ARC Resources Ltd. (ARX) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen, and welcome to the ARC Resources Limited Year-end 2021 Earnings Conference Call. [Operator Instructions]. This call is being recorded on Friday, February 11, 2022. I would now like to turn the conference over to Dale Lewko. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us on our fourth quarter earnings conference call. Joining me on the call today are Terry Anderson, President and Chief Executive Officer; Kris Bibby, Chief Financial Officer; Armin Jahangiri, Chief Operating Officer; and Lara Conrad, Chief Development Officer. Before I turn it over to our executive team to take you through our fourth quarter and year-end results, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP and other financial measures with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars, unless otherwise stated. The press release, financial statements and MD&A are also available on our website as well as SEDAR. Following our prepared remarks, we'll open the line to questions. With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

Thanks, Dale, and good morning, everyone. Let me start by congratulating Armin and Lara on their appointments to our C-suite. They are proven leaders within our industry and have played an important role in our company over the past 10 years. People and assets are differentiators in our business, and I firmly believe ARC has the best of both. I'll keep my remarks relatively brief touching on 3 key items before I pass it over to Kris. First, highlights from a record year; second, an operational update that focuses on our learnings at Kakwa; and third, our outlook and priorities for 2022 and beyond. So let's begin with a brief look back at last year. Our fourth quarter results capped off an exceptional and transformational year for us. With the acquisition and integration of Seven Generations, we strengthened our competitive position and delivered a record year for our shareholders. The business combination was our first major acquisition in over a decade, and our 2021 results are proving that our patience paid off. We added high-quality assets and a team of great people at the right time in the cycle, and our company is more profitable as a result. 2021 was also a demonstration of how ARC operates, disciplined allocators of capital with a continuous focus on operational efficiency. The result was record performance across several key measures. First, ARC generated 1.4 billion in free cash flow, the highest in our 25-year history, driven by our low-cost structure and strong commodity prices; second, our field operations team delivered the lowest operating cost in ARC's history of CAD 3.86 per BOE, reinforcing that owning and operating our infrastructure is a competitive advantage; finally, we delivered record average annual production of 302,000 BOE a day. This comes after a strong Q4 of 345,000 BOE a day. Other noteworthy achievements include the progress we've made deleveraging the business following the transaction. With the strong commodity price environment, we're able to aggressively pay down debt to well below 1x debt to cash flow allowing us to return more of our profits to shareholders, faster than we anticipated. ARC has now completed the integration. We captured $190 million of synergies, which is well above the initial $110 million target due to lower financing costs, and more recently, operational and marketing efficiencies that far exceeded our expectations. And finally, we leveraged our scale to secure a transaction with an LNG Canada participant to supply gas for the project. An example of our market diversification strategy, an important first step into LNG supply. As many of you know, this project is very material for Western Canada fundamental -- gas fundamentals, adding 2 Bcf a day demand at start-up. Turning to operations. We were able to continue the momentum we achieved in the third quarter. And most importantly, we did it safely. Our team has now surpassed 8 years without an employee lost time incident, an achievement that we are very proud of. Safety is our #1 priority. I'd also like to take a few moments to just discuss the progress we've made at Kakwa. This is a world-class asset, and we are realizing the benefits of integrating it into our portfolio. Simply put, we have made this high-quality asset even more profitable. In particular, I'm really pleased with how our people have come together and shared and implied what they have learned. Well costs have decreased by over 10% from drilling and completing the wells differently. And early indications show better deliverability by changing where and how we land the wells. Ultimately, this is encouraging, and we expect that we'll be able to reduce sustaining capital at Kakwa by approximately 10% over time. Finally, our priorities for 2022 have not changed. We put forth a budget in November that balances reinvestment in our highest return assets, reduces emissions and prioritizes a meaningful return of capital to shareholders through the base dividend and share repurchases. We believe this generates the optimal risk-adjusted returns for our shareholders. Our near-term priorities are to safely and efficiently sustain production at our base assets and invest in our highest-return projects like Sunrise and Attachie once the regulatory environment in BC supports it. To that end, we remain confident there will be a resolution between the Blueberry River First Nations and the BC government in a timely manner. With that, I'll turn it over to Kris to go through some of our financial highlights.

Thanks, Terry, and good morning, everyone. I'll briefly touch on a few additional highlights so that we can leave a lot of time for questions. We closed 2021 with a strong fourth quarter. Cash flow is about 7% above consensus estimates, and we generated nearly $0.5 billion of free cash flow for the second quarter in a row. Of that, we returned over 60% to our shareholders through dividends and share repurchases and allocated the balance towards debt reduction in line with our capital allocation framework we outlined late last year. We were able to rightsize the legacy Seven Generations alliance agreement, which will see us reducing our commitment at the end of 2022 to better align with our development plans. Our market diversification strategy resulted in average realized natural gas prices in the quarter, of $6.50, $1.50 above the AECO benchmark. As volatility increases, we believe we have a competitive advantage in how and where we're able to market our products. We have exposure across 5 different natural gas markets in North America, have significant interprovincial flexibility given our infrastructure ownership, and we will continue to evaluate the additional opportunities to reach markets outside North America. On the liquid side, our average realized condensate price was nearly $100 a barrel in the quarter, which further supported our strong cash flow in the quarter. Profitability measures continued to improve. In 2021, ARC generated $2.16 per share of free cash flow, a record in our 25-year history and realized an 18% return on capital employed. These results were not solely commodity price driven, but were due to structural improvement in the capital intensity of our business. ARC invested long-cycle growth capital in our early days, accumulating a large asset position, consolidating inventory and building a massive infrastructure network to support a multi-decade development plan. We are now executing on that plan in a capital-efficient manner. With capital allocation top of mind, we have committed to return 50% to 80% of our free cash flow to shareholders with the balance used for further debt reduction. The base dividend is our core mechanism to return capital and it always has been, and we will continue to grow our base dividend with our business while ensuring it is sustainable through the cycle. In addition, we will continue to return capital by reinvesting in our shares as they remain dislocated from the intrinsic value of our business, even under mid-cycle prices and double-digit discount rates. We have purchased approximately 5% of our shares since September, and we believe this is a very attractive return for our shareholders. Commodity prices are strong, but we are mindful that we operate in a volatile and unpredictable cyclical business. With that in mind, we will continue to be a balance sheet first company. Our capital program, including the dividend can be funded with cash flow below USD 40 WTI and $2 natural gas, a reflection of our low-cost, high-quality assets. With that, I'll turn it back to Terry for some closing remarks and questions.

Thanks, Kris. So 2021 was a record year, and I'm excited for what is to come for ARC. We are observing in real time the need for responsible resource development as part of the global energy mix and the transition to a lower carbon economy. ARC has spent 25 years positioning itself to thrive in this environment, with world-class assets and emissions performance, exceptional people and leading cost structure. Today, we have the scale and proven operating track record that affords us numerous opportunities to reinvest in our business and provide a very competitive and sustainable return for our shareholders. With that, I'll turn it back to the operator for questions.

[Operator Instructions] Your first question comes from Travis Wood with National Bank.

I have a couple of questions here. First, Terry, in your opening remarks, you mentioned, I think, an attractive risk profile and how you're thinking about the NCIB. With, I think, 50% to 80% of that free cash allocated to some sort of return of capital profile, how should we start thinking about dividend growth, especially as we start to appreciate the magnitude of the free cash that ARC's spitting out right now?

Yes. Thanks, Travis, for the question. So yes, the dividend growth, how we look at it is, obviously, we're trying to take a balanced portfolio to our capital allocation being a dividend growth and share repurchases, obviously, along with investing in our business. So the way we look at it is we want to have an annual dividend increase, and that kind of goes along with growing our business. So we talk about that, we've talked about 5% compound annual growth in our business in -- that's kind of what we think our annual dividend increase should be. So we're trying to tie those 2 together. That's kind of how we are viewing the dividend growth for the future here.

Okay. And then just, I mean, trying to -- appreciating that maybe we're at top end of the cycle, uncertain how long that we drive along, but how can we think about stressing that? Or how are you guys thinking about stressing it through the low cycles in terms of kind of what kind of commodity price assumptions you're running? Or where do you like to see the payout or leverage? Or how are you thinking about that on a lower cycle basis just to ensure that sustainability of a base dividend?

Travis, it's Kris here. I think the way we're trying to design the dividend policy is really so that just because prices are high, we wouldn't be increasing our dividend. What we are doing is targeting mid-cycle pricing, which we would currently define in that kind of $55 WTI and $2.50 natural gas range so that the payout is really kind of reasonable there. And what that will allow us to do is in times of higher pricing, we'll have some more strength on the balance sheet. But if -- when prices did dip below that, it doesn't cause you to have to readjust your dividend. And then the other factor is, obviously, with very active NCIB in place. The absolute level of the dividend will grow at that 5%, but the per share metrics have the opportunity to grow a bit quicker than that, obviously.

Okay. That makes sense. And then just kind of one final one around this. You've been really active on the NCIB. Given kind of the plan for base dividend growth nearing kind of 10% on the NCIB probably by midyear, do you see the potential to run an SIB as well?

It's something we'll look at, Travis. I mean we're halfway through the dividend NCIB program right now at 5%. We've got until September to finish off that program. At this pace, I think we're comfortable that we'll continue to monitor how the share price performs. Obviously, it is an on-off switch. And as we get closer and closer to an ultimate intrinsic value, we would have to reevaluate how we're returning our capital to shareholders.

Okay. And just one final one here. Now you just sparked a thought. That intrinsic value, you kind of highlighted the NAV on -- from the reserve report in the note. How do you guys think about intrinsic value internally? And do you put some goalposts of commodity prices around that intrinsic value as well?

Yes, you bet. So we definitely do have some goalposts on the commodity prices. When we look at our intrinsic value, we try again to match up with our dividend policy. At mid-cycle pricing, what would we look at an intrinsic value-based approach. And then when we look at buying back shares, it is -- ultimately, it's competing for capital. So are we better off buying shares and returning funds to shareholders that way or is it better giving cash out? And currently, we have a strong preference for share buybacks in addition to the base dividend, which again, over the long term, the base dividend is really going to be the primary return of capital mechanism.

Your next question comes from Jamie Kubik with CIBC.

I have a couple. Maybe just with respect to operating costs, we saw OpEx trend lower through 2021 and Q4 ended the year at around 350 BOE. Your guidance for 2022 implies this increases a bit. Can you just talk a bit about where the inflation this year might happen versus last year? And how you sort of expect OpEx to trend through 2022?

Yes. Thanks, Jamie, for the question on operating costs. Yes, we had obviously an amazing year last year on operating costs. So a record low. And the teams have done such a great job of integrating the Kakwa asset into our portfolio and with a real focus on cost, whether it's capital cost or operating cost. We want to be that low-cost producer and I think, once again, just as I mentioned, owning and operating our infrastructure is helping us manage that cost. So that's why it's so low. The difference between this year and going into next year in our Kakwa field, we have a number of turnarounds on a lot of our compressors out there. So -- that we need to do. And unfortunately, they are all bunched up at the same time in next year or this year is that time to actually be doing the maintenance on them. So it's kind of a onetime extra cost this year, and then we're going to try to smooth that out over in the future so that all those costs aren't hitting in 1 year. So that's really the difference. Otherwise, are continuing to focus on driving those costs lower.

Okay. Great. That's helpful. And then maybe sticking with Kakwa here. You did indicate sustaining capital in that asset could be reduced by 10% over time. And you also highlight that the reduction in drilling completion costs in the asset year-on-year of about 16%. Does -- is the forward reduction of 10%, is that primarily the result of the reduced drilling and completion costs? Or is there an additional step down that you see plausibly coming as a result of something else at Kakwa?

Yes, Jamie, this is Armin. Yes, definitely, I guess, we continue to see efficiency improvements in Kakwa from an executional standpoint. There's obviously the inflationary pressure and supply chain challenges that we are also trying to offset as we see operational efficiencies. I think Kakwa is also benefiting hugely from a lot of optimization that the team has done in that asset. And those optimizations play a huge role in terms of producing the sustaining capital over time. So I pass it over to Lara here because she has a lot more context on the optimization that the team has done.

Thanks, Armin. Yes. So the drilling and completions teams under Armin have done a fantastic job of reducing costs very quickly upon integration. Looking forward on the development team, we've been working on the well spacing. I think that's something we've been talking about quite a lot over the past few months since we closed the deal that we see the opportunity to widen out the spacing. And so that extra 10% look forward on sustaining capital that Terry referred to is really as we implement that wider development plan, we think we can capture similar reserves and productivity, but with fewer wells.

Okay. That's great. And then maybe last one, just dovetailing a bit off what Travis was asking, but ARC was really aggressive at repurchasing stock through 2021. We did see that taper a bit in January. Should we think of the slowdown in repurchases as some level of price sensitivity on where the stock is trading? Or was it a bit more of a mechanical decision given the blackout period?

Most of it is really probably -- it's more mechanical in nature. When we go into blackout, we do put in an automatic share purchase program. And so that was kind of more of the function. If you recall, when we put it in place, we did try the message that we're going to hit it pretty hard out of the gate for the first few months, which we did. We got a whole bunch of shares retired at what we think were very attractive prices. And then now with the release out today, we can get back into a bit more of a managed approach for the next couple of months.

[Operator Instructions]. There are no further questions at this time. You may proceed.

Okay. Well, thank you, operator, and thank you to everyone who joined us today. Last year, the pillars that have defined ARC as an industry leader, world-class assets and people, operational excellence, leading ESG performance and a long-term focus on profitability resulted in a record year for shareholders. This is the type of consistency and discipline that our shareholders have come to expect of us and will continue to guide us for the next 25 years. Thank you very much. Have a good day.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.