Freehold Royalties Ltd. Update
Sym: FRU on the TSX at $14.14 (Can)
Q1/24 AS EXPECTED. GUIDANCE UNCHANGED. BOARD REFRESHED
Aaron Bilkoski^ Dustin Besaw, CFA^ THE TD COWEN INSIGHT
May 7, 2024
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Q1/24 was largely as expected, and the company remains on track to meet 2024 guidance. We continue to be attracted to the diversified nature of Freehold's royalty assets. Its valuation remains below the royalty peers, despite our view that its growth should be comparable.
Event: Reports Q1 Results
Impact: NEUTRAL Q1/24 as Expected by TD; CFPS Modestly Shy of Consensus: Freehold reported royalty production of 14.7 mBOE/d, in line with both TD (14.9 mBOE/d) and consensus (15.0 mBOE/d). Volumes were largely unchanged q/q as recently acquired production (previously announced), which contributed ~0.4 mBOE/d to Q1/24, helped offset cold-weather-related outages in January. Volumes ramped up later in Q1/24, reaching over 15 mBOE/d. CFPS of $0.36 was exactly in line with TD ($0.36), although it was slightly shy of consensus of $0.37.
Canadian Activity Better Than We Had Expected, Given Cold Weather: There were 5.9 net new Canadian wells drilled in Q1/24 and 0.5 net new U.S. wells drilled. Relative to last quarter, this represents a material uptick (55%) in Canadian activity. Activity on the U.S. assets contracted 29% q/q and 38% y/y.
New Leases Signed: 20 new leases were signed in Q1/24, with 12 individual operators. It appears that the vast majority of this activity is being done with private or junior counterparties.
Our View: We are encouraged by the strength in the Canadian activity, which we had anticipated would have ebbed, given the challenging operating environment. This is further helped by the new leasing activity, with an array of operators, with the majority of those being private or juniors companies. The implication of this is that they are earlier-stage and are more likely to grow than larger producers. Although the U.S. well count contracted, it is off a small base (<1 net well). We have come to expect lumpy U.S. drilling, which results in production additions later in the year.
Peter Harrison Retires from the Board; New Members Added: Founding Board member, Peter Harrison (CNID), will not stand for re-election. In his place will be Mathieu Roy (CNID). Sylvia Barnes will also not stand for re-election, and her spot will be filled by Kim Lynch Proctor - a prominent Calgary director with a law/finance background.
Dividend Remains Well-covered by FCF; Financial Leverage Continues to Trend Towards Nil: The current yield of 8% remains well-funded. Under strip pricing, we estimate an all-in payout ratio of 64%/58% in 2024/2025E and financial leverage to be nil by YE-2025
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Our Investment Thesis
Freehold offers cross-border diversification, stable volume growth, an ~8% dividend yield, and is tracking to be debt-free by early 2026. Despite the positive attributes of the royalty model, Freehold is trading at an attractive FCF yield of 12%, which is in line with the average FCF yield of our Canadian E&P universe.
Forthcoming Catalysts
Interest rate cuts directionally positive for royalty producers; potential consolidation of fragmented royalty interests through accretive acquisitions; increased growth in oil plays (such as the Permian and Clearwater).
Base Case Assumptions
US$75/bbl WTI for 2024E (US$65/bbl long term), US$2.50/mcf HH for 2024E (US $3.50/mcf long term); In-line production; Status quo regulatory and/or fiscal framework
Upside Scenario
US$90/bbl WTI, US$4.00/mcf HH represents a 34% increase in our 2025E CFPS and a more attractive FCF yield of 17%; Potentially higher-than-forecast production; Positive changes to regulatory and/or fiscal framework.
Downside Scenario
US$40/bbl WTI, US$2.00/mcf HH represents a 56% decrease in our 2025E CFPS and a less-attractive FCF yield of 7%; Potentially lower-than-forecast production; Negative changes in regulatory and/or fiscal framework Price Performance Aug-23 Nov-23 Feb-24 May-24 C$16 15.5 15 14.5 14 13.5 13 12.5 12 Source: Bloomberg
Company Description
Freehold Royalties Ltd. is a publicly traded oil-weighted royalty company. It derives its revenue from third-party drilling on lands it holds a royalty interest across Canada and the U.S. Given that capital costs and production expenses are generally shouldered by thirdparties, the business generates high margins and significant FCF.
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Source
TD COWEN EQUITY RESEARCH,
A division of TD Securities
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