Freehold Royalties Ltd T.FRU

From RBC

[Al42]

EQUITY RESEARCHRBC Dominion Securities Inc.Luke Davis, CFA (Analyst)[phone] Harvey, P.Eng. (Analyst)[phone] Lowenberger, CPA (Associate)[phone]: Oil & Gas - High PayoutOutperformTSX: FRU; CAD 5.32Price Target CAD 7.00 ↑ 6.00WHAT'S INSIDE Rating/Risk Change Price Target Change In-Depth Report Est. Change Preview News AnalysisScenario Analysis*DownsideScenario4.0020%CurrentPrice5.32PriceTarget7.0036%UpsideScenario8.0055%*Implied Total ReturnsKey StatisticsShares O/S (MM):131.0Dividend:0.24Market Cap (MM):697Yield:4.5%Avg. Daily Volume:765,396RBC EstimatesFY Dec2019A2020E2021E2022EProd (boe/d)10,6289,67310,19710,314Prev.9,2419,265Cash Flow118.167.996.0113.4Prev.68.080.388.5CFPS Diluted0.990.570.730.87Prev.0.680.75Prod./Share(boe/m)32.6729.6228.4028.73Prev.29.8028.4928.57P/CFPS5.4x9.3x7.3x6.1xAll values in CAD unless otherwise noted.December 9, 2020Freehold Royalties Ltd.Expanding the US footprintOur view: We reiterate our favourable view of Freehold shares followingthe acquisition of diversified royalty assets throughout the US. The dealcontributes to near-term liquids weighted production growth, backed byresilient and diversified counterparties. Freehold remains on both ourGlobal Energy Best Ideas List and our Canadian Small Cap Conviction List.Key points:Expanding the US footprint. Freehold acquired 400k gross acres of royaltyland across various plays throughout the US (Exhibit 2) for US$58 million.Current production of 1,150 boe/d (62% liquids) is expected to grow toroughly 1,450 boe/d into 2022, supported by a backlog of 79 drilled butuncompleted wells. The acquired land had 31 gross spuds during Q2/Q3,roughly in-line with FRU's entire Canadian land base. The package includesmore than 100 diversified counterparties with several high quality payorsat the top end of the list.Metrics compare favourably to select US transactions. Transactionmetrics of US$50k/boe/d and 6.2x cash flow appear favourable relative tocomparable US deals at US$117k/boe/d and 11.7x as noted in Exhibit 3.We believe near-term growth potential should be viewed favourably withmanagement noting that over 90% of the existing development locationsare economic at current strip prices (US$45/bbl).Updating estimates - accretive to cash flow per share. After incorporatingthe deal and C$61 million equity financing/private placement (incl over-allotment), production per share is flat/+1% in 2021/2022. CFPS increases8%/16% in 2021/2022 alongside adjustments to our oil differentialassumptions. We now see the company carrying $37 million in net debtat year-end 2021 and a net cash balance at year-end 2022. This maps to aD/CF ratio of 0.4x in 2021, compared to royalty peers at 1.1x (Exhibit 7).Modeling a dividend increase following deal close. Freehold left its$0.24 annual dividend unchanged but we have assumed a bump to $0.36following deal close (~7% yield). Based on our updated estimates, webelieve this maps to a 2021 payout ratio of roughly 48% at our currentoutlook (52% at strip), compared to the company's 60-80% mandate.Valuation - trading well below peers. As displayed in Exhibit 7, Freeholdcurrently trades at 7.4x/6.0x EV/DACF in 2021/2022, translating toapproximately a 23%/32% discount to the North American oil & gas royaltygroup average. We continue to view this as a strong entry point for long-term investors given our view that the stock is pricing in minimal WCSBdrilling activity, which we expect will normalize as pricing recovers.Outperform rating. Our rating and price target reflect Freehold’s highmargin royalty model, diversified portfolio, and strong financial outlook.We have bumped our one-year price target to $7/share (previously $6/share), alongside increased estimates.