Falcon Minerals Corporation (FLMN) 2020 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Falcon Minerals Third Quarter Earnings Call. (Operator Instructions) As a reminder, today's call is being recorded. (Operator Instructions). At this time, it is my pleasure to turn the floor over to your host, CFO, Bryan Gunderson. Sir, the floor is yours.

Good morning, everyone, and thank you for joining today's call to discuss Falcon's Third Quarter 2020 results. Before we begin, I'd like to remind everyone that during this call, we will make certain forward-looking statements that address our expected future business, financial performance and financial conditions. Actual results achieved by the company may differ materially those made or implied in any forward-looking statements due to a wide range of risks and uncertainties included those set forth in our SEC filings.

I would also like to caution you not to place undue reliance on these forward-looking statements, which reflect management's analysis as of the date hereof. The company expressly disclaims any obligation to update or revise any forward-looking statements. Additionally, this presentation also includes non-GAAP measures. Reconciliations of these measures to the most directly comparable GAAP measures are included in the earnings release, which is posted on our website.

Lastly, the company will be attending several virtual investor conferences in the coming weeks, including the 2020 Stephen's All Sector Virtual Conference on November 18, and the 2020 Capital One Virtual Energy Conference on December 7 through 9.

With that, I'll turn the call over to Falcon's President and Chief Executive Officer, Daniel Herz, for his remarks. Daniel?

Thanks, Bryan. Good morning, everyone. It is nice to speak to you. I hope you are all well. Thank you for joining today's Falcon Minerals Third Quarter 2020 Earnings Call. Bryan, our Chief Financial Officer, who you just heard from, will give the financial report following my remarks. And then we will take your questions.

But first, in these unique times, I would like to offer you a quote from the Great Athenian philosopher, Plato, "Be kind, for everyone you meet is fighting a hard battle." Now as we announced last quarter, we have been working on a fulsome evaluation of different avenues to maximize value to our shareholders and address what we see as a substantial value disconnect in our equity trading price. We have made significant progress, and I look forward to coming back to you to discuss Falcon 2.0 as soon as we have fully completed our review. I don't plan to give a specific time line as we believe it is imperative to make sure we have thoroughly explored all options.

While our strategic review is important, we believe that more important is the great position that Falcon is in. This strength allows us tremendous flexibility in choosing what we believe is the best way to drive equity value back to you, our shareholders. I will now review how the business has performed, our expectations over the coming quarters and the long-term value proposition that exists at Falcon Minerals.

Our balance sheet is strong and continues to improve, with approximately $36.5 million of net debt at the end of the third quarter, down from the second quarter net debt of $38.8 million and $40 million at the beginning of 2020.

Falcon generated $0.07 of free cash flow per share during the third quarter, more than 2x the second quarter of 2020. As such, last night, we announced a dividend for the third quarter of $0.065 per share or $0.26 annualized. This represents a payout ratio of approximately 93%. This dividend is an increase of 117% above the dividend paid during the second quarter of 2020. And as you will hear, we think there will be further substantial dividend growth to come.

Now to the underlying activity across Falcon's acreage position. As a reminder, we have 0 capital expenditures associated with the development of our position, which allows us to generate, in return, substantial free cash flow. During the third quarter, we produced 4,471 barrels of oil equivalent per day or BOE per day. This was a modest increase over the second quarter of 2020. Importantly, this modest increase occurred even though only 0.03 net wells were turned in line during the quarter. The increase in production was driven by wells that had been curtailed during the second quarter and then came back online throughout the third quarter. We believe, as of the end of September, all of the curtailed wells are back online and are producing to our benefit, with the barrels of oil selling at substantially higher prices that existed during the curtailment period. Very good news for us all.

While the third quarter had limited wells turned online, which is consistent with what we had expected and previously discussed, activity has begun to pick up. Of highest importance, our line-of-sight wells has grown to 3.13 net wells, which represents an increase of 24% since our last quarterly earnings call just 3 months ago. That increase includes the recently permitted 6-well Hooks Ranch pad, which represents 0.45 net wells as the 6 wells are shared unit wells similar to the Hooks pad that came on earlier this year.

This continued activity and pacing of activity on Hooks Ranch is consistent with our expectations and our past discussions and further demonstrates the fact that our acreage position in the Karnes Trough produces the best economic results in the Eagle Ford Shale.

During the third quarter, our operators averaged 2 rigs running across our position, continuing to turn permitted wells into ducts. Furthermore, our major operators, including ConocoPhillips, and EOG have continued to complete wells and begun to increase the frac crews that they are deploying. As such, we now have 1.70 net wells that have either been completed and are waiting to be turned in line or that have been drilled and are waiting to be completed.

These 1.70 net wells provides a strong visibility and confidence in production over the next 3 quarters as those wells are turned in line and begin producing. Of course, that still leaves us the 1.43 net wells that are already permitted, which we expect to also come online during 2020 -- '21. Let me repeat that. Of course, that still leaves us the 1.43 net wells that are already permitted, which we expect to also come online during 2021. To put this into context, if we just have our 3.13 net line-of-sight wells come online over the next 14 months, with no additional wells added, that will be approximately twice the net wells that will have come online during 2020.

Historically, our operators have turned on nearly 100% of the line-of-sight wells within approximately 10 months from permitting. Of course, 2020 has been an exception in many ways. But given our operators publicly stated plans, we believe it is conservative to assume these wells will be turned in line by the end of 2021. This is exactly what should provide meaningful growth to production, free cash flow and maybe, most importantly, dividends over the next year.

While we are not providing formal guidance, in an effort to make the math simpler, these modest assumptions provide for 2021 estimated average production of approximately 5,000 BOE per day, which would generate a current strip pricing. Inclusive of our hedges, free cash flow of approximately $0.50 per share. This would represent a free cash flow yield of greater than 25%.

Furthermore, as we look out beyond 2021, and again, for conservatism purposes, we assume a reduction in historical activity levels, we still see the potential for a decade of stable production and cash flow at the 25% yield level. That's a decade. If we return to historic activity levels, we're even modestly higher levels than our conservative assumptions. There's obviously substantial growth beyond the 25% free cash flow yield levels. And it should be noted that if oil prices rise, we have further upside available to us as well. All of this is solely based on our current assets and does not include potential acquisitions that we could make over time, providing further growth and upside. A strategy that at past companies we have run has proven to be fruitful.

In conclusion, I'm very satisfied with the third quarter, and pleased with the trajectory of the business as we head into 2021. This is why we are in the fortunate position to be able to take our time in choosing our strategic direction. I'm confident in our ability to grow organically, return cash flow and drive substantial returns to our shareholders, all driven by a uniquely well-positioned asset base in the core of the core of the Eagle Ford Shale.

With that, I will turn the call over to Bryan to walk through the financial results of the third quarter. Bryan?

Thanks, Daniel. Our assets generated $9.9 million in royalty revenue during the third quarter 2020. We recognized a $0.3 million loss from our commodity derivative instruments during the period. Falcon's net realized price for oil during the third quarter was $36.91 per barrel. Average realized price for natural gas was $1.98 per Mcf, and our NGL realizations averaged $13.58 per barrel.

During the third quarter, Falcon initiated a natural gas hedging program for volumes beginning in the fourth quarter of 2020 and extending into the first quarter of 2021. All volumes were hedged in September through the use of costless collars. Natural gas hedges are in addition to the crude oil swaps that Falcon put in place during June for the third and fourth quarters of 2020 and the first quarter of 2021. Exact volumes and the associated pricing for all hedged volumes are laid out in the company's investor presentation that is available on Falcon's website.

Total cash operating cost was $3.2 million. Looking at the breakdown, ad valorem and production taxes were approximately $0.7 million for the quarter. This reflects a $0.1 million increase compared to the prior quarter, which is due to higher realized prices. Marketing and transportation expenses were $0.6 million for the quarter, or $1.37 per barrel. This expense represents a decrease on a dollar per barrel basis from the $1.50 per barrel of expense that we reported in the second quarter 2020.

Cash G&A expense was approximately $1.9 million for the third quarter. Cash G&A excludes approximately $0.9 million of noncash stock compensation expense recognized in the period. Adjusted EBITDA for the third quarter was $6.5 million, which represents an increase of $3.1 million from the $3.4 million reported in the second quarter 2020. The increase was largely attributable to a 68% increase in average realized oil prices compared to the second quarter. At the end of the third quarter, Falcon had $39 million outstanding on its revolving credit facility and $2.5 million cash on hand, resulting in a net debt of approximately $36.5 million at the end of the third quarter.

Falcon's net debt to LTM EBITDA ratio at the end of the third quarter was 1.27x. Falcon reported a third quarter net income of $0.6 million on a stand-alone basis and $1.3 million net income, inclusive of noncontrolling interests. Our GAAP income tax expense of $0.2 million for the quarter is mostly attributable to the utilization of our deferred tax asset, the company had an estimated taxable loss for the quarter.

Similar to the last 2 quarters, the company incurred no amounts related to current period income tax expense and incurred no cash income taxes in the third quarter 2020. This is primarily due to the tax benefit of a basis step up related to the assets that Falcon acquired as part of the transaction with Royal Resources in 2018. As a result of this stepped up basis, we expect to benefit from a cash tax perspective for the foreseeable future.

As I mentioned on previous earnings calls, 80% of our dividends paid to Class A shareholders during 2019 were classified as non-dividend distributions, and therefore, represent a reduction of basis rather than ordinary income. As a reminder, non-dividend distributions are treated as a reduction of basis until the time when an investor's basis is fully recovered. The reduced tax basis will increase shareholders' capital gain or decrease shareholders' capital loss when the shareholder sells their common shares. Falcon expects that substantially all of the dividends paid to Class A shareholders during 2020 will be classified as non-dividend distributions in 2020. This treatment will generally result in nontaxable reduction to the tax basis of shareholders' common shares.

Yesterday, Falcon declared a third quarter dividend of e 0.65 per -- $0.065 per share. This dividend is payable on December 8, 2020 to shareholders of record as of November 24, 2020. The $0.065 dividend payment reflects a payout ratio of 93% pro forma free cash flow. Pro forma free cash flow per share was approximately $0.07 per share for the period. We define pro forma free cash flow as adjusted EBITDA inclusive of noncontrolling interests, less interest expense and pro forma cash income taxes. Our estimate of pro forma free cash flow for the third quarter of 2020 did not include an amount for pro forma cash income taxes.

With that, I will now turn the call back over to Daniel. Daniel?

Thanks, Bryan. Great news on the taxes. Melinda, why don't we open the call up for some questions?

(Operator Instructions) And we'll take our first question from Lee Cooperman with Omega Family Office.

I'm just curious, you mentioned in the release that looking at different alternatives to create value for the shareholders. Can you elaborate the -- what different considerations are you pursuing?

Thanks, Lee. Nice to talk to you. Looking forward to hearing your views and perspective on the election at another point. But to answer your question, we are looking at all options. We'll let your experience and knowledge of what all options may be assume what that includes. And we're looking at all those options. And as soon as we have a view, we will be back to you and to the full market, with Falcon 2.0 or whatever the result of that review is.

Next, we go to the line of Jeff Grampp with Northland.

I was curious, first off, if you guys have a more rig count. I think you guys said 2 was kind of the average for the quarter, but do you guys have kind of a more recent tally where that's headed in the fourth quarter? And any kind of insight based on the line of sight what that might infer for rig counts go as we move into '21?

Sure. So Conoco and EOG are running in total, 7 rigs currently in the play, right? We've been varying between 1 rig and 3 rigs across our position that is taking those permitted wells into the DUC category. And then there's 3 frac crews running from EOG. We're up to another 2 from ConocoPhillips. I'm sure you saw, Devon has said that they're going to begin their completion activity, again, in the Eagle Ford in early 2021. And so we've seen, obviously, an increase in our waiting on connection. That means wells that have already been completed. And based on our land department's great relationships with our producer partners, we have a very strong line of sight into the completion activities, especially on our high net revenue interest pads. So we really see activity in wells turning in line, ramping this quarter and really into next year and throughout 2021.

Got it. Really helpful, Daniel. And for my follow-up, we've seen some peers of yours looking at scaling back payout ratios, trying to retain cash for other purposes, obviously, on the balance sheet, certainly no requirement there for you guys to address your -- that seems in good shape. But just wondering if you could discuss the merits of that to fund anything, whether that be acquisitions or obviously a big disconnect in the stock, so a buyback, I imagine could make some sense. So just wondering, from a high level, how you might view the merits of payout?

Yes. I appreciate that question, Jeff. I'm going to put that into the category of our strategic review. We're looking at all options, all options and look forward to coming back to you as soon as we have determined the best path forward.

Next, we go to the line of Pearce Hammond with Simmons Energy.

Just making sure I understand, so you said that based upon the line-of-sight wells that you have right now, that as you look at '21, you think that you could average about 5,000 BOE per day next year and then a free cash flow of roughly $0.50 a share. So that equates to a free cash flow yield of 25%. Is that correct?

Yes, that's exactly right. And I would, just again, restate that average 5,000 BOE per day and $0.50 of free cash flow at strip pricing. It only includes the line-of-sight wells, the 3.13 line-of-sight wells coming online throughout 2021. So over the next 14 months. And of, I think, critical importance within that, historically, line-of-sight wells -- this entire group of line-of-sight wells, and when I say historically, I mean over the last 10 years, has been under 300 days from permit to turned in line.

So if we take that, say, 10 months and we extend it out, which is what we're assuming to 14 months, that's what's embedded within the assumption to get to 5,000 BOE per day. We believe a, based on history; b, probably more important than history, the direct discussions that we have with our producers and our producer partners that, that's a very reasonable assumption based on that discussion and their publicly stated activity, that gets you to that 5,000 BOE per day average. Now to caveat that a little bit further, of course, we see that ramping through the year. So the number -- the production would be below 5,000 in the beginning part of the year and above 5,000 in the later part of the year.

Okay. Great. That's super helpful color. And then not trying to peak into what 2.0 is going to look like, but just high level, when you've talked to shareholders and you've had discussions within the company, what do you think holds back the valuation? Is it just simply the size of the company, the company is small or our people feel like you need more inventory, but you said you have felt very confident at that decade level at sort of a 25% free cash flow yield. So just high level, what do you think are the puts and takes around it? That kind of maybe depress Falcon relative to other mineral companies?

Sure. I think there's -- we can go back through a little bit of the history of the year. And I think the fact of the matter is, we have a world-class asset base with world-class operators. We're generating free cash flow we have a strong balance sheet. We're returning that free cash flow. We have defined growth. And I think in my experience with our half a dozen plus public companies, the Mr. Market doesn't leave money sitting on the ground for very long. And so I think there happens to be a period right now that is an opportunity for investors to really step in and make a lot of money from that free cash flow yield, 13% at current levels. That's our dividend, 14% in our cash flow generation. And then the upward trajectory through next year, which is, I think, extremely well defined.

So I think there's an immediate opportunity that exists for investors. I think you can look at the year-end tax selling as a as a catalyst for what's depressed our price over the last month or so, especially with the, I think, illiquidity in the stock price -- or excuse me, in the volume I think that definitely weighs and has weighed. But I think Mr. Market is pretty efficient. And obviously, energy is hated small-cap energy is hated. There's been -- we have great investors, some of which have had great years outside of energy and are taking their tax losses.

And I think all that does is set up a great opportunity for those who sit through the wreckage who want to make money. And Falcon is a great place to make money, it certainly feels like from our perspective. We're in heads we win, tails we win scenario from a shareholder standpoint, in any which way we go. And so I think it's a pretty exciting time for those who want to come in and make a lot of money in Falcon today.

Next, we go to the line of Derrick Whitfield with Stifel.

Perhaps for you, Daniel. In light of the record M&A activity we've seen across the E&P sector. I wanted to ask if you could offer your views on the potential merits of consolidation within the minerals sector?

Sure. As we've, I think, talked about in the past, as you've heard from others, there's billions of dollars of minerals held within private equity firms as well as family offices. But in places where they're not meant to be held over the long term. And I think you will see consolidation in the space. And I think there's an opportunity for value creation as a result of that.

Understood. And as my follow-up, I'll just shift over to the Marcellus. In light of the increasingly constructive natural gas backdrop, could you offer any color on activity trends you're seeing in the Marcellus that could impact your financials for 2021?

Sure. So we've always said our Marcellus position is a -- they recover around 80,000 gross unit acres, 1,500 net-net acres approximately. But we've always viewed that as a great call option on gas. And I know there's been periods where there's a feeling of, there's no hope for gas ever, and lo and behold, things change. And I quoted Plato to hopefully uplift some people.

But Plato always described the constant change of life. And just when we thought gas was dead, of course, natural gas prices are above $3 and that's a great call option for us. And we have 2 rigs running across our acreage position. And we have a nice amount of gas. We're not assuming anything -- any upside in any of the numbers I talked about, just our line-of-sight wells that we have and that's pretty satisfying. We may have upside beyond what I've described, but we're not assuming any of it.

Our next question or comment comes from the line of Brian Downey with Citigroup.

On the line-of-sight wells and the Hooks Ranch, recent permit activity that you highlighted specifically, how are you thinking about timing of those Hooks Ranch turn in lines during 2021? Have you had any conversations with the operator around that property or at this point, is that connection estimate based on historical timing ranges?

Sure. So thanks, Brian, nice talking to you. Maybe as your follow up, you'll have a financial question. So Bryan can get an answer in here. But we, of course, have regular dialogue with our operators. As you know, as I've mentioned, we make it an absolute policy not to front run our great partners, our great operators. And so we do have a view on timing and I think a pretty strong understanding as to when that timing will occur. That, of course, will be, in all likelihood, in the second half of next year. The numbers, the 5,000 BOE, on average for next year assumes, call it, late third quarter, early fourth quarter turn in line for those 0.45 net wells. So I think that gives us a lot of comfort with that number and conservatism built into the 5,000 BOE per day average throughout 2021.

Great. And then I actually, I did have a follow-up for Bryan. How are you thinking about your hedging strategy going forward? You started hedging oil and now more recently, natural gas. Any change in thinking around how you're going to approach that? Is there a particular target price level or hedge percentage or so forth that you're going to target there?

No, it's a good question. I appreciate it. And good to talk to you. So obviously, in June, we put on those crude hedges, really defensive in nature given the volatility that we had seen in 2Q in pricing. So that was really a defensive measure on the crude side. The gas edge is, obviously, as Daniel mentioned, we saw gas pop up above $3, which is pretty attractive pricing. So -- and we feel good about where we are hedged right now. And we're going to continue to monitor it, but there's no -- we don't feel a need to add anything else at the current juncture. We feel pretty comfortable.

Sorry, I was going to ask, is that -- so is that going to be more opportunistic rather than systematic?

No. I mean we're going to continue and evaluating and continuing to watch the market. I think we have no obligations to hedge. And so we're always going to be looking at it on a market-dependent basis so...

Yes. Brian, just to add on to that. Yes, I think opportunistic is the right way to think about it. We saw on the oil side, oil rebound to $40-plus a barrel and felt pretty satisfying after the depths of -- disparate the market belt in April to be able to put on -- put in place hedges at $40 plus for the fourth quarter and first quarter. On the gas side, felt pretty satisfying to lock in $3 type gas prices.

So we've got a good business. We good cash flow, good balance sheet. If we feel like there's good prices, we'll take them off. I mean, historically, because our operating expenses are so well on a per-barrel basis, we certainly don't need to hedge. And we kind of also have lumped this into our strategic review and really rolling out a fulsome Falcon 2.0. So it's conceivable that way, yes. There's a number of factors that we'll come back to the market with inclusive of payout ratio and hedging to really lay out the next phase. So that's how we think of it today.

Ladies and gentlemen, this concludes our question-and-answer session. We turn back to Daniel Herz for closing remarks.

Great. Thanks, Melinda, and thank you all for joining the earnings call. Please be well. Stay safe. We look forward to speaking to you soon.

Thank you. This does conclude today's teleconference. We thank you for your participation. You may disconnect your lines at this time. Have a great day.