Author Topic: FRU.TO - Freehold Royalties  (Read 1230 times)

Cigarbutt

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FRU.TO - Freehold Royalties
« on: March 29, 2020, 08:16:56 PM »
This is an interesting stock for interesting times.
97% of total revenues come from royalty interests in more than 44700 wells with a relatively diversified base of more than 300 partners based in Alberta, Saskatchewan and a recent and small acquisition in North Dakota. They have small working interests which they tried to sell in 2019 (see below).

They have a long story and are dedicated to their model. The reserves are well covered in the annual info form and they give the typical relationship between key inputs (WTI etc) and FFO although non-linear results could happen at these levels. They have good exposure to light and medium oil.

They went through 2014-6 relatively well and, in fact, issued shares to buy interests and help with the inherent production decline. The 2019 AR has a 10-yr table with key results. Their FFO is simply WC-adjusted CFO. So far, they've maintained the dividend but, given present circumstances (CV, price war, egress problem etc), changes may occur on that level.

Valuation wise, it's interesting that price targets from before have had limited usefulness, given the high volatility of oil prices. In 2014-6, there was a similar scenario and I went for few names in the CDN oil patch but it feels different now and Chinese state-sponsored investors are unlikely to focus on foreign direct investments in Canada this time. Unlike the typical O+G producer, even if levered, because of the royalty model and their exposure, they are unlikely to fail and it is reasonable to expect the stock to be multiplied by 4 at some point during the next ten years, notwithstanding the dividends that will come along. The underlying resource will deplete over time but they report having more than 40 years of drilling inventory.

The net debt is now 94.6M and ND to FFO is 0.8. They still have room on their revolver, due in 2022 and the two financial covenants have reasonable room.

It's basically a reasonable position to benefit (in a relatively muted way) from higher oil prices over some time with quite reasonable downside protection, with the optionality that FRU actually benefits from the more difficult environment, which may last longer than consensus.

There's another similar royalty company out there but it does not look as solid. Will take a deeper look.

https://www.petersco.com/pdf/Freehold_InformationMemorandum_CentralAB-DeepBasin-Lloyd.pdf


Pondside47

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Re: FRU.TO - Freehold Royalties
« Reply #1 on: March 29, 2020, 08:32:53 PM »
Thanks. This looks interesting.

bizaro86

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Re: FRU.TO - Freehold Royalties
« Reply #2 on: March 29, 2020, 09:03:27 PM »
I own this and have added meaningfully this month.

That said, I have two comments on their business model that make it less than the perfect royalty business. The first is that when the assets were seeded into freehold (by the CN pension fund) only the producing horizons were included. So all unproducing geological layers were kept by the pension fund. This reduces their upside, because less new zone discoveries belong to them.

Secondly, their newer assets are nearly all gross overriding royalties as opposed to their original freehold royalties. That is more risky in a prolonged downturn, because the underlying fee interest belongs to the government. Their claim is on a leasehold. If production ceases (because of uneconomic conditions) the lease is no longer held by production and reverts back to the crown, nullifying their interest.

I have never been able to conclusively determine what happens if the producers they have the GORRs with declare bankruptcy, and it seems likely that some will. If their claim is on the lease title it may survive bankruptcy, but if its contractual it could be rejected. I would be very interested in knowing the answer to this question!

On the upside, they are well positioned to survive a downturn. They have almost no operating costs, and are not responsible for capital spending either. Their production declines of course, but would grow if the macro conditions were better I think as operators spent capital on their lands. That isnt to be thought of now, but I think they are very likely to survive to higher prices, which is all that is necessary to make them investible at present imo.

skanjete

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Re: FRU.TO - Freehold Royalties
« Reply #3 on: March 30, 2020, 01:23:05 AM »
How does the royalty system actually work?

Do they receive a fixed price per barrel, or do they receive a percentage of revenues, or a mix of both systems?

KJP

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Re: FRU.TO - Freehold Royalties
« Reply #4 on: March 30, 2020, 06:16:42 AM »
How to you view FRU versus Black Stone (and the other O&G royalties companies if you've looked at them, e.g., Dorchester Minerals, Viper Energy, Falcon Minerals)?


KJP

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Re: FRU.TO - Freehold Royalties
« Reply #5 on: March 30, 2020, 06:20:36 AM »

That said, I have two comments on their business model that make it less than the perfect royalty business. The first is that when the assets were seeded into freehold (by the CN pension fund) only the producing horizons were included. So all unproducing geological layers were kept by the pension fund. This reduces their upside, because less new zone discoveries belong to them.

Great point.  Part of the attraction of a full royalty interest is that it's perpetual.  So, if you own the full freehold (royalty interest in US), you get the benefit of all future advances in drilling tech, including ways to get to new layers.  I think it's impossible to model that, but it's a nice option to have.


bizaro86

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Re: FRU.TO - Freehold Royalties
« Reply #6 on: March 30, 2020, 08:40:58 AM »
How does the royalty system actually work?

Do they receive a fixed price per barrel, or do they receive a percentage of revenues, or a mix of both systems?

Freehold's leases are based on a percentage of revenue. Generally at the battery for oil (so their only costs are clean oil transportation) and at the wellhead for gas (so they would typically pay for processing on their share of gas production).

Gas has not been meaningful to them, but may be now given current oil prices...

Cigarbutt

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Re: FRU.TO - Freehold Royalties
« Reply #7 on: March 30, 2020, 12:41:46 PM »
How does the royalty system actually work?
Do they receive a fixed price per barrel, or do they receive a percentage of revenues, or a mix of both systems?
Freehold's leases are based on a percentage of revenue. Generally at the battery for oil (so their only costs are clean oil transportation) and at the wellhead for gas (so they would typically pay for processing on their share of gas production).
Gas has not been meaningful to them, but may be now given current oil prices...
Their royalty rates on production revenue vary from less than 1.0% (for some gross overriding royalties) to 22.5% (for some lessor royalties). They have a royalties 101 section in their 2017 asset book, pages 10-11 of the "book":
https://www.freeholdroyalties.com/sites/default/files/docs/freehold_asset_book_final.pdf
The overriding royalties are similar on the surface but tend to pay less and don't run with the land.
BTW, the payment of the royalty can be in kind (FRU gets paid this way to a small degree).

How to you view FRU versus Black Stone (and the other O&G royalties companies if you've looked at them, e.g., Dorchester Minerals, Viper Energy, Falcon Minerals)?
i "view" this space as two potential opportunities: one now and one that may develop over time if O+G royalty financing becomes a product in demand, assuming that 1-capital discipline will never really happen in the oil markets but that 2-the price of money may mean something at some point. Oil and gas is not a natural 'fit' in the investment plan and i plan to continue developing this thesis over time, which includes looking deeply at the names you mention. Probably more to follow unless the market gets exciting elsewhere or overall.

...
Secondly, their newer assets are nearly all gross overriding royalties as opposed to their original freehold royalties. That is more risky in a prolonged downturn, because the underlying fee interest belongs to the government. Their claim is on a leasehold. If production ceases (because of uneconomic conditions) the lease is no longer held by production and reverts back to the crown, nullifying their interest.

I have never been able to conclusively determine what happens if the producers they have the GORRs with declare bankruptcy, and it seems likely that some will. If their claim is on the lease title it may survive bankruptcy, but if its contractual it could be rejected. I would be very interested in knowing the answer to this question!
The upside is limited but everything is relative. The GORRs' status with partner distress or bankruptcy remains blurred. Perhaps this is a question that needs to be addressed directly? Even if the documents point to a mineral ownership transfer ("interest in the land") the intent of the transaction (IMHO) remains, in substance, a form of financing. The royalty is contractual and is money exchanged for a portion of generated revenues. There have been some legal developments in Canada:
https://www.mondaq.com/canada/InsolvencyBankruptcyRe-structuring/872288/Let39s-Talk-About-Royalties-The-Continued-Uncertainty-Surrounding-The-Creation-And-Legal-Status-Of-The-Overriding-Royalty
As always in these situations, the definitive answer is never clear.
On a longer term basis, this may eventually become an advantage as royalty financing may become associated with better terms of engagement.
« Last Edit: March 30, 2020, 12:47:04 PM by Cigarbutt »

skanjete

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Re: FRU.TO - Freehold Royalties
« Reply #8 on: March 31, 2020, 05:57:14 AM »
Thanks for the reply.