Strathcona Resources Ltd

TSX:SCR

Q1-2025 Earnings Call

[Operator]

Good morning. My name is Ina, and I will be your conference operator today. I would like to welcome everyone to the First Quarter 2025 Conference Call of Strathcona Resources Limited. [Operator Instructions]

I now introduce Angie Lau, Treasurer of Strathcona to open the conference and introduce the speakers. Please go ahead.

[Angie Lau, executive]

Welcome to the Q1 2025 Conference Call of Strathcona Resources Limited. Over the past 2 days, Strathcona released its first quarter 2025 results, reached definitive agreements to sell substantially all of its Montney business and disclosed an investment in MEG Energy along with an intention to make an offer for the balance of its shares, it doesn't currently own. We encourage our investors to visit Strathcona's website and review the disclosure materials in detail.

On today's call, we have from our management team, Adam Waterous, Executive Chairman; Connor Waterous, Chief Financial Officer; Connie De Ciancio, Chief Commercial Officer; Dale Babiak, Chief Operating Officer; Kim Chiu, President, Strathcona Cold Lake; Seamus Murphy, President, Strathcona Lloydminster Conventional; Ryan Tracy, President, Strathcona Lloydminster Thermal.

Please note that all commentary made by today's speakers are subject to the same advisories regarding, among other things, forward-looking information and non-GAAP measures as can be found in our earnings and M&A press releases and our other disclosure materials. Listeners and participants are urged to refer to and review those advisors and materials carefully.

In particular, any comments made regarding the asset dispositions, including completion and timing for completion of these dispositions, commencement of the formal offer to MEG shareholders and timing of such offer as well as any related financings and any expectations about the pro forma results or resulting capital structure of Strathcona are based on our current expectations regarding our business and combined business and are in part based on MEG's available public data. While we believe our current assumptions and expectations to be reasonable, actual results could differ materially from those discussed today, and listeners should place undue reliance on any such statements.

Please note that no offer to purchase MEG shares has been made by Strathcona at this time, and any such offer will be made in Strathcona's sole discretion pursuant to a formal offer to purchase and takeover bid circular of Strathcona. Please refer to the press release of Strathcona relating to its intention to make an offer for further information.

With that, and keeping with our practice, we will take all of our materials as read, and we would now like to jump straight to questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Justin Ho from RBC Capital Markets.

[Justin Joshua Ho, analyst]

It's Justin Ho on the line for Greg. Just wondering if you can just give us a little bit more detail around the strategic rationale you're thinking going to this positioning away from the Montney and kind of doubling down here on thermal and oil sands.

[Adam Waterous, executive]

Sure. This is Adam Waterous speaking. I'll try and give you a perspective. Well, maybe to give you the first thing and I'll try to be -- we're trying to be incremental to what maybe some material we've provided. Maybe on a macro base, we remain very constructive on long-term oil demand. And we remain pessimistic on long-term oil supply. I've been fairly public on being bearish on incremental U.S. oil supply.

That doesn't mean we're negative on natural gas. And I quickly would say that I think that the 3 buyers of our former Montney business are going to be very successful with their purchases. And all 3 buyers are very sophisticated buyers and the assets fit them like hand-in-glove. So I think they're going to be very successful with what we have sold them.

Having said that, generally speaking, we're more constructive on long-term oil than natural gas. So that's maybe as a starting point. The second -- and that helps maybe explain the divestiture of the Montney business. The second thing is why we're making the proposal to MEG shareholders is -- we think that these are extremely complementary businesses. When I mean, extremely, I am actually not aware of 2 businesses of any scale in North America that share this level of complementary nature.

These are doppelgangers, brothers from another mother, twins, identical twins, that -- and why that ends up being particularly important is that our ability to then be able to maximize operational synergies from them. We think will be comparatively straightforward. I'll talk a little bit more about that again.

But it's also -- essentially, it is getting more of what we already have, which is long-life, low decline, high free cash flow oil. And when we think about the business that we're building, the business will be what we believe is going to be the only investment grade, long-life, low decline, high free cash flow oil company that does not have mines or refineries in North America.

So if someone's interested in a lower risk long-life, low decline, high free cash flow oil business of scale in North America, we think that this is going to be the business to own. And -- if you look on Page 5 of the deck that was posted on our website last night, you'll see that the combination, [moves us] within Canada to 219,000 barrels a day, the fifth largest oil producer in Canada.

I think more relevantly, if you look at it in North America, on a reserve basis, net of royalty, that's U.S. convention deducting royalties. So for comparability purposes, our peers are Diamondback, Occidental, EOG's got a fair amount of natural gas, but Diamondback, Occidental. And those businesses are very fine businesses but have a very short reserve life indexes. Meaning as they have several multiples our production and the same reserves. So we think that if a company is looking for what will be a senior producer with a very long life, we think we're going to be very uniquely positioned in the North American landscape.

The second rationale is and I can maybe try and give a little bit more color on is the accretion. So I know -- it's a lot of very sophisticated, knowledgeable analysts on the call today. But this is how M&A usually works. How M&A usually works is a bigger company takes over a smaller company. And the bigger company trades at a bigger multiple than the smaller companies. So the smaller company trades, let's say, 5x cash flow, and the bigger company trades at 7x cash flow. And what the bigger company does is they pay the smaller company a premium, say, 10% premium.

And they say, okay, so they're going to be buying it for 5, a 5.5x multiple. But the -- and so the selling shareholders is, well, I got a premium. I got 10% more than I thought, that's a good thing for me. And the bigger company that's straight at 7x gets accretion. That's essentially a large percentage of how M&A works in all sectors, not just the sector.

Now what's super unusual about this is that, in this case, the company that is effectively being acquired trades at a bit of a premium to the buyer, the buyer being Strathcona, essentially the target being MEG. And -- so that's really unusual. Now why we think that's the case is that, Strathcona is a fairly new company, has a comparatively limited float. All things that understands affects price. Of course, price what you pay value is what you get.

Now what that leads to is this super unusual dynamic. And that is if you're a MEG shareholder, you get 2 things: the first thing is you get a premium, which we would have obviously seen based on yesterday's close, the -- our proposal indicates a 9.3% premium. So that's a good thing. But they also get per share accretion on a variety of different metrics.

Very rare. Usually, you get a premium and then you actually on a per share basis, you've got some dilution. So they get both things. Now at the same time, what's also super unusual is Strathcona also gets accretion on almost all metrics. So what is the Jedi mind trick? How does that happen? Well, there's 2 reasons why Strathcona also gets accretion is, number one, we're putting a little bit of cash in the deal.

And as you get leverage, you can get accretion. You can trade at a discount relative to the target. And the second reason is the operating synergies. So the pro forma, the combined business is going to have incremental cash flow. And as you would have seen in the material we provided, that's going to be $175 million in annual synergies, $50 million from overhead, which we think that MEG, is extremely heavily staffed, given the size and operations of their business.

The interest savings because the combined business will have about $1.5 billion in debt, but will be investment grade and which will lead to a lower overall interest rate savings.

And the third is the operating synergies, which we had $75 million in capital, $25 million in operating costs. And just to give you a sense on the scale of the business. The pro forma business is going to be drilling about 1/4 of all of the SAGD wells in Western Canada.

Our ability to be able to get volume discounts from our suppliers is great. We also think that we're going to be able to share best practices which will increase capital efficiency. We've seen that very directly in our SAGD business in Strathcona where our different SAGD assets what we learned from one, we can apply to another. And we also think that we're going to be more effective at controlling costs. 75% of management's compensation is tied to -- controlling capital costs and F&D, where -- to our MEG is 10%, all right? So we think we're going to have very meaningful synergies.

So for those -- for 3 reasons, fits like hand in glove, the 2 most similar companies, we believe of scale in North America, uniquely, both companies get synergies. And there's going to -- mean accretion and there will be large operational synergies. That was essentially the strategic rationale for the proposal.

[Justin Joshua Ho, analyst]

Great. Great. That was very thorough. Just one follow-up, I think a part of these transactions that might be flying under the radar a bit is the rail terminal acquisition. Could you walk through your thinking around that and how that kind of ties into your strategic outlook, whether as a stand-alone or pro forma entity?

[Adam Waterous, executive]

Sure. I think I'll have Connor answer that.

[Connor Waterous, executive]

Sure. So a big part of our strategy from day 1, as we have thought about putting -- investing more capital in the business is the first to obviously, a focus on value. And second on how is the best way to manage risk. And obviously, a big risk for oil and gas heavy oil business like ours, is the WCS differential. And so what we think we've been able to do by buying the largest crude-by-rail terminal in Western Canada is buy an asset which has cash flows, which are going to be in adversely correlated to the cash flows in our oil and gas upstream business.

And so while the asset is making about $12 million of free cash flow today or call it a mid-20s free cash flow yield. On the $45 million price that we paid. We think that in the event pipelines get full again and dips start to get wider -- that -- those cash flows are going to start to go up pretty fast, which will be a nice hedge to the cash flows from our upstream business.

[Operator]

[Operator Instructions] There are no further questions at this time. I will now hand the call back to Mr. Adam Waterous for any closing remarks.

[Adam Waterous, executive]

I'd like to thank everyone for calling in today. Hopefully, what we've provided online, we tried to make it extremely comprehensive, not only regarding what we have done in terms of exiting the Montney business, but a good view on why we've made the proposal to MEG. So hopefully, that's helpful, and we appreciate everyone tuning in.

[Operator]

Thank you. And this concludes today's call. Thank you for participating. You may all disconnect.