Rolling Hills Energy Ltd. (TVE) Earnings Call Transcript & Summary

Good morning. Welcome, everyone, to the Tamarack Valley Energy webcast on April 21, 2022, discussing this morning's press release. I would like to introduce today's speakers, Mr. Brian Schmidt, President and CEO; and Mr. Steve Buytels, Vice President, Finance and CFO. [Operator Instructions] Mr. Schmidt, you may begin your conference.

Good morning. I'm joined here today with Steve Buytels, VP Finance and CFO. We're pleased to announce the acquisition of Rolling Hills Energy, a privately held Clearwater oil producer for consideration of $93 million, along with a 20% increase to our base dividend and a return of capital update. The acquisition consists of 2,100 barrels of oil per day in the Southern Clearwater Fairway and 70 or 54 net future development locations along only 1/3 of the land base, providing significant further exploration potential upside. In addition to the highly economic drilling inventory, the assets have an attractive environmental and ESG profile with minimum ARO of less than 1 million and limited freshwater requirements. The acquisition of Rolling Hills completes the consolidation of our core operating area in the Southern Clearwater, which will allow us to fully optimize the development going forward. In addition to the corporate acquisition, we're excited to announce that we have entered a second strategic partnership with the Peavine Metis Settlement, which sees our Peavine Metis land grow to 45 net sections, offsetting recent industry successful drilling results. Further to this, during the quarter, we've been successful in adding 26 sections in the greater Peavine Clearwater trend, driving our total Clearwater land holdings to 593 sections, making the company the largest public Clearwater landholder. Our production pro forma with the acquisition will be about approximately 13,500 barrels per day, and we're forecasting now an exit of about 16,000 barrels per day of Clearwater production. I'll pass it over to Steve to walk through the transaction metrics and financial accretion numbers and return of capital updates.

Thanks, Brian. The Rolling Hills transaction is highly accretive to Tamarack shareholders. The $93 million purchase price implies a 1.5x annualized operating netback multiple with a free funds flow yield in excess of 30%. The transaction is accretive on a per share basis to forecast 2023 adjusted funds flow by 5% and free funds flow by 7% at strip pricing, while maintaining a resilient sustaining funds flow breakeven, including the base dividend of approximately $35 per barrel WTI long term. The transaction is leverage neutral on a pro forma 2022 basis with forecasted year-end net debt to adjusted funds of less than 0.4x on strip and increases our debt adjusted free funds flow per share by more than 3% throughout Tamarack's 5-year plan at $55 per barrel WTI and enhances our long-term return of capital framework given the debt-adjusted free cash flow accretion. We are pleased to announce we plan to increase our base dividend by 20% to $0.01 per share per month, beginning with the June declaration payable in July on the back of the close of the acquisition. The increase in the base dividend reflects the improvement in sustainable free funds flow per share the company has generated through accretive acquisitions and operational momentum using our $55 long-term price deck for our base dividend calculation. In addition, based on the current forward commodity prices, we expect to implement an enhanced return to shareholders payable in the third quarter that will be funded through free funds flow the company generates in Q2 2022 prior to giving effect of the Clearwater transactions. We will provide updated pro forma 2022 guidance in conjunction with our Q1 results on May 3, 2022, which will include both updated capital, pro forma, the Rolling Hills acquisition as well as production. I will turn it back over to Brian for some closing remarks.

In closing, the Rolling Hills acquisition further delivers on our commitment to grow sustainable free funds flow per share for shareholders and providing long-term accretive return of capital growth. I'd like to thank our employees, Board of Directors and shareholders for all of their support. I'll pass over to the moderator for questions.

Our first question, any impact on taxability or tax shields that come with this deal on strip prices, where do you forecast taxes stand for 2022 and 2023?

Yes. So with this deal, just given the [indiscernible] really sort of ramping up production with the assets in the Clearwater that we're getting, it will have minimal tax pools. So when we look at adding this deal in and the income that this deal is going to generate for us for the year, we'd be standing in and around $100 million of cash taxes in 2022. And that number on strip for 2023 would look similar, maybe a little bit higher than that for now the way that we're modeling out.

Has Tamarack bought back any share NCIB as of today?

We haven't filed on anything. Again, as we talk about our enhanced return framework, the NCIB is a part of that. So when we come out in conjunction with our Q2 results will be -- which will be in July, we'll talk to the enhanced return component that's driven by our Q2 free cash flow. And a part of that will be either NCIB and/or special dividends.

Could you discuss the long-term development plan of the Clearwater, previously indicated at 18 to 19 MBOE per day?

Yes. I think when we look at the 5-year plan in the Clearwater, the 18,000 to 19,000 BOE a day would have been, obviously, prior to this Rolling Hills acquisition. And then that wouldn't have contemplated any waterflood in Nipisi and it doesn't contemplate any success in the greater Peavine land. So without the Peavine and without waterflood, we'd be in and around probably 21,000 to 22,000 BOE a day longer term on just a primary basis. And then, like I say, the Peavine and the waterflood could potentially double that.

Where do you see the 2,100 BBL per day growing to in 2023?

You know what this asset will -- we're not going to grow on it hard. The deal here is really -- it offers a significant free cash flow yield. So we're going to manage this in and around, I'd say, 2,100 to 2,500 barrels a day through 2022 and 2023. And again, look to just ensure we optimize that free funds flow that's being redirected into projects like the Nipisi waterflood in the Clearwater, like some potential Peavine exploration and then also growing the returns for shareholders.

Does this deal impact the $220 million to $270 million in sustaining plus moderate growth capital in the 5-year plan?

Yes. So great question. We are, like I mentioned, going to update the capital budget and the production pro forma with our Q1 results on May 3. But yes, obviously, this will add a little bit of capital to sustain that production and grow that production a little bit. And I would say, you're going to be around $15 million to $20 million of increased capital that's going to go along with this acquisition for the remainder of the year. But again, we'll formalize all that here on May 3.

What proportion of your lands in the Clearwater have a GORR on them? And do the Rolling Hills lands have any?

Yes. So almost all of our Clearwater lands would have GORRs on them. And I would say the only things that don't are a bunch of the new Peavine acreage that we bought on the Crown sales. But for the rest, the majority has GORRs that were on already through the acquisitions that we bought over the past 1.5 years. The Rolling Hills lands do have an existing GORR on them. And I think the majority of the GORRs with Rolling Hills is actually with PrairieSky.

Why has Tamarack Valley Energy lagged most other oil companies of the same size in the past number of months?

That's a good question. And I guess I'll leave it to the experts. But when we look at it, we have -- there has been some filings from one of our larger shareholders that reduced exposure as we've increased our multiple and obviously seen accretion in the stock. I think that's been one thing. And I think the other thing, too, is we're -- there were definitely rumors around on us doing different things and potentially on the M&A side. That's always going to be a part of our strategy. However, we want to ensure that there's a balance with the return on capital component. And as we show through the press release and the news this morning, we will balance that and we're not going to rob from Peter to pay Paul here. We're going to make sure that what we've told investors, we're going to deliver on that. And we're going to augment that strategy with bringing in accretive acquisitions that are strategic to the company at the right time if they present themselves. But again, it's got to be accretive to us on our 5-year debt-adjusted free cash flow per share. And if it's accretive there, it means it's going to be accretive to that free cash flow that's going to be coming back to shareholders.

Are there any significant hedges that come with the acquisition?

Yes. They do have for the second half of 2022, approximately 60% of their production hedged. So when we walk through the impact of that, we see about $10 million of impact to cash flow for the back half of the year on strip. And then they are -- they have no hedges past year in 2022 on that. So we'll look to work within our risk management program and the way we do things to protect the floors moving forward into 2023.

What will be the methodology for determining the Q2 enhanced dividends?

Yes, that's a great question, and it's probably worth a couple of seconds on. So as we laid out in the framework, the way we're going to look at it is we won't pay out anything until we know what is in the bank account. So for example, in Q2, we'll look at what our cash flow is, and then we'll take out our CapEx for the quarter. And then what will -- once we hit our debt target, 50% of that will be allocated to return on capital. So what we'll look at is of the free cash after we hit the debt target, 50% will be allocated to the returns. The base dividend, obviously, will grind that out, that gets counted, that's inclusive in that amount. And the remainder then will come back to shareholders in either a special dividend and/or buyback or a combination of both. So that's the way we'll work that moving forward. Here, obviously, we're going to adjust for the acquisition here. That's going to go into the strategic tuck-in in M&A and debt paydown bucket. So that's how we'll make sure that we're balancing the timing of when this acquisition hits with ensuring that we're delivering on the framework and the timing that most of the analysts or shareholders would have been forecasting moving forward.

Can you talk about the potential impact on operating costs? And should we assume a half year of maintenance spending is likely with these assets?

Yes. So again, that maintenance capital spend, that's a fair way to look at it. There's maybe a little bit of growth in there, but a very small amount. In terms of OpEx, I think, again, these assets are assets that core up the existing Southern Clearwater for us. We own and have working interest in a chunk of the lands that we're bringing in here. So we'll be able to gain efficiencies by splitting that infrastructure costs, roads, et cetera, tie-ins over more wells. So we'll see some capital synergies. We will see some OpEx synergies. And then the other piece of it, too, here, our marketing group sees opportunity to further enhance the netbacks here through some of the different strategies that we undertake in-house. So I think you're going to see both an impact positively to potential price realizations and then also to the reduction of costs moving forward just with a larger scale.

What is the decline rate of the incoming assets from Rolling Hills?

Yes. So given, again, as I talked to with the tax question earlier that this is all newer drilling through the back half of '21 and into early 2022, the decline with these assets is probably closer to about 50% right now. And as I mentioned, with the sustaining capital, we see moderating now the growth relative to what these assets have undertaken over the last year, and we'll run at that range of that sort of 2,100 to 2,500 barrels a day out of the asset. You'll see that decline moderate down to levels probably into that 35% mark as we move through 2023 here.

Would you consider placing a GORR on outstanding Clearwater acreage to enhance shareholder returns or buyback stock?

We would. But again, it's a question on, is it accretive to that 5-year plan. And I think a lot of the new acreage is -- we've got to get in there. We've got to test what we have. We've got to derisk it and really understand that acreage before we're just going to go flip a GORR on it. So yes, there's a potential down the road that we could use that as another enhancement. But right now, I'd say, for the most part, I think we have to derisk more of those lands before we can move through adding anything on that front.

All right. Our final question. What is pro forma corporate decline?

Yes, pro forma corporate decline, we look at it in a few different ways. I would -- right now, with bringing in on closer Rolling Hills, we're probably in that 33% range pro forma. We do long term with waterflood investment in the Clearwater, want to drive that back down to the mid-20s. We have a plan here over the 5 years to get that with driving West Nipisi waterflood forward along with other waterflood initiatives in our portfolio. So again, we'll bring these assets in. We'll optimize them and get them to run at a sustainable run rate that we think optimizes the proper production level for these assets. And then again, we'll stay true to our disciplined portfolio of capital investment that $0.25 of every dollar that we invest has to go to waterflood initiatives, and we'll provide an update on that as we come out with our capital program here in -- along with our Q1 results on May 3.

All right. Thank you very much. There are no more questions.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.