Civitas Resources, Inc. (CIVI) Earnings Call Transcript & Summary

Good morning. My name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Civitas Resources Midland Basin Acquisition Conference Call. [Operator Instructions] I will now turn the conference over to John Wren. John, you may begin your conference.

Thanks, operator. And good morning, everyone, and thanks for joining us today. I'm joined today by our CEO, Chris Doyle; CFO, Marianella Foschi; COO, Hodge Walker; and Jeff Kelly, the most recent addition to our senior team as Chief Transformation Officer. Today, we announced a highly-accretive bolt-on to our growing Permian Basin position, and we posted some informational slides on our website that we plan to reference. Please note that today, we plan to make forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ materially from our projections. Please read our full disclosures regarding forward-looking statements in our 10-Q and other SEC filings. We may also refer to certain non-GAAP financial metrics. Reconciliations to certain non-GAAP metrics can be found in our news release, our second quarter earnings release and our SEC filings. After Chris' brief prepared remarks, we will all be available to take your questions. [Operator Instructions] Now I'll turn the call over to Chris.

Good morning, everyone, and thank you for joining us. We're excited to share our thoughts on today's announcement and look forward to addressing your questions shortly. Let me first start by recognizing the Vencer team. Just as we saw with Tap Rock and Hibernia, the Vencer team has created a very strong business. I want to congratulate them on their hard work, their dedication and their well-earned success. We look forward to working with this team and integrating these assets into Civitas. For us, our North Star has been and will always be our business model, and this transaction advances our key strategic pillars. It's a fantastic bolt-on that increases the depth of our Permian position, adds significant free cash flow and, importantly, maintains our strong balance sheet. We're adding premium scale that fits well with our current Midland position as well as our broader Permian position, and we're able to achieve that scale and capture these assets at a very attractive price, just 2.8x 2024 EBITDAX, which compares favorably to recent Permian transactions. We see approximately 400 high-quality, high-value locations but use less than half of those to underwrite the economics of this transaction. The $2.1 billion purchase price includes approximately 7.3 million shares of common stock to be issued to Vencer and about $1.55 billion of cash. We plan to fund the cash portion of the transaction with debt and equity financings. Pro forma, we expect to generate about $1.8 billion in free cash flow next year, assuming $80 oil and $3.50 gas. This will further enhance our industry-leading shareholder return program, which has delivered $1.3 billion to shareholders since early last year. We'll maintain our strong balance sheet and expect our leverage ratio to be below 1 turn by the end of 2024, and our long-term leverage target of 3/4 of a turn is unchanged. Higher cash flow and expected proceeds from noncore asset sales will push our leverage ratio closer to our long-term target in the coming quarters. Now turning to the assets. Vencer adds about 44,000 net acres and enhances our strong position in the Midland Basin. The assets currently produce about 62,000 BOE per day, of which about half is oil. Pro forma for this transaction, our estimated 2024 Permian production, will be about 170,000 BOE per day. And total company production will range between 325,000, 345,000 BOE per day. We've updated our outlook slide in today's deck. Bottom line, this extends the duration of our proven business model by adding high-value locations in Midland, Martin and Upton Counties. And in total, Civitas will now have about 1,200 locations in the Permian, which equals about a decade at our planned pace of operations. Before taking your questions, let me wrap up with these three key takeaways. First, scale matters; depth and quality of inventory matter. Civitas has scale with quality inventory in both the Permian and DJ basins. Second, value matters. We captured this deal at a very attractive valuation and allow us to maintain a strong balance sheet. Incremental free cash will be used to achieve our leverage targets less than a turn by the end of '24 and our long-term leverage target of 3/4 of a turn. Finally, duration matters. This deal further extends the duration and durability of our proven business model. We're confident in our ability to generate significant cash through cycle and continue to provide unparalleled returns to our shareholders. Civitas is stronger today. We've added scale, quality and duration at a compelling value that complements our already strong business. Operator, we're now happy to take questions.

[Operator Instructions] Your first question comes from the line of Neal Dingmann from Truist Securities.

Congrats on what appears will be a solid deal. Chris, my first question is around the origination of the deal specifically. Maybe just talk around, was Vencer a marketed deal? And back when you announced the close of the Tap Rock and the other deals, had you already been looking at this? I'm just curious sort of that timing market, all that sort of things on this.

Sure. Thanks for the question, Neal. As we thought about how to create long-term shareholder value in this business, we started with our business model. And I think the two super important components of that business model that really fuels that model are scale and depth and quality of inventory. And as we look to continue to build scale within the DJ, what was really lacking beyond our own assets was that depth and quality, and so we started looking at other basins, and we focused in on the three lowest breakeven basins as we talked about on the last call. As we thought about potential entry points into the Permian, whether it's the Delaware or Midland, we have a short list of targets. Hibernia and Tap Rock were obviously on that list. Vencer was also on that list. We brought in Hibernian and Tap Rock. Vencer had died. We've had conversations with them for some time. Like any good transaction, this thing died multiple times. The team has been very, very disciplined and worked alongside Vitol and Vencer to see if a transaction made sense. We stuck to our guns. We're able to pull it over the finish line. Really excited that we're able to do it. This was not a marketed transaction. They were getting ready to head into a potential transaction later in the year. The quality relationship that we've built with the counterparty here allowed us to get this over the finish line before they went to market, and we're super excited about the quality asset that we pulled in at the value that we did so.

Great. That's very interesting. And then second question is just on assumed activity. You all mentioned you suggest, I think, around 62,000 BOE per day today, and then I think it's around 50,000 or 60,000 for next year for Vencer. Just wondering, could you speak to how many rigs this assumes? Maybe you or the guys speak to the number of wells in progress DUCs, all those sort of things that might impact how you're thinking about sort of activity between the 62,000 today and kind of what you're thinking about for the year.

Sure. So Vencer has been running about three rigs this year as they were preparing for a potential monetization. Production was growing a little bit. As we look out into 2024 and we realign to our business model, that focuses on optimizing for free cash, protecting our balance sheet and getting that cash back to shareholders. We're going to let activity moderate a bit, and what we've assumed in our outlook is those three rigs go down to two. In 2024, we'll average just a little over two in this asset. I'll tell you, with that moderate -- moderation of activity, you'll see production range between 50,000 and 60,000 as we've indicated in our outlook. That 50% oil cut will drop a little bit into just above sort of mid-40s for this asset. It's a very simple capital plan today that we've outlined in the outlook, two rigs with the addition of Vencer, that complements the two rigs on the Midland side and two rigs on the Delaware side. So six total and then the two rigs in the DJ. That's our initial outlook. What I'm excited about, and this is one of the true values of this transaction, is the quality of the inventory that Vencer brings to the table. And I'll point you to Slide 6 in our deck. You can see how this compares to not only recent transactions, but also to the broader Midland performance. So it's really high-quality inventory. It might call for more capital. I'm super excited about the competition that we're lining up with scale, positions, super high quality, low breakeven inventory in the DJ on the Delaware side and now even a more scaled position on the Midland side. In terms of wells in progress, et cetera, really, this doesn't come with a big DUC backlog or anything like that. It does come with 15 to 20 wells. It's really just operational inventory, and we'll seek to optimize that as we've done in every other part of our business.

No, it looks to be a good deal.

Your next question comes from the line of Tim Rezvan from KeyBanc.

I know you reiterated the desire for $300 million of noncore asset sales. How does this acquisition, which kind of will likely increase gross debt, how does that make you rethink the timing or amount of asset sales? And would you expand that to maybe noncore Permian as well?

So I'll start with how this could potentially impact how we're thinking about noncore asset sales. I think the biggest thing, Tim, is we've just pulled in 400 high-quality sticks that go to the front of the line, and many of them go to the front of the line. And so noncore assets that simply do not compete for capital, whether it's within the DJ or the Permian, that hurdle is getting more and more difficult, which is exactly what we want as a leadership team and for our shareholders is to drive that capital competition. We've been very pleased. We're right in the middle of the noncore asset sale process. We've been very pleased with what we've seen in terms of participation. We're going to let value lead this decision, however. And whether that means leaning in a little bit or holding off, we'll let the market decide that. But I'll tell you, we have built a tremendous portfolio, now balanced between the DJ and the Permian. 1,006 in the DJ, 1,200 in the, Permian, and those things are going to be competing for capital to allow us to optimize and as we think about strategic capital allocation over the next 3 to 5 years. So I think we'll have more insight, more guidance on that as we approach closer to the end of the year, but we're really happy with participation today.

Okay, okay. We'll stay tuned. And then it seems intuitive that when you announced this first set of deals in June that you weren't done. Obviously, you didn't kind of have that, call it, a decade of inventory. And now as you work towards closing on this, should we think that you will continue to be opportunistically acquisitive assuming that you can still find accretive opportunities? How do you think about kind of the next 1, 2 years on the M&A side?

As we've demonstrated as a company, to your point, we're very opportunistic. But importantly, we're very disciplined. This transaction died just about as many times as I've ever seen a transaction die, and it died because we were very disciplined with how we saw value and very happy with the position that we have created with the two previous transactions. When we're head down focused on integrating these assets, the Permian assets, and super excited to share through early results with you guys on our next call about how integration is going, it was going to take a very compelling opportunity to pull our eyes away from that. And Vencer was that compelling opportunity. Ultimately, just as with the divestment process, we're going to let value lead the way here. I'll tell you, we have approached that decade of duration. That's an important target for us. But depth and quality of inventory and duration really drives long-term shareholder value. I love where this company is from a diversity and a scale perspective and the inventory of quality opportunities we have in now the three lowest breakeven basins in North America. It's going to have to be quite compelling to get us to add to that. But to your point, we're very opportunistic, but we're also very, very disciplined.

Your next question comes from the line of Phillips Johnston from Capital One.

Congrats. Can you maybe give us some color on the next 12-month PDP decline rate on these assets and how that might compare to your overall stand-alone company decline rate?

Sure. Thanks, Phillips. So as we look at January close, we'll enter the year with these assets, in particular in the low 30s base decline, about 33%. That's really in line with the DJ base decline. The assets that we acquired earlier in the year were a little bit higher base decline than that. But this is, I would say, accretive to overall base decline. And so we're excited about that. It makes for a very -- an opportunity to further optimize our '24 plan.

Okay. Just to clarify in your answer to Neal's question about the activity for next year, would the two-rig program essentially stabilize production at that sort of '24 guidance rate of 50,000 to 60,000 a day kind of exiting the year and looking out into '25?

That's correct.

Okay. Got it. And what's the average working interest of these locations, by the way?

So we have about -- average across the entire position is about 80% working interest. Very high NRIs on this position that would drive further value, about 80%.

Your next question comes from the line of Leo Mariani from ROTH MKM.

Just a few questions on some of the incremental numbers here. Can you talk about the kind of cost structure of the Vencer assets kind of compared to the previous Tap Rock, Hibernia assets? Are you guys adding any incremental G&A with this deal? And then obviously, I think with the previous Hibernia and Tap Rock deal, you guys talked about kind of having the share buyback program. Does this deal also maybe push back that share buyback program a little bit as you prioritize that? Just kind of talk through some of those numbers would be helpful.

Sure. I'll kick this off and then kick it over to Nella. So on a cost structure basis, these assets on the Midland side are very consistent with how we underwrote and how we saw Hibernia and how Hibernia's cost structure is set up. That's slightly accretive to the overall Permian picture and to the company picture but very consistent with how we saw Hibernia. On the incremental G&A side, we are adding $15 million to $20 million of annual G&A. We see that as overall accretive for the assets that we're bringing in. And then finally, on the share buybacks, we still have $480 million under the $500 million authorization in place, and that's really driven by a couple of things. One, we like having the opportunity to have that out there, to be opportunistic. You've seen us pull down shares at very compelling values. We like to have that flexibility. And it's also a realization that this is a business that is going to spin off $1.8 billion of free cash flow next year. And so we feel like we can have the industry-leading dividend program in addition to delevering, in addition to a potential buyback. So we like to have an all-of-the-above approach, and so we've maintained that buyback out there.

Leo, this is Marianella. Just in terms of modeling health, so if you look at $80 oil, this deal is about high single digit, call it, 8%, 10% accretive to our margins. In large part, that comes from the lower cost structure. So the cost structure for these assets is a little bit lower than our current company as a whole, especially when you think about the deals that we just did, including the Delaware asset, which has a higher cost structure as well. This one being a Midland, the cost structure, a little bit more -- it's a little lower. So when you look at G&A as well, we have -- our current company previous deal is about $1.30 per BOE of G&A. With the additional head count and the expected additions of G&A, I think that's going to come in about $0.70, $0.80 per BOE. So that's another aspect of accretion to the cost structure. Once we add in the additional overhead, it's going to be an additional expansion to the margins.

Okay. That's helpful color, guys. And then just one more for me here. Obviously, you've got the $1.55 billion cash component, which I guess could go to $1.5 billion. On the previous Tap Rock deal, you guys were pretty aggressive in getting bonds kind of out there right away. Should we assume that we're going to see something similar in terms of the kind of secondary financing for this, in terms of getting some bonds out there and perhaps an equity slug as well to kind of get this financing taken care of sooner than later?

Leo, this is Marianella again. We really can't speak to the timing right now. I will say that signing of close timing is fairly long relative to the last deal. We're about 90 days. We have a lot of flexibility in our capital structure right now. We have a $500 million deferred payment as part of this transaction. So that's going to give us optionality even beyond closing. I mean from our perspective, we preserve that flexibility with where our leverage sits and where our liquidity sits, and we plan to optimize the deal and the financing in a way that -- out of the gate, a lot is slightly accretive to our leverage profile, which was the governor on how we thought about financing the transaction. Just over time, the accretion is going to be even further because as you -- as we materialize the cash flow from this transaction, it will be very accretive for leverage profile. But as we thought about financing, again, key was making sure it was leverage-neutral at least at close. And then over time, that will be accretive as well. But really can't speak to the timing. We'll continue to exercise the flexibility in a way that's beneficial to our company strategy and our core pillars.

Your next question comes from the line of Noel Parks from Tuohy Brothers.

Just a couple of things. I was wondering, you talked about in the release a certain number of locations that you expect a 40% IRR at $75 oil. And I was just wondering, as the distribution of returns across locations, you have your -- looks like you're new in Martin and Glasscock with this acquisition. Just wondering, is there -- has product mix remained variable as you look at the returns on locations? Or is it more just rock out of a particular location?

Yes. I think what we point to is 400 gross development locations, mainly in the Spraberry and Wolfcamp. 40% of those having an IRR in excess of 40% at $70 oil. This is a high-quality asset. It gives you exposure to some of the best rock north to south in the Midland Basin. As we think about how we will develop this asset, you're going to have more dense wells, certainly in the north in Martin and Midland County. You'll start to upspace as you go south, more consistent with how we underwrote Hibernia. And so this gives you opportunities to really flex whether it's rock quality or oil and flex capital allocation and really optimize for a better 2024 and beyond solution. It's one of the things we really like about this beyond just the operational synergies of plug-and-play with the Hibernia assets on the Midland side. I think what you'll see if you pull historical performance for these assets is really a head nod to the Vencer team that has driven additional capital efficiency, and that's really by upspacing and taking a very deliberate view on how to optimize development here. We'll continue that and look forward to pulling the value out of those 400 gross locations onto our portfolio.

Okay. And since you mentioned it was quite a long courtship back and forth before you reached an agreement, just curious about where there were some of the differences of opinion, whether it was just price deck to use or valuing upside of PDP. Any -- just interested on what issues you're able to overcome to get you to this.

Sure. I would tell you that we're very disciplined, some might say stubborn. As we saw commodity prices strengthen over the past little while, certainly, that put pressure on how we viewed value because we were steadfast in how we are underwriting this asset and every other asset. We take a long-term view. We are not influenced by the rapid run-up in commodity prices, and that makes deals very difficult. We continue to dig in on the asset. But our views of value were fairly consistent at the beginning of the year as they were today. And that's a credit to how we look at value long term for our shareholders. And ultimately, you build a relationship with the counterparty, you build trust, and we're able to get this over the finish line. But that disciplined approach, but also opportunistically getting out in front of a potential competitive process, I think, was key to delivering what I think is a super compelling value for our shareholders.

Your next question comes from the line of Kevin MacCurdy from Pickering Energy Partners.

Congratulations on the acquisition. It certainly looks to fit your strategic pillars. Following up on Noel's question, will the initial activity be split between the north and the south? Or do you plan to mainly focus on the north?

So we'll look -- I'll tell you that 2024 outlook, we'll look to access all parts of the asset. I think one thing I'm excited about, we touched on it a little bit earlier, is I wouldn't tell you our '24 outlook is the optimal view, is the fully optimized capital program. So you might see -- just given the asset quality here, you might see us pull more capital into the Vencer assets. I will tell you, currently, they're active more in the southern part of their position. We'll continue -- we'll look to continue that but also sprinkle in some northern activity as well.

Great. And I know it's early days for Civitas in the Midland, but have you identified any operational synergies between your assets and the Vencer assets? I mean it does sound like you plan to space wells similar to what Vencer was doing. Is that correct?

Yes. I think as broader industry has really looked at optimizing returns, and that's through optimizing development and upspacing, we're big believers in that. We've seen that in the DJ. We've seen it in past lives as well, and industry has caught in to -- or caught on to how best to develop this rock. I would say what the performance enhancements that the Vencer teams deliver really is on the backs of that, and we'll look to continue to perform and drive further performance enhancements into the program.

[Operator Instructions] Your next question comes from the line of Phillips Johnston from Capital One.

Just one more quick one, sorry. As we look at in [ bears ], it looks like most of the wells in the property since 2021 were drilled in sort of the Martin and Glasscock area. Is that correct? Or are there some wells in Uptown and Reagan that show up under a different operator's name? Sounds like from your comments earlier that you said the current mix of wells is flowing a little bit more towards the south, so I was just trying to reconcile that.

Yes, they've got a lot of their activity in the south currently. And so that mix, we're comfortable with how we've underwritten the assets. Certainly, the Martin, Midland County is fantastic rock. It's more dense development, but they've been active in the south as well.

Okay. Sounds good. So as we look at sort of the cume curve on Slide 6, would you think that, that would sort of be a representative of the average well that you'll be drilling over the next couple of years or so as that mix sort of increases more towards the south?

Yes, I think that's fair. There's one thing, and going back to Kevin's question, I wanted to hit on, and it really relates to your question as well. As we think about how we're allocating capital, what we've seen currently to date in the Midland, and it applies to Delaware as well, is there's real resource here that may not have been part of the underwriting case. But we're starting to see extremely compelling results point to the Wolfcamp B as an example in the South. And so some of the early days integration that we're seeing, we're pulling learnings across the basin, even from the DJ and unlocking additional resource. So the only thing that gives me a little bit of pause, Phillips, is saying, hey, as we think about optimizing capital and deploying additional capital, we could look at some of the zones that provide really strong returns but may not have been part of the underwriting case. We're going to be super focused on how do we deliver the most optimal capital program over the next 3- to 5-year time frame, and we'll do so. And that may mean leaning in more on these assets and maybe leaning in on Hibernia or Tap Rock or in the DJ, but we'll take a very strong look at how best to optimize strategic capital allocation. The other thing that I wanted to touch on -- and again, this is very strong in our DNA, and is strong in the DNA of the companies that we've acquired, is this view of continuous improvement. I think the industry does a phenomenal job of continuing to build a better mousetrap. And some of the learnings that we've seen just early days in the first quarter of taking a little bit of a different approach on some of the Midland Basin assets or even the Delaware assets, pulling learnings in from the DJ and across all three basins, there's real value here. And it's hard to put a hard number or to underwrite any type of synergies that come from having three very strong, high-quality, deep inventory basins, but that's what we've got. And early days at quarter end, I'm super excited about the teams pulling together and really coming up with a better solution. So I'm very confident in saying that how we see 2024, 2025 and beyond is only going to get stronger. And so -- and that's not just us. Again, that's overall industry.

And we have no further questions in the queue at this time. Chris Doyle, I'll turn the call to you for closing remarks.

All right. Thank you. Thank you again for joining us. We appreciate your continued interest in Civitas, and we look forward to sharing our results and sharing our continued progress on our next quarterly call. Have a wonderful rest of your day, and please be safe.

And this concludes today's conference call. Thank you for your participation, and you may now disconnect.