Freehold Royalties Ltd. (FRU) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the Second Quarter Results Conference Call. I would now like to turn the meeting over to Mr. David Spyker. Please go ahead, Mr. Spyker.

Good morning, everyone, and thank you for joining us today. On the call from Freehold are David Hendry, our CFO; and Rob King, our COO. The second quarter delivered consistent results across our North American portfolio. Production of 14,667 BOE a day was in line with the previous quarter and up 9% over Q2 of last year. Year-over-year growth was due to organic growth on both sides of the border as well as acquisition activity completed in the Midland and Eagle Ford basins. Revenue of $74 million was in line with expectations, generating funds from operations of $53 million or $0.35 per share. Realized pricing for the quarter of $54.05 per BOE continues to benefit from the premium pricing associated with our U.S. portfolio. In the U.S., we realized a 39% uplift over our Canadian realized price due to both quality of oil and proximity to sales points, which significantly reduces pipeline transportation costs. We reduced our long-term debt by $7 million during the quarter, and our net debt was increased to $131 million or 0.5x trailing funds from operations. This increase in net debt is a result of $24.4 million in income tax deposits being reclassified from a current asset to a long-term asset due to the expected time line for appealing assessments with the Canada Revenue Agency. We continue to expect to be successful in challenging the assessment based on the legal advice that we have received. The diversified high-quality nature of our North American portfolio has furthered the sustainability of Freehold's dividend, which we have grown to its highest level since 2015. As a consistent income provider, we remain committed to targeting a payout ratio of approximately 60% of forward-looking funds from operations. During periods similar to what we realized during the second quarter, we are very comfortable at higher payout levels given our low leverage and high-margin business, which we believe results in dividend coverage below USD 50 per barrel WTI. Full year, we are anticipating payout ratios in the mid-60% range based on current strip prices. Our Canadian volumes averaged 9,800 BOE a day for the quarter, no change from the previous quarter, with organic growth offsetting the 225 barrels a day -- BOE a day production shut-ins associated with the wildfires in Western Canada. This shut-in production has now been restored. Strength in our Canadian portfolio year-to-date reflects its high-quality nature, well positioned in the active drilling plays across Western Canada. We have had strong drilling in the Viking with 62 gross wells drilled, resulting in our oil volume contribution from this play reaching a 3-year high. The Clearwater continues to be a growth area with 17 wells drilled year-to-date driven mainly in the Figure Lake area with excellent results to date and an active drilling program expected in the second half of the year. Leasing activity has been very robust so far in 2023, with 67 agreements signed during the quarter, yielding bonus revenue of $1 million. Continuing past the quarter, another 16 leases have been signed, bringing the year-to-date numbers to 83. We're halfway through the year, and we have matched our 2022 levels already. The much improved health of the industry has been evident across our Southern Saskatchewan acreage. We have seen a revitalization of this legacy acreage as smaller, well-financed operators aim to achieve growth in these areas, targeting the Mississippian and Bakken formations. Nearly 1/2 of the new leases have targeted development of the Mississippi in Southeast Saskatchewan, and approximately 25% are with Mannville heavy oil operators as they are focused on capitalizing on technological advancements in heavy oil development along with narrowing Canadian heavy oil differentials. On the U.S. side, our production volumes of 4,867 BOE a day were also consistent with the prior quarter and were in line with our expectations. Rig activity year-to-date has been strong, with rigs on our acreage setting a high watermark of 31 rigs in April. Current activity is in line with average 2022 levels. The Eagle Ford and Midland Basins are the most active areas in our portfolio, with drilling underpinned by high-quality investment-grade entities. For those that are watching the webcast, there's a lot going on in this slide, and it mirrors the significant drilling activity we are seeing in multiple reservoir benches and from large pad drilling operations. We expect U.S. volumes for the second half of 2023 to benefit from the completion of several of these large multi-well pads, contributing to strengthening volumes throughout the remainder of the year. These pads are high impact and are expected to bring on significant production. An example is a 19-well pad drilled by CrownQuest on our acreage in the Midland Basin and put on production in Q4 of last year. The little illustration to the right just shows the 19 wells that are targeting several different reservoir benches in a spacing unit. On a gross basis, this pad had a peak rate of 27,000 BOE a day with average production in the first 6 months of 17,000 BOE a day. To put this into perspective, when started up, 5 of these pads will be equivalent to the current levels of Clearwater oil production in Canada. While our royalty interest in the pad is 0.5%, the size of the pad and the production from it makes it meaningful to Freehold's net production, contributing 160 BOE a day at peak rate and 100 BOE a day on a 6-month average. We have several of these high-impact DUCs and permits that we expect to contribute to near-term production growth. Specifically, we anticipate 3 new pads totaling 41 gross wells, 0.6 net wells operated by Exxon and Pioneer to be on production in the second half of this year. The combined gross initial productivity of these pads is expected to be around 50,000 BOE a day. We continue to reiterate the simplicity of royalties as an asset class to investors. Freehold's dividend remains our primary return mechanism and remains sustainable at commodity prices materially lower than current levels. Our North American portfolio offers significant diversity with greater than 350 quality industry payers through 2 countries, 5 provinces and 8 states. During periods where we saw a temporary slowdown associated with the wildfires in Canada or slowdowns associated with spring breakup, maintaining a North American presence ensures that our return profile remained consistent for our shareholders over the quarter. Our balance sheet remains in a strong position with capacity to mitigate weakness in commodity prices or support portfolio reinvestment for value-enhancing opportunities. Looking forward, we remain excited about the long-term outlook for Freehold as we continue to strengthen Freehold's asset base, balance sheet and the long-term sustainability of our business. We will now take the time to answer any questions that investors may have.

[Operator Instructions] The first question is from Travis Wood from National Bank Financial.

David, you talked about a bit of the inventory and the high-impact nature of kind of the U.S. development plans and the significance of the pads. I noticed a couple slides here kind of highlighting that, that you referenced in your opening remarks. But could you help us or maybe even remind us how you think about that in terms of your planning around guidance maybe from the conservative side? Or is there any risk to that changing in terms of the timing of the production adds? Just kind of how do you think about that? How comfortable are you with the planning? You kind of talked about the onstream dates from Exxon as an example. But just help us appreciate, I guess, the risk profile around the timing of that and how you layer that into your plan?

Yes. Thanks for the question, Travis. I've got Rob here, and he's grinding through this stuff every day. So I'll let him answer that.

Travis, so a little bit of context for -- I'll back up just a little bit. When we sort of think about our U.S. portfolio, to keep production flat, we sort of need somewhere in the 3 to 3.2 net wells. And again, that varies depending on what the productivity is of those underlying wells. But that's sort of a general number that we look to. When we look at Q3 specifically, our forecast has about a little under 1 net well that we expect to be turned in line and brought on production. And I think what gives us some confidence in that number for Q3 are those 3 paths that Dave talked about in his remarks. Just to provide a little bit of color on those, those represent -- over 50% of those wells that we expect to be turned in line in Q3: 2 are under Exxon; 1 is under Pioneer. The Exxon, we have 1 in the Eagle Ford, it's a 12 gross wells. We have a 0.7% net royalty interest on those wells. That pad is -- it's fully complete with 1/2 already reporting production. Exxon also has a pad in the Midland, the Houston Ranch, which is 14 gross wells. We have a larger net royalty interest on that particular opportunity, 2.3%. That compares to our U.S. average of about 0.6%, 0.7%. So this is a meaningful pad, both on a gross number of wells as well as net to Freehold. That pad is over 90% complete. And we've had dialogue with XTO, Exxon's back offices, understanding when those pads will be coming online. They've already started bringing on some of those wells on that 14 gross well pad. The last is Pioneer in the Midland, [ Eric Sim's ] pad, that's 15 gross wells. We have a 0.8% net royalty interest. That pad is fully complete, and we're waiting to see that come online shortly.

Okay. That's great. And just for some context, I think that the slides that you guys have layered in there, specifically, I think 15 is super useful as we think about the impact of that as we lay out the working interest across each of those.

The next question is from Jamie Kubik from CIBC.

A little bit along the lines of what Travis asked here, but I guess, just on the activity in the U.S., noticed that net wells drilled were down quarter-over-quarter. But you did note that the rig activity in April set the high watermark in your U.S. portfolio at 31 rigs on your lands and rig activity so far has mirrored 2022 levels. Just wondering if you can help us reconcile maybe the difference between gross versus net activity and maybe how that will translate into the production growth you guys are talking about in the second half? And then maybe a tag on to that question is, where do you think U.S. production volumes could go to in the second half?

Yes. So it's Rob here again, Jamie. In terms of rig activity in the U.S., as you mentioned, we did see our highest levels, a little over 30 rigs on our lands in April. That's trended down to about 20 rigs on the lands currently, which is in line with 2022 average levels. In terms of the lower amount, when we looked at the gross drilling activity, quarter-over-quarter is pretty similar between -- on the U.S. side. But we did sort of see some lower net wells that were drilled. And I think in terms of how that will impact production, we'll see. As you know, it takes somewhere between 3 and 9 months for those wells, once they've been drilled, to be completed and turned in line. So that's sort of somewhere in that Q4, Q1 time frame. So lots can change between then and now. I know you had a second question there. I'm just trying to recall what it is. I apologize.