Freehold Royalties Ltd. Investor Day Highlights
Our view: Freehold's investor day underscored the unique value of the transition into US basins alongside a refresh of key plays within the Canadian portfolio and resurgence in underlying organic growth. In our view, the business is better positioned than any time in recent memory and we expect M&A will continue to drive growth in 2022. Freehold remains our top royalty pick in the group; OP and $16/share target unchanged.
Key points:
US expansion a key differentiator. Management’s focused M&A efforts have driven significant growth within the US with 2022E royalty volumes expected to reach 4,900 boe/d (70% liquids). The company has diversified its holdings with exposure to 100+ royalty US payors, weighted to top tier plays including the Eagle Ford and Permian (Midland, Delaware). Notably, US payors are primarily investment grade (70%) and publicly listed (90%). There are currently 18 rigs running on Freehold’s US royalty lands, which compares to 7 in Canada, setting up for strong organic growth over the next several years.
M&A will continue to be a key theme. Freehold reiterated its bullish stance on the US, which is underscored by a high weighting to mineral title, high level of capital investment, and compelling valuations. Management anticipates robust deal flow will continue into 2022 led by owners who postponed plans to market their assets in 2020/2021, alongside sponsors seeking to monetize investments, and noted a commitment to remain highly selective on play and valuation. Approximately 50% of free cash flow will be allocated to M&A going forward.
Canadian portfolio provides a stable base. Freehold reiterated the value of the Canadian portfolio, with the company currently holding over 6 million gross royalty acres with roughly 25 net wells per year required to sustain production. The portfolio is highly diversified, though the top 6 areas contribute roughly 70% of total production (see Exhibit 3). M&A could continue if opportunities arise and will likely be focused on GORRs in key growth areas including the Clearwater, Charlie Lake, Montney, and Spirit River.
Balance sheet in good shape. Based on our updated estimates, we see the company carrying a net cash balance of $54/$152 million in 2022E/23E, which compares to NAm royalty peers carrying slight leverage with average D/CF ratios of 0.7x/0.6x. We do not model further acquisitions, though we believe management will remain actively engaged on this front with a $500 million shelf prospectus approved subsequent to Q3 to streamline potential acquisition financing.
Valuation remains attractive. Freehold currently trades at 6.1x/6.7x EV/ DACF in 2022E/23E, translating to an approximately 28%/23% discount to the North American oil & gas royalty group average (Exhibits 6/8). We continue to view this as a strong entry point for long-term investors and believe deployment of free cash to accretive M&A combined with expected dividend growth should result in continued re-rating.