Freehold Royalties Ltd.

This conference is being recorded. Cette conférence est enregistrée. All participants, please stand by. Your conference is ready to begin. Good morning, ladies and gentlemen. Welcome to the first quarter results conference call. I would now like to turn the meeting over to Mr. David Spiker. Please go ahead.

Good morning, everyone, and thank you for joining us. On the call with me today are David Hendry, our CFO... Rob King, our Vice President Business Development, and Matt Donahue, our Manager of Investor Relations and Capital Markets. The first quarter marked a period of rebound for Freehold as the company restored production levels, generated significant improvements in funds from operations, increased its dividend, and completed its first transformational U.S. royalty transaction, all while reducing leverage. To start this morning, I would like to talk about the dividend increase, and then we will focus on the excellent operational performance we have had. In conjunction with projecting 10 to 15% production growth over 2020, we will be increasing our dividend for the third time this year, increasing our monthly payout by 33%, from $0.03 per share to $0.04 per share, starting in June to shareholders of record on May 31, 2021. This healthy dividend increase represents a measured approach in moving the dividend upwards towards our long-term 60 to 80% payout ratio objective. This stepwise approach takes into consideration that despite the improvement in the commodity price outlook, there still remains considerable risk with uncertainty on the ultimate pace and sustainability of demand recovery as COVID-19 vaccination initiatives are well underway. We also see this as an opportunity to deleverage our balance sheet with free cash flow after dividends being directed to further reduce our debt, retaining financial flexibility to do further high-quality acquisition work. The key highlight for the quarter was the completion of our acquisition of a diverse U.S. royalty package, reinforcing our identity as a publicly traded, North American-focused oil and gas royalty company. The $74 million acquisition closed in early January and has provided freehold with exposure to 450,000 gross drilling unit acres of mineral tidal lands and overriding royalty interests across 12 basins and 8 states, predominantly weighted towards the activity-rich Permian and Eagle Ford basins. Our team has worked hard to incorporate these assets into our portfolio over the quarter, with early indications suggesting performance exceeding expectations. Additionally, over the quarter, we were able to complete three tuck-in acquisitions, adding exposure to the Bakken and Permian basins. These deals totaled $4.9 million and closed this quarter. They are estimated to add 85 BUE day of production in 2021 and will provide additional growth into next year. We have been extremely encouraged with the level and quality of acquisitions we have seen to date, with the initial transaction providing us a strong suite of assets to expand on through further deals. In the near term, we expect to be busy on both sides of the border with a focus on enhancing the quality of our royalty portfolio and providing strong returns to our shareholders. We see the growth of Freehold's U.S. portfolio as further diversifying our royalty lands. enabling participation in some of the most attractive plays in North America. Moving forward, we believe our U.S. royalty lands will provide a key growth wedge to our production profile, increasing option value to provide returns to our shareholders. On the operations front, production for the quarter averaged 10,944 BUE a day, representing a 13% improvement over Q4 2020 and a 3% gain on a per share measure. We had a small period of weakness associated with our U.S. portfolio with the cold weather in Texas over the quarter, but this has since rebounded. Production from freehold U.S. royalty assets averaged 1,285 BOE a day in Q1 2021, a 400% increase from 257 BOE a day in Q4 2020, and a 414% increase versus the same period last year. Based on our first quarter results and our outlook for activity on our royalty lands, both within the US and Canada, we are maintaining our 2021 production guidance range of 10,500 to 11,000 BUE a day. At current commodity price levels, we see third party activity offsetting natural declines, which enables free cash flow for growth of the dividend, value enhancing transactions, or to pay down leverage. On the drilling front, 111 gross 3.9 net wells were drilled on our royalty lands in Q1, a 37% decline on a gross measure versus the same period in 2020, but flat when compared to Q4 2020. With the upward move in crude oil prices, we have seen activity increase on freeholds royalty lands with approximately 10 rigs, six in Canada, four in the US, running on our royalty lands during the quarter. In Q1 2021, approximately 75% of all locations drilled in Canada targeted gross overriding royalty prospects, with 25% focused on prospects on freehold mineral title lands. 50% of all locations drilled targeted prospects in Saskatchewan, with the remainder focused in Alberta. The vast majority of wells drilled, more than 90%, were focused on oil or liquids prospects. The Clearwater Oil Play in Central Alberta represents Freehold's most active area over the quarter. The increase in activity reflected a change in operator late last year and subsequent ramp-up in that operator's spending on the lands. We expect this to represent a key growth area for Freehold in the near to medium term, with the play offering strong economics at current commodity price levels. In the U.S., Activity levels on Freehold's mineral title lands have met expectations, with the majority of the focus on light oil prospects targeting the Permian and Eagle Ford basins. Overall, 18 gross wells were drilled on our U.S. royalty lands over the quarter, with between four to five rigs continuing to drill on our lands. The acquisition of additional U.S. royalty production and royalty lands in Q1 2021 as further diversified and enhanced Freehold's asset base, bringing added sustainability to its portfolio and dividend. We have considerable optimism heading into 2021 and will continue to focus on positioning Freehold to be a premier North American royalty company with a strong balance sheet, a sustainable dividend, and prospects for growth in top-tier oil and gas operating areas. I will now pass the call to Dave Hendry to walk through some of the financial highlights.

Thanks, Dave, and good morning, everyone. Financially, as commodity prices improved over the quarter, Freehold continued to deliver on the core 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 $36.8 million for Q1 2021, up 42% from the fourth quarter of 2020. Funds flowed from operations for Q1 2021 totaled $32.4 million, or 25 cents per share, up 47% versus the previous quarter. The increase of both reflects strong upward momentum in crude oil prices and the positive contribution from our U.S. acquisitions. Freehold's dividend payout totaled 24% for Q1 2021, consistent with Q4 2020, and down from 92% during the same period in 2020. As previously mentioned, we increased our monthly dividend for 2021 from 3 cents per share to 4 cents per share, reflecting a measured response to an improved commodity price outlook and an expected increase in third-party spending on our royalty lands in 2021. For Q1 2021, cash costs totaled $4.37 per BOE, slightly up from $4.11 per BOE in Q4 2020, with annual short-term incentive plan paid in the first quarter of each year. but down 24% versus the same period last year. This strong result reflected reduced G&A financing and operating cost charges. Over the year, we executed upon a number of cost-saving measures which have improved our net back and profitability. Our 2021 U.S. acquisitions are expected to only add a marginal amount of G&A which should continue to improve our corporate cost base and net back. Net debt totaled $64.8 million at March 31, 2021, representing 0.8 times net debt the funds were from operations, relatively consistent with Q4 2020, as free cash flow was applied to our recent acquisitions, but a $37 million reduction from Q1 2020, The decrease in net debt year over year reflected strong funds flow from operations alongside a lower dividend payout. Three holds prudent strategy of maintaining long-term debt to funds flow from operations below zero and are between zero and 1.5 times alongside a longer term dividend payout target range of 60 to 80% of funds flow from operations. Provides cushion, for potential volatility in commodities. In conjunction with our recent U.S. acquisition, Freehold exchanged 12.6 million subscription receipts for an equivalent number of Freehold common shares, raising gross proceeds of $60.7 million. This represented one of the first successful Canadian E&P financing in a number of years, and we would like to thank all of our shareholders and the Syndicate of Banks that helped Freehold complete the transaction. In March 2021, Freehold also amended its credit facility with a syndicate of four Canadian banks, maintaining the committed revolving facility at $165 million and the operating facility at $15 million. The amended credit facility agreement includes a permitted increase in the revolving facility to $215 million, subject to lenders' consent. Both the committed revolving and operating facilities mature March 31, 2024. At the end of Q1 2021, $96 million was drawn on these facilities versus $93 million at year-end. This slight increase is due to the recent acquisitions of U.S. royalty properties. The credit facilities are secured with a $400 million first-charge demand to venture's over all of Freehold's Canadian royalty income assets and fixed charge mortgage securities on certain U.S. royalty income assets. Now back to Dave for his final remarks.

Thanks, Dave. So looking forward, we remain enthusiastic about the next 12 months of operations. We've seen a steady trending up of capital and production volumes on our lands, both in Canada and the U.S., and 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 2021 monthly dividend, we highlight that this is the third time in the past six months that we have revised our 2021 payout upwards. The groundwork is in place for an exciting 2021 and beyond. The improved economic conditions are very positive for our industry and highlight the strength of the royalty model. Through execution of our strategy in the coming quarters, we expect to be able to showcase the strong return proposition an investment in freehold provides, with the ultimate commitment to maximize value to our shareholders. Thank you. Okay, so we'll now turn the meeting over to questions. So if anyone has any questions, please feel free to bring them forward at this time, and we'll answer those.

Thank you. If you have a question and you're using a speakerphone, please lift your handset prior to making your selection. If you have a question, please press star 1 on your device's keypad. You may cancel your question at any time by pressing star 2. Please press star one at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. Once again, please press star one at this time if you have a question. The first question is from Elias Soskalas with Industrial Alliance. Please go ahead.

Good morning, and thanks for taking my call. Got a couple questions. First one is if you could comment on the trap line of potential acquisitions in both Canada and the U.S. Just maybe flipping back to six months ago and today, do you see that trap line is greater or equal to or less than, very broad, could be numbers or size? And really what I want to drive to is, is the potential increase in the capital gains tax rate driving some of that potential upside.

Sure. It's Rob King speaking. I'll take this question, Elias. So maybe I'll just give you a couple of data point numbers in terms of the opportunities that we've sort of looked at in the first, you know, four months of the year and sort of what we're seeing on our plates right now. You know, in the first four months, you know, between US and Canada, you know, we looked at about 35 opportunities in depth. there's probably about the same number that we did not look at in terms of something we wanted to allocate our time to, whether it's the wrong basins or not the right mix of development versus the near-term production, et cetera, a bunch of reasons why we might have decided not to evaluate those other transactions. I think we're seeing a pickup, particularly in the U.S., as it relates to opportunities that we're seeing coming forward. Private equity, which is, they've put north of 15 billion of capital towards the mineral title sector in the last half a dozen years. They really haven't had an opportunity for an exit in the last year and a half. And so I think are increasingly looking to test the waters in terms of how this more constructive price environment may play out, and we're looking at right now close to a dozen opportunities in the U.S., primarily focused on the Permian and on the Eagleford. In terms of the capital gains comment, I think that was something that we saw a bit more activity in late Q4 in terms of a number of sellers wondering that that was something that the rumors and the prospects of that, and certainly that's probably accelerated a little bit in terms of people, again, suspecting there will be some near-term tax changes. I think the commodity price has a bigger impact, frankly, in terms of encouraging people than the capital gains from what we're seeing.

Okay, I really appreciate that color. I know my questions are a little higher level or macro. Maybe one last one. You know, the dividend payout ratio is relatively low using Q1, and you do have your targeted range. Targeted range is probably based on a number of factors, but over what period of time would you see moving into that targeted range? Would that be four quarters, eight quarters? Very broad question, but I thought I'd throw it out there.

Hey, this is Dave Spiker. I could respond to that. From a target perspective, you know, the 60% to 80% range, we view that where we want to be is probably more in the lower end of that target range right now. And so, you know, going forward at the $55... that we're using in our model, you know, we're projecting kind of run rate payout in that low 50%. So, you know, we're getting toward that 60 range. And so, you know, a couple of things that are keeping us there is that, you know, still a little bit uncertainty on the commodity price. You know, we like where it's at right now, but we recognize, you know, given what's supporting it, that it can still be a little bit fragile. And also, just with the opportunity set that Rob referenced that we see in front of us, we think that there's an opportunity to continue to add meaningful, high-quality assets to the portfolio. One of our advantages is that with the recent reconstruct of our portfolio in the U.S. acquisition work and some of the work we've done in Canada, is that we see a really low to no decline forecast for the next few years. So we can be much more patient and finding the right opportunity that we want to add. So we've got a certain recipe that we have to build the portfolio. And so we want to just keep some capacity available to do that. So in our view, we'll keep at that low end of the payout range. We may be slightly below that for the next year or so. but we'll inch our way back up into that range as we have confidence in the commodity price outlook.

Great. I really appreciate that answer. It helps with the calibration points and what you're thinking of. Got lots more questions, but I'll turn the call over to others in the queue. Thanks very much.

Thank you. Once again, please press star 1 on your device keypad if you have a question. The next question is from Jamie Kubik. Please go ahead.

Yeah, good morning. Thanks for taking my question here. You guys highlighted in your press release you had 10 rigs running, six in Canada and four in the U.S. on your royalty lands. Can you maybe frame or remind us, I guess, what level of rig activity would drive growth on your asset base in Canada and what level would probably be needed to remain flat, I'm sorry, both in Canada and the U.S. on that question.

Yeah. So in terms of rig activity, when we came to the forecast for our 2021, the 10,500 to 11,000 barrels a day, that sort of baked in about 15, 1.5 net wells, on our U.S. and Canadian lands over the course of 2021. And so as of first quarter end, we're at just under four. So we're sort of on path to that effectively is maintaining a flat production year over year. So about the level that we sort of saw in Q1 and sort of the run rate that we're seeing right now.

And Jamie, I don't think it's just necessarily, it's Matt here, sorry, but I don't think it's just a rig number because we've had a producer in the Viking go to longer reach wells that add to productivity. We've seen some more deep basin drilling that add higher volumes, and we're still kind of triangulating on the U.S. and what an actual, you know, what a rig translates to a well, translates to a net well, and adds production. So, But, you know, I think we've done a pretty good job of trying to figure out what the profile looks like. And it looks, you know, at a much more constructive level than it has in the past with, you know, I think it inching up through the back half of the year as the U.S. grows and maybe Canada's declined slightly.

Yeah, good comment there on the net wells, Matt. I mean, it's one where, you know, we're still calibrating these numbers, but When we look at what a net well in Canada brings on relative to one net well in the US, it's quite a different story. A net well in Canada for us would bring on about, call it 70 BOEs a day of incremental production. One net well in the US would bring 700 barrels a day of incremental production. Obviously, our royalty rate in the US is much smaller than it is in Canada. 4% or 5% in Canada, 0.5% in the U.S., but it sort of shows our ability to expand the U.S. portfolio can certainly bring a lot more incremental production gains.

Okay. That's good, Collie, guys. Thank you. That's it for me.

Thank you. There are no further questions registered at this time, so I'll turn the meeting back over to Mr. Spiker.

Okay, thanks everyone for attending today. And say, we're really excited about, you know, go forward in 2021. And we've got a lot of good initiatives underway and look forward to catching up with everybody at the next quarter conference call. Thank you.

Thank you, Mr. Spiker. The conference has now ended. Please disconnect your lines at this time and we thank you for your participation.