Freehold Royalties Ltd. Q2/21 – Go Big or Go Home
Our View: Freehold posted a solid quarter driven by robust payor activity. This was augmented by a 25% dividend increase (+150% since the beginning of the year) and three sizeable post-Q royalty transactions in active and growing North American resource plays. Second half guidance was increased on improving activity and acquisitions, setting the company up for a strong 2022.
Key points:
Q2/21 activity remains robust. Q2/21 volumes of 11,137 boe/d (58% liquids) were a snick above consensus at 10,980 boe/d (RBC: 11,134 boe/d). This drove CFPS of $0.30, 3% above consensus at $0.29 (RBC: $0.31), with key variances to our numbers noted in Exhibit 1. Drilling activity continues to normalize with 84 (2.1 net) wells drilled on Freehold's land. Payors continue to focus on oil/liquids plays (96%) with 16 rigs currently running across the land base (9 in Canada, 7 in the US). The company also increased the annual dividend by 25% to $0.60/share.
Post-quarter acquisitions underpin near-term organic growth. Freehold announced three post-quarter acquisitions, enhancing the company's exposure in the Eagle Ford and Permian plays South of the border and the Clearwater in Canada. The acquisitions were funded with cash for gross proceeds of approximately C$94 million and were completed at average multiples of $118k/boe/d and 7.3x 2022E cash flow (Exhibits 2/3). Management expects the Midland assets to grow at a CAGR of roughly 25% through 2024 (2022E base of 550 boe/d), underpinned by DUCs and current drilling commitments.
Transactions may temper near-term dividend growth. Based on our updated estimates, we see the company carrying a net debt/(cash) balance of $74/($51) million in 2021E/22E, with the post-quarter acquisitions potentially limiting near-term dividend growth. That said, we continue to model another dividend increase to $0.70/share in 2022 given robust free cash generation. We do not model further acquisitions, though we believe management will remain actively engaged on this front.
Valuation remains attractive. As displayed in Exhibit 4, Freehold currently trades at 6.5x/4.9x EV/DACF in 2021E/22E, translating to an approximately 39%/43% discount to the North American oil & gas royalty group average. We continue to view this as a strong entry point for long-term investors and believe continued deployment of free cash to accretive M&A combined with expected dividend growth should lead to a re-rating.
Reiterating Outperform rating with $12.50 price target. Our rating and price target reflect Freehold’s high-margin royalty model, diversified portfolio, and strong financial outlook. We maintain our one-year price target of $12.50, which reflects our three-year projected FCF model, an 8.5% discount rate (in line with E&P valuations), and -1% terminal value.