CIBCFRU is rated Outperform with a $16.00 target. GLTA
EQUITY RESEARCH
November 23, 2021 Earnings Update
FREEHOLD ROYALTIES LTD.
Marketing Takeaways: Capital Allocation And Asset Integration
Our Conclusion
We recently hosted David Spyker (President and CEO) and Matt Donohue (Manager, Investor Relations & Capital Markets) for a series of investor meetings. The primary focus centred on Freehold’s increased exposure to low-cost resource plays in the U.S. and the capital allocation outlook for 2022. The full impact of FRU’s recent U.S. acquisitions will be displayed with the company’s Q4/21 results, and we take the upward 2021 guidance revision with its Q3 results as an early positive signal. We continue to favor the stock given that our estimates see it as conservatively valued relative to other North American royalty peers, and expect the stock to benefit from
index inclusions through increased market capitalization. We have increased our cash tax estimates for 2022 and 2023 and leave our rating and price target unchanged.
Key Points
The primary focus is on near-term debt reduction and asset integration. While the recent filing of its mixed shelf prospectus was topical in meetings, management indicated the filing was primarily done for future flexibility, and it intends to focus on debt reduction and asset integration in the near term.
Acquisition focus likely to remain centered on U.S. assets with an emphasis on quality. The U.S. portfolio was the dominant talking point in meetings, and rightfully so, as Freehold’s U.S. production is expected to comprise ~1/3 of its total volumes following its recent M&A activity. Management highlighted that the quantity of attractive acquisition opportunities in U.S. resource plays remains robust; however, Freehold will remain selective with acquisitions. While we see it as still being early days in the company’s transition towards a larger U.S. asset weighting, the acquisition metrics, operator exposure, and resource play focus have been intriguing, and supportive of forward cash flow. Management also noted that most U.S. royalty deals are transacting at 4x-7x forward cash flow, which has
allowed for competitive acquisition metrics that have been accretive to FRU’s trading range of ~6.0x-7.0x 2022E EV/DACF on strip.
The payout ratio remains conservative and upward dividend revisions remain likely (in our view). We have included a higher assumption for cash taxes in our forward estimates. However, our revised payout ratio of 45% on strip pricing in 2022 still sits below the low end of FRU’s 60%-80% targeted range. Management noted it is targeting the low end of its stated payout range at current pricing. We expect the company to look to balance dividend increases with debt reduction and/or potential M&A activity. We note that FRU has historically operated with lean debt levels and our current estimates see FRU exiting 2021 at 0.6x D/CF. Given our current estimates see the company exiting 2022 in a net cash position, we expect FRU could acquire ~$200MM worth of assets without accessing equity in 2022, and remain <1.0x D/CF.