Freehold Royalties Ltd. Marketing Highlights
Our view: We hosted a series of investor meetings with David Spyker, CEO, and Matt Donohue, Manager of Investor Relations and Capital Markets. Key focal points included dividend sustainability/RoC, the M&A environment, improved production sustainability, and key growth drivers into 2023. We continue to highlight FRU on our Canadian Small Cap Conviction List; reiterate Outperform and $21/sh target price.
Key points:
Dividend sustainability a key focus. Investors remain focused on Freehold's $1.08/sh dividend (7% yield) in the context of commodity price volatility. Management underscored dividend sustainability, with a 75% payout ratio in 2023 at a US$75/bbl WTI price and coverage down to the low-US$40/ bbl range (RBC ~US$50/bbl). Our estimates map to a 55%/49% 2023E/24E effective payout ratio (68%/71% at strip). Management is comfortable with the current payout with price unlikely to be a driver of dividend growth going forward; further increases will likely be associated with M&A.
M&A has improved corporate sustainability. Freehold reiterated the value proposition of the US with better pricing, growth, sizeable capital spend, and a larger opportunity set relative to Canada. Management outlined recent M&A (USA, Woodcote) totaling $377/$183 million in 2021/2022 and adding 4,400/1,400 boe/d of initial volumes acquired. This has bolstered Freehold's diversification efforts with strong exposure to key plays across North America. The company no longer has to backfill production declines with M&A given a stable to growing profile for the next several years.
Key growth drivers. Management reiterated its focus on the Permian and Eagle Ford in driving US growth, with the company seeing an incremental 2.4 MMbbl/d of oil growth through 2026. In Canada, the team emphasized the Clearwater where Freehold holds 460,000 gross acres of land (latest Clearwater monthly here). Freehold also expects to benefit from broader industry activity in key gas plays including the Montney and Spirit River.
Balance sheet supports further M&A. We see Freehold carrying a net debt (cash) balance of $17/($156) million in 2023E/24E, compared to NAm peers averaging 0.6x D/CF in 2023E; the majority move into net cash positions into 2024E. We do not model M&A, though we believe management will remain actively engaged in the US market while also outlining select opportunities in Canada. Select investors honed in on what the appropriate payout should be given the vast US opportunity set, suggesting accelerating accretive M&A may be rewarded more than incremental RoC.
Reiterating favourable outlook. We reiterate our Outperform rating and $21/share price target, reflecting Freehold’s high-margin, inflation- protected royalty model, diversified portfolio, and strong financial outlook. Freehold trades at 7.9x/6.6x EV/DACF in 2023E/24E (Exhibit 4), compared to Canadian peers at 9.7x/8.4x and Oil and Gas royalty peers at 7.7x/7.2x.