Earnings Transcript for FRHLF - Q3 Fiscal Year 2021

Operator: Good afternoon, 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 afternoon and thank you for joining us. On the call with me today are

David Hendry: Thanks, Dave, and good afternoon, 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 investment, differentiating itself from traditional oil and gas E&P companies. Royalty and other revenue totaled $50.9 million for Q3 2021, up 13% from the previous quarter, and 120% when compared to the same period last year. Funds from operations for Q3 2021 totaled $48.2 million, an all-time record for Freehold, up 20% versus the previous quarter, and 143% for the same period in 2020. This significant increase in funds flow from operation provides added financial strength and flexibility, and how we manage our business. On a per share basis, funds from operations was $0.36 per share during Q3, representing a level not achieved since 2014. Freehold’s royalty revenue and funds flow benefited from the strong upward momentum in oil price and natural gas prices, while growing production particularly in the U.S., which receives better pricing relative to our Canadian assets. Freehold’s dividend payout totaled 35% for Q3 2021, up slightly from Q2 2021 and 8% from Q3 2020. As previously mentioned, we are increasing our monthly dividend from $0.05 per share to $0.06 per share reflecting a measured response to an improved commodity price outlook, strong production volumes and increasing third-party spending on our royalty lands in 2021, which is expected to continue into 2022. For Q3 2021, cash costs totaled $2.49 per boe, the lowest in Freehold’s history, down materially from $4.48 per boe in Q2 2021 and $3.70 per boe during the same period in 2020. We continue to drive efficiencies in this area through reduced G&A and operating costs, while increasing production volumes. Acquisitions completed late in the quarter and after quarter-end, are expected to only add a marginal amount of G&A as we continue to drive optimization on our cost structure, resulting in a better net back to our shareholders. Net debt totaled $75.3 million on September 30, representing 0.5 times net debt to 12-month trailing funds from operations. Overall, Freehold’s net debt increased by $35 million versus the previous quarter, but was still lower than September 30, 2020. The increase in net debt reflects acquisitions completed over the quarter, was stronger funds from operations also meaningfully contributing to the funding of these acquisitions. Freehold’s prudent strategy of maintaining net debt to funds flow well below 1.5 times, alongside a lower longer-term-dividend payout targets starting at 60% of funds from operation provides protection to the business from commodity price volatility, while maintaining capacity as we continue to grow through strategic acquisitions. Concurrent with the closing of the Eagle Ford transaction highlighted earlier, Freehold amended its credit facility with a syndicate of 4 Canadian banks increasing the committed revolving facility to $285 million and maintaining the operating facility at $15 million. The amended credit facility includes a permitted increase in the committed revolving facility of up to $360 million subject to lenders’ consent. Both the committed revolving and operating facilities mature September 28, 2024. Lastly, Freehold’s board has approved the filing of a preliminary short form base shelf prospectus. Upon filing the final base short form shelf prospectus, Freehold will be able to, from time to time, offer and sell common shares, preferred shares, subscription receipts, warrants and units on an aggregate amount of up to $500 million during the next 25-month period. Freehold has no immediate plans to raise equity capital however, the filing of a shelf prospectus is a natural and prudent step for the company for financial flexibility as it continues to enhance and expand its asset base and drive continued business improvement. Now, back to Dave for his final remarks.

David Spyker: Thanks, Dave. So in November of this month, November 25, Freehold will celebrate its 25th anniversary of business, the leadership team has committed to continue building on our successful history, as we evolve Freehold into the premier North American oil and gas focused royalty company. The current economic conditions are very positive for our industry, and the strength of our royalty model, and the strong return proposition and investment in Freehold provides will continue to be showcased going forward. We remain incredibly enthusiastic about the next 12 months. There has been a steady trending up of capital spending and associated production growth on our lands, both in Canada and the U.S. At current commodity price levels, our high royalty margins offer significant option value to provide returns to our shareholders. With today’s increase to our monthly dividend, we reiterate that this is the 5th consecutive quarter that we have revised our dividend upwards. The acquisition work that has been completed in Q3 along with the transaction after quarter-end are expected to provide both near- and long-term value for our shareholders and further our patient execution of our strategy. There’s been a tremendous amount of work completed in the transformation of Freehold from a premier Canadian royalty company to a premier North American royalty company. The fourth quarter of this year will be the first period our shareholders will see the full impact of the approximately $320 million of acquisition activity in the third and very early in the fourth quarter. And we are confident that Freehold will deliver record levels of royalty production and funds from operations. I would like to personally thank all of our shareholders for their support over the past 25 years, and thank our board and employees that contributed the ideas, the energy and the inspiration that has made an investment in Freehold a success. Thank you, and we will now take questions.

Operator: Thank you. We will now take questions from the telephone lines. [Operator Instructions] We will take the first question. Please go ahead.

Matt Donohue: Luke Davis.

David Spyker: Hey, Luke.

Luke Davis: Hey, afternoon, guys. Just had a quick one here relating to the shelf. I’m just wondering if you can kind of frame out the thinking behind this. I know you hit on it a little bit. But should we read into that, that you are kind of setting up to do something larger, or you’re really just looking to kind of enhance flexibility there? And then, I guess, the second piece of that would just be, it is fairly sizable. So just wondering if you can kind of frame out how you came to that $500 million. Any kind of details there would be helpful.

David Hendry: Sure, Luke. It’s Dave Hendry here. Yeah, no, we have absolutely no immediate plans to utilize the shelf. This was merely about being prepared. So, the shelf just gives us added flexibility. Should a future opportunity come along, we want to make sure that we’re adding the best value, being able to communicate it in the best way. So this is purely about the preparedness. As far as on the size of it, what we did is we looked at what peers were putting out from the last shelf prospectuses over the last year or so. And, what we found was about a medium of those was about 25%. So we took a look at our market cap, 25%, and that sort of rounded to around that $500 million mark. And then, we looked at deal opportunities. We want to make sure that it’s reasonable side, because it’s going to be out there for that shelf period of 25 months. So that was the logic on how we came around $500 million.

Luke Davis: Got you. Makes sense. Maybe just another one for you, Dave. Just around hedging. I mean, things look really good now, activities picking up, margins are high. But the industry is pretty notorious for kind of overestimating pricing. So wondering if you have any updated thoughts on hedging and how that might look over the next couple of years?

David Spyker: Yeah, so as far as on hedging, it’s something we do discuss regularly with our Board. As far as, whether we want to apply it. Right now, I mean, with our dividend, or sorry, our net debt to fund flows projections, where we’re looking around that more 0.5 times is relatively, let’s call it, conservative on the leverage. And so, hedging doesn’t really have a lot of logic to it, for protecting that. When as far as protecting the dividend side, you’re still seeing, let’s call it a backward dated position of the hedging. And so, at this point, we’re comfortable with not having a hedging position, but we continue to evaluate it every single quarter with the Board.

Luke Davis: Got you. Thanks for that.

David Spyker: My pleasure, Luke.

Operator: Thank you. We will take the next question. Please go ahead.

Matt Donohue: Travis Wood.

David Hendry: Hey, Travis. How are you?

Travis Wood: Yeah, hey, guys. Thanks. I have 2 questions for you. The first, could you give us some color used around the strength of pricing you’re seeing. I think, specifically in the U.S. on the liquid side, as well as the natural gas side, and then I’ll have one more as well.

Matt Donohue: Okay. So you’re going to keep Dave Hendry busy, so.

David Spyker: Yeah, he is there at the end of the day.

David Hendry: Yeah, exactly. So, yeah, to help provide a little bit more detail, I guess, one of the changes that we made to our MD&A and financial statement disclosure was providing data both on a Canada and a U.S. basis. And so, I’m just pointing out to the 9-month, just providing a little bit more of a smoothed pricing scenario, rather than looking at particular quarter. And where you can see on a crude basis, our realized pricing in the U.S. on oil is about $10 higher. So, you can take a look at it and saying is for – over the last 9 months we were getting about $68 net on oil versus in the U.S. we’re at $78. And, similarly on a gas basis, where our natural gas realized pricing was $3.90 relative to $2.60 Canadian. So you’re seeing a $1 delta. And in the third quarter that natural gas delta was even wider, where it was $1.40 improvement on that. So we’re seeing great realizations in the U.S. And so our production in the third quarter was about 16% weighted to the U.S. And obviously, with that Eagle Ford deal that weighting will go up, and you’ll continue to see that torque of the improved realizations on our U.S. products. And if you look at on a net oil equivalent basis blended together. So for the first 9 months of the year, and you’re looking at almost $52 a barrel, in the U.S. relative to $42. So it’s noticeably improvement in the U.S. And so that’s why we’re projecting funds flow to improve proportionately better than that weighted average percentage of production in the U.S.

Travis Wood: Yeah, that’s great color. And then one more, just around activity, I mean, guidance for the tail end of this year into 2022, it’s higher, we’ve seen the resilience in pricing continue. But on the services side, I think you mentioned 20 rigs, is that picked up subsequent to the quarter? And how should we think about kind of the pie chart of the U.S., Canada from rig activity through at least the tail end of this year, I guess?

Robert King: Yeah, Travis, it’s Rob King speaking. On the – this is the latest update, this is up until a couple of days ago, we actually had an increase from those 20 rigs across the U.S. and Canadian lands to 24 rigs. So now there are 17 running in the U.S., 11 are in the Midland, and the other 6 are sort of scattered between Eagle Ford, Bakken, and Appalachian. In Canada, we’ve seen an increase to 7 rigs running on our lands, so even split between Alberta and Saskatchewan. Viking and Cardium are definitely the most active – the active plays with 4 rigs – Alberta 4 rigs. Viking and Cardium are definitely the most active right now for us. So almost every time we update our rig activity, we’re sort of seeing an increase, ever since sometime early September timeframe. So it does give us some pretty solid confidence about what we’re going to see in the balance of Q4 and into 2022.

Travis Wood: Okay, perfect. That’s all for me. Thank you very much.

David Spyker: Thanks, Travis.

Operator: Thank you. [Operator Instructions] We will take the next question. Please go ahead.

Matt Donohue: Jeremy McCrea.

David Spyker: Hey, Jeremy. Did we lose you, Jeremy?

Operator: I’m sorry. I’m unable to hear anyone. [Operator Instructions] Hearing no response. We will have to go to the next question. Please go ahead.

Matt Donohue: Elias Foscolos.

David Spyker: Hi, Elias.

Elias Foscolos: Good afternoon. I’ve got – and thanks for taking my question. I’ve got a question on the guidance, I appreciate the production guidance. I’m trying to tie in as to what the commodity price guidance where that kind of relates to things, I mean, directly with commodity price guidance, I guess, I would be expecting some sort of fund flow or cash flow guidance, but there isn’t any there. So can you frame us to what I’m supposed to get out of the commodity price guidance for Q4 and 2022?

David Spyker: Yeah, basically, Elias, what we’re doing. First, we’ll start with the production guidance, so just recognizing the significant evolution of the portfolio throughout the year, just trying to tie all the bits and pieces together of the acquisition work that’s been done and give you some insight into our view of what Q4 shapes up to and then continuing that forward into next year. This is really – it’s tying all these, all the acquisition work together. For the production – for the pricing guidance, we’re just giving you what we’re using in our modeling for pricing, part of it when we talk about the dividend that pricing there and midpoint of guidance for us triangulate around kind of a 50% payout on pricing. And that’s all we’re trying to just let the analysts, investors, kind of see what we’re using in our numbers as we’re thinking through our business strategy and plans.

Elias Foscolos: Okay. So I can use that, in a sense for the dividend. And what I would say the amount of cushion off of that is to redeploy capital, I guess, would that be correct?

David Spyker: Yeah, in the way we’re looking at managing the dividend is that, we think that debt level of that pricing continues to triangulate around that 50%. We still see considerable opportunity for acquisitions in front of us right now. And so, we take that level of dividend, we can pay down debt, and get ourselves comfortably that 0.5 times debt to cash flow, and still leave opportunity available money to invest on the acquisition front. So we’re just trying to strike that balance and kind of lay that out a little bit more clearly for our readers.

Elias Foscolos: Okay. I appreciate that. And maybe a bit more of a high level question, given the current commodity prices that are out there, and the current drilling activity that you’re seeing absent of acquisitions. How do you see production on your current stream of assets? Would it be holding relatively flat? What am I really trying to get at is, are we at a point now where we’ve got something that’s flat, slightly growing, slightly declining, leaving you the ability to add upside through acquisitions?

David Spyker: Yeah, it’s a good question, Elias. And how we model that right now, we see ourselves essentially flat for the next 3 years. So, we don’t have to deploy capital into acquisitions to maintain that stable production profile. So that’s a significant difference from historically, what we had to do with the company and this reflects how we really repositioned and restructured the asset base in the last 9 months. And so, what that’s allowed us to do is, we can be pretty selective on the bid level that we’re proceeding with on assets, and the exact type of assets that we want to bring into our portfolio. And so, we’ve got a lot more horsepower to run our business with the increased funds flow. And with the production profile, where we’re at, we’ve got a lot more ability to really drive the value and the location of where we’re adding to the portfolio.

Elias Foscolos: Great, perfect. You answered the question, kind of what I was looking for. So appreciate that, that clarity. That’s it for me. I’ll turn it back. Thanks.

David Spyker: Thanks, Elias.

Operator: Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Spyker.

David Spyker: Thank you for everyone participated today. Once again, we’re very excited with the quarter. We’re very excited about going forward. So, thank you all, and please don’t hesitate to call if anyone has further questions. Thank you.

Operator: Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.