shareholder value by investing our free cash flow with dividends, value-enhancing acquisitions and are paying down our debt. Overall, Freehold offers investors a lower-risk oil investment vehicle.

I'll now pass it over to the moderator for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Dennis Fong from Canaccord Genuity.

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Dennis Fong, Canaccord Genuity Corp., Research Division - Exploration and Production Analyst [2]

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I've got 2 here. So the first was I noticed that you guys had a little bit of a current income tax in this quarter. Could you just make a bit of a comment as to how we should be thinking about corporate taxes going forward as well as providing a little bit of context around the U.S. components of your assets in that relation. I've got a second follow-up.

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Alan G. Withey, Freehold Royalties Ltd. - Former Interim VP of Finance & CFO [3]

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Dennis, this is Alan. The U.S. tax is the current income tax for the period, it's from United States operations. We expect that United States operations tax will max out at about 8% for the first, call it, 5 years in terms of percentage of operating cash flow. But it isn't a taxable operation, it's intended to be profitable. And as a new entrant, we expect that to be in that 8% at a maximum.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [4]

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And Matthew, do you want to transform?

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Matt J. Donohue, Freehold Royalties Ltd. - Manager of IR & Capital Markets [5]

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Yes, that's a U.S. cash flow statement...

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [6]

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Which is about 2% of our cash flow today.

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Matt J. Donohue, Freehold Royalties Ltd. - Manager of IR & Capital Markets [7]

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Correct.

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Dennis Fong, Canaccord Genuity Corp., Research Division - Exploration and Production Analyst [8]

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Okay. Okay. And then the second question is just related to kind of the level of production. You guys have been doing a pretty good job in maintaining kind of activity levels across your land base. Can you just kind of talk a little bit more about some of the potential other initiatives that you're working on in addition to providing a little bit of royalty incentive in exchange for activity on your land that's helping you offset, frankly, the significant decline we're seeing in activity across the Western Canadian sedimentary basin?

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David Michael Spyker, Freehold Royalties Ltd. - COO [9]

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Dennis, it's Dave Spyker here. I'll answer your question. Really, we do a lot of regional work. We've really been focused on continuing to build a really high-quality oil portfolio in the most economic trade in Western Canada and North Dakota. And so what we're doing now, which is taking quite a collaborative approach with our primary operators in Eagle oil plays, try to get a better understanding of the development plans and ensure that the royalty structure and the quality of opportunities on the Freehold lands continue to compete with their other investment options. So some of the things that we talked about, as we take the form of royalty incentives for drilling commitments, looking at potential royalty incentives for implementation of enhanced recovery schemes, whether that's either waterflood schemes or treasury schemes or for recompletion or reactivation initiatives. And these are opportunities where we see that we can add additional value by prioritizing developments on these assets and so that we think that, that we can strengthen NPV of the portfolio with specific incentives regarding these types of things.

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Dennis Fong, Canaccord Genuity Corp., Research Division - Exploration and Production Analyst [10]

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Great. I appreciate that. And just maybe the last bit is that, that should frankly translate to obviously being able to reiterate your 20 net well guidance this year? And should we fully be expecting something relatively similar as you guys are kind of looking to the 2020 time frame?

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [11]

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Yes. Dennis, it's Tom here. Actually, we're pretty comfortable with our 20 net wells for this year. We are giving our guidance for next year in March, once we gauge what the activity levels will be for all of our producers. Our drilling has been relatively consistent over the last couple of years. Unless some of our big drillers have a major falloff, I don't see any change in levels until next year. Sorry, Bob.

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Robert E. Lamond, Freehold Royalties Ltd. - Vice-President of Asset Development [12]

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This is Bob Lamond. Maybe I'll just add a tiny bit color on that, too. Our hope also for next year is to start reporting on a couple of U.S. net wells coming in. And the production from those -- I mean, and that's sort of coming up on our number, the value of the U.S. net well could be considerably higher than our Canadian net well. But the direction seems roughly the same towards next year, but we'll have a better number as the quarter goes on.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [13]

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Yes.

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Operator [14]

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The next question is from Amir Arif from Cormark Securities.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [15]

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It's actually a follow-up to the comment that Bob just made here. If you can just give us a little more color in terms of the type of drilling that you do see in the U.S. on your lands relative to the average well that is drilled on the Canadian land. I'm guessing, just -- could being in the Bakken, probably a lot more productive, higher rates relative to what you're seeing in the Viking and your conventional drilling on the Canadian?

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Robert E. Lamond, Freehold Royalties Ltd. - Vice-President of Asset Development [16]

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Thanks for the question. This is Bob Lamond, again. Yes, I think we do, in fact, see that large, large uplift in productivity in a play like a Bakken. So though the increases in net royalty interest can be somewhat lower, the productivity from the wells is considerably higher. And so our exposure to that, we're very excited about, especially seeing that some of our acreage is right offsetting a couple of absolute record wells recently drilled. So currently, we have no new net wells on our land to report this yet, but that will change in the future quarter.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [17]

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Okay. And then just the -- and then if -- can you give us some color in terms of the U.S. deal flow? And I noticed the small additional tuck-in acquisition of some mineral title lands there. Is there a lot of little deal flow that you are seeing? Or is it just relative to the Canadian side? If you can just give us some color on that.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [18]

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Yes. Amir, it's Tom. We're informed that the deal flow, both -- and in U.S. is relatively strong right now. At any one time, we're looking at 3 to 5 acquisitions. That level hasn't dropped off. Given the limited access to equity for a lot of producers, we are finding that there's good deal flow both in Canada and in the U.S. And we are paying a little more attention to U.S. today than we are in Canada given the "potential growth" profile differences in the basins.

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Operator [19]

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(Operator Instructions) The next question is from Adam Gill from Eight Capital.

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Adam Gill, Eight Capital, Research Division - Principal [20]

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Just looking for a little more color on the net wells drilled. Of the 6.1 net drilled in Q3 and the projected 20 for the year, how many of those wells are on the royalty lands that were acquired through Q2 and Q3?

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Robert E. Lamond, Freehold Royalties Ltd. - Vice-President of Asset Development [21]

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So it's Bob Lamond. [Right here, calling]. The acquisitions from Q2, Q3, we're very excited in this quarter. One of the operators we did do our deal with is actually our second largest driller for the quarter. We are especially excited about our Viking production and drilling around the Alberta-Saskatchewan Border. But this Sparky zone and the drilling that's happened on that has been a new add for us. So we've had roughly 15 wells drilled by this operator on that play in the area, and the initial production results are very favorable, and we plan to continue.

If I can add a bit more color again. So Viking remains very strong on both sides of the Alberta border. We're excited about this land bill, Sparky in particular, but more of the heavy oil resurgence in just more of that Viking trend. Also, we've given some guidance before on our Clearwater acquisition we have made. Happy to report that drilling on that is ahead of expectations. We've had more wells drilled on it than expected to be in initial production, actually very favorable in that Clearwater trend as well. Also in Duvernay, drilling on that remains at pace as well. And while a small portion, we're excited by the results.

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Operator [22]

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There are no further questions registered at this time. I will return the meeting back to Mr. Mullane.

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Thomas J. Mullane, Freehold Royalties Ltd. - President, CEO & Director [23]

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Well, thank you, everybody, for joining us on this call this morning. Given our results for Q3, we're extremely happy with the drilling levels on our land. And again, that's a testament to the quality of our lands. We continue to be a lower-risk investment in the energy space for investors, and we're very -- and very happy and we've got our results in Q3 and look forward to next year.

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Operator [24]

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Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.