Diversified Energy Company (DEC) Earnings Call Transcript & Summary

Greetings. Welcome to Diversified Energy Company's PLC acquisition update. [Operator Instructions] Please note, this conference is being recorded. At this time, I'll now turn the conference over to Mr. Rusty Hutson, Jr. Please go ahead, Mr. Hutson.

Thank you, and good morning to everyone on the phone and on the webcast. So we appreciate everybody taking some time this morning. We're going to go over the deal that we announced this morning in pre-market, both in London and in the U.S., an acquisition in our new Central Region assets from Tapstone Energy. And we're going to flip through a presentation that we have that everybody should have off the website. We're going to spend about 15 minutes walking through the transaction and the impacts to Diversified, overall. And then we'll open it up for some questions, if anybody has them. In the -- on the presentation, we'll start here on Page 3. Tapstone, the acquisition we announced this morning, we -- obviously, it's a 50-50 acquisition with our capital partner, Oaktree, the third one that we've done with them now. So we're starting to gain some momentum as it relates to transactions, over $250 million with them. The acquisition purchase price for us are 50%, gross was $218 million. Net purchase price after closing adjustments will be approximately $174 million. It has an effective date back to August 1, and we expect this to close in early December. So a little -- right at 60 days from now. It will be all cash, cash and debt purchase price or financing. And post acquisition, this will take us back up to our pre-equity offering, May -- back in May leverage ratio of about 2.1x. So we've now fulfilled pretty close to what we expected to from the equity raise back in May. And so now we're back up to our leverage ratio that we typically like to stay at. Some of the acquisition valuation metrics. The estimated EBITDA for next year, for 2022, is around $95 million. So 1.8x purchase price multiple with the PV27 on the PDP only. So very compelling valuations for us. It continues to expand this area of our operation that we've talked about now for a while that we felt like would be a big opportunity for us in Oklahoma. And our first entry into Oklahoma, we feel like will be the first of many kind of like we talked about in that East Texas area. So this is our fourth package now of low risk, mid-life PDP assets. And we continue to believe that as we continue to add assets in this region, we'll continue to see scale and synergies start to take effect as we move forward. One thing that we really liked about these assets when we were looking at the package was the high EBITDA margins that come along with it. Obviously, the revenue stream here is 3 different revenue streams. You've got natural gas, NGLs and oil, and 70-some-percent is natural gas. And so we're very, very excited about that. We feel like this is a very good asset for us, an asset that Tapstone had acquired through the Chesapeake. A large percentage of it was the Chesapeake restructuring back in 2020, and we feel like it's got a lot of opportunity for us as we move forward. Anyway, so that's the overall acquisition summary, the valuation. You can see some of the things that we really like to highlight in the acquisitions. As you look at the PV10 of these assets for our share was $324 million. The PDP reserves, 35,000 MMBoe. Current production around 12,000 BOE per day, obviously, 70-some-percent natural gas and NGLs. And total cash cost of $11.69, which is a little higher than what we've seen from an operating perspective in Appalachia. But as we've talked about, this region also affords us the opportunity to see higher gas prices because the basis, they are certainly much less than what we see in Appalachia. So the margins are pretty significant, that 65%. Flipping to the next page, this Mid-Continent area in Oklahoma. You can see here, this is a big area with a lot of different operators, a lot of different types of assets, both vertical and horizontal. And what I really like about Oklahoma, and we showed this in one of our other presentations with the East Texas Cotton Valley area, you can see, since about 2015, the amount of development has slowed substantially, which has allowed these assets to mature and for decline rates to moderate on the portfolios, and that's when we can step in and really take advantage of that mature producing asset that we can really hedge out and lock in cash flows and margins. And so it gives us a big inventory of assets in an area that we feel like has a lot of opportunities to grow it, drive synergies and efficiencies in the portfolio, and make extremely profitable margins on the assets. 50,000 square miles of the Anadarko Basin, 70-plus years of production in this region, and a very favorable regulatory and social environment for operators. Oklahoma, obviously, a big oil and gas state, similar to Texas and Louisiana. So it just creates a lot of opportunity. You can see a lot of assets with a lot of different operators over there in that box on the right. Flipping to Page 5. You can see now kind of what we've built in the Central Region. We've got over 50,000 BOE per day now. So it's probably around 40% of the total production of the company in that vicinity. A large percentage of our PDP reserves. And you can see kind of how those -- the assets that we've acquired already kind of fit into that box that we showed you from day 1 as it relates to the Central Region. The initial entry was obviously in that East Texas, North Louisiana area, Cotton Valley, Haynesville-producing zones in Texas and Louisiana. We expanded into the Barnett with the Blackbeard transaction. And now we went into the Central West -- Oklahoma area with the acquisition of the Tapstone assets. So we've started to fill out the box very well but there's more to do. And we think that with the announcement of the Tapstone acquisition that we'll continue to see opportunities show themselves in this area. Flipping over to Page 6, kind of talking about the Central Region by the numbers now. It's pretty interesting to me that in a very short period of time, you can see what we've added to the company through this new region. Net production, 50,000 BOE per day. We're up to 150,000 BOE per day when you compare it to 2020 reported numbers. Tapstone was 12,000 of that. The other areas that we talked about, the Blackbeard and the East Texas was about 38,000 BOE per day. Significant addition to reserves, PDP reserves. And then the PV10 values are almost at $3 billion now with the addition of the Tapstone deal. So a lot of value has been added over the last 6 months through the Central Region. And the EBITDA, as we look at Tapstone, adding around $95 million worth of EBITDA. In total, we've added about $214 million through the Central Region. Tapstone is half of that. So it's a very high margin, very lucrative asset for us. And you -- as we look further into Oklahoma going forward, those high-margin businesses like that are really what's attractive to us. And so you can see as 2020 is reported at $301 million, the additions of these assets that we've acquired puts us up around $500 million now of EBITDA, which is a significant increase from 2020 reported numbers. And you can see over on the right, the production is up 50% from 2020. And when you add all the acquisitions in, 71% increase in adjusted EBITDA. PDP, PV10, up substantially, 44% and 30% (sic) [ 30% and 44% ] increase in overall reserves. So we've really added a lot in a very short period of time here in the Central Region. And then turning to Page 7. You guys, especially those who have been around for a while, you know our business model, you know what we're trying to accomplish. And the Central Region really checks all the boxes that we like and get excited about when we're looking at acquisitions. The accretive value of it, obviously, this one being adding an additional EBITDA with no shares being issued, fully cash and debt deal, highly accretive, continuing to add scale to the region so that we can be -- find more synergies and efficiencies and drive down those costs further. And then obviously, a lot of opportunity here as we look over the landscape with the fragmented ownership of assets, a lot of different types of owners that are looking to divest and exit the areas, gives us a big opportunity here to be a natural consolidator in the region. Our strong balance sheet, our partnership with Oaktree for larger transactions affords us the ability to transact and to be effective in executing on these transactions. So the Central Region has become a big part of what we're doing, and it will be -- continue to be as we move forward, as I look out over the landscape and over the next several months. The opportunities are vast. The acquisition market has been very strong, even in the -- with the prices being up, both natural gas and oil. There's a very limited amount of capital out there to transact. And so it continues to be, to some degree, a buyer's market for those that can raise capital. And that puts us in a very good position as we move forward. So with that, I'm going to stop my comments. Eric, anything you would like to add about anything before we move on to questions?

No. Hopefully, that was a helpful overview. But the one thing that I think maybe kind of a hidden gem within all of this is that if you add it up, we've done now $1 billion of transactions this year, 3 of them, of course, Oaktree participated in. So part of that is on their ledger. But importantly, we've talked about -- obviously, we're an accretive -- or an acquisitive model, and you don't always have line of sight to how we'll continue to acquire over time. But building that inventory alongside Oaktree, so that at the right time when they're looking to monetize with the financial investment to them, having the visibility to an asset we ought to be operating, you're starting to see a very sizable asset portfolio sit here. So I think it's a nice thing to just keep in mind as we're putting together these really nice assets that are highly accretive.

So with that, I will turn it back to the moderator, and we'll open up for some questions.

[Operator Instructions] Our first question comes from the line of David Round with Stifel.

Right. First one for me, just on hedging where obviously, you've got a fairly disciplined strategy across the portfolio. I just wonder, as this is a stand-alone deal and given the gas price backdrop, why did you choose to hedge a greater proportion of these barrels in order to lock in returns? And then the second one is on just wanted to ask about the chart on Page 4, please. Again, you've made your stance on drilling very clear, but it's interesting to see the production response to drilling activity. It's obviously quite a positive response there. So are you thinking yet about ways where you could benefit from this? And just to ask again on the 2020 and 2021, there is a bit of drop-off in drilling activity. Do you know if that was capital constraints or opportunity?

Yes. Well, let's address the hedging question first because that's -- I'm glad you prompted me to do that. So we've already -- under the terms of our RBL and our bank syndicate facility, we have -- when it comes to acquisitions, we obviously have some provisions in there that allow us to -- under the collateral base of our existing assets to hedge production forward for these transactions in advance of closing. So we've already started hedging some of this production. So I would tell you that the oil and the NGL production that we've already hedged probably on a percentage basis, how much, 50% or 60% for next year?

50%.

50% for next year already. And as you know, David, I mean our goal is to take as much risk off the table as possible. The total natural gas production is about 70 million a day of natural gas production. So our half will be about 35 million, 40 million?

40 million, total.

40 million, total. So our half, right?

Yes.

Yes. So we could probably, and we'll probably hedge, 50% of that prior to closing. So we'll probably be in a position where 50% of the production that we're acquiring will be hedged even before we close in early December. And then obviously, on the back end of closing, we'll continue to ramp that up as much as we can or want to at that point. But we never, as you know, ride risk. We're more about lock in the production that's necessary to get the cash flows that are necessary to pay -- operate the business, and as we look at dividends and stuff like that. So we're already hedged for some of this production, and we'll continue to add additional on the back end of the closing. As it relates to your second question, which is on Page 4 and drilling. Drilling in this area has slowed down substantially when oil prices went down and natural gas being so low over the last 4 years. This is an area that needs a little bit higher prices to drill versus, say, the Permian, for example. And so I expect that there's 2 reasons why you haven't seen a resurgence in the drilling. Number one is capital constraints. If you're going to drill, you have to drill with cash flow. There's no ability to drill outside of cash flow. And I believe that most companies have developed discipline around their development processes going forward. I know in Appalachia they have, and I believe that most areas have. And so I don't foresee a massive increase in additional drilling going on in this area. And to be honest, I don't really see it happening significantly in most basins. Even the Permian is up, but it's not up to anywhere where it was prior to the oil prices going down a few years back. So I just think it's one of those situations where drilling will continue to be tapered. Now we are looking at some opportunities in the portfolios that we've acquired in the Central Region, where I think we'll be able to strike some deals that will be accretive to shareholders, whether that be JVs, outright sale of undeveloped acreage or some combination of both. And we're currently in some negotiations with some operators about that. So more to come on that. We'll probably have more to come on that as we do our Capital Markets Day in November.

The next question is from the line of [ Matt Looper ] (sic) [ Matt Cooper ] with Peel Hunt.

I appreciate the presentation, and congratulations on the acquisition. I've got 3 questions, if that's alright. So first one, can you just discuss a bit as to why this time we're paying a smaller proportion of the purchase price as a multiple? Second question is around the likely terminal decline rate of the Tapstone assets? And when you think this is likely to occur? And then the third one is a bit of a follow-up [ and that's ] on drilling. Just interested to know, are any reserves with the [indiscernible] both the PDP [indiscernible] drilled well locations and [indiscernible].

Yes. The first question was really, really hard to understand. You have a really bad static on your phone, but let me answer the reserves. There are undeveloped reserves here. There's no doubt. Tapstone was completing some wells prior to us acquiring them or signing the deal. So obviously, there is some undeveloped reserves there. We didn't price that into the deal, obviously. And I think that's pretty much the case across all basins at this point. Nobody is really paying up for undeveloped. It's just not -- it's not doable with the restrictions on capital. And so unless you have -- unless you're one of the larger E&Ps -- public E&Ps that have the ability to pay in the Permian, for example, you're not really going to pay for undeveloped. So I don't think -- there is a lot of undeveloped reserves here, but we didn't pay for them. That wasn't part of the evaluation. Decline rates. What I would say there is that we'll probably see a mid to low teen decline rate on this asset in the next 12 months. But when you combine it with our portfolio, it still has a moderately small increase in the overall portfolio decline rates. I think, we're like 8 3/4 or something like that. So what our goal is, is to continue to acquire assets. They're not all going to have single digits to start with. All going to have single-digit decline rates. But they will all moderate to single decline rates -- single-digit decline rates at some point in the near future. So what we're trying to do is to manage the portfolio at the company level to stay in that single-digit decline area. And if we can do that, we're going to be highly successful. And I believe we can. And so even though this asset may have mid-teen decline rate in year 1; year 2, that will be less; and year 3, you start to get into single digits, and that just combines with the existing portfolio, especially our conventional Appalachian portfolio that's 1% or 2%, 3% at most. And then you're really starting to see where that -- all these assets combined are just starting to moderate into the single digits and it stays in that area anyway. That's where we want to manage the business to, single digits, because that's where we can through cash flow be able to replace reserves on an annual basis as we move forward. And then I think the third question was around the -- or the first question actually, but around purchase price multiple, which was -- I'm sorry, I didn't hear about...

I think he was asking you, we paid 1.8x, which is rather low. What was sort of the catalyst for the lower purchase price multiple and...

Yes, yes, yes. Well, I think it's a variety of things. And we've talked about this. When you're buying assets that have a little higher decline rate, the multiple is going to be a little lower than what you would see if it was a 6%, 7% decline rate for the foreseeable future. You have to make some provisions because there could be in -- with a higher decline in year 1, you lose quite a bit of that EBITDA rolling off in year 2. And so you want to make sure that you're paying a multiple that you can feel comfortable with as you move forward. So the 1.8, really, it fell out. I mean we were just -- we weren't trying to manage to a multiple in that situation. We were managing to an NAV value and it just kind of fell out because that first year, next year, especially, is a big revenue year because oil and natural gas are pretty high and NGLs. So the multiple itself is a reflection of higher prices next year, along with the fact that there's a little higher decline rate. So we wanted to make sure that we were pricing that in accordingly.

Yes. And Matt, for your benefit, and I'm sure you saw it but for others as well. Page 11, we tried to visually present what Rusty walked you through on decline. We really do look at this holistically as a portfolio. And it's important to remember, and we've said this for some time, as you acquire, you're very unlikely to acquire at the type of decline rates that we've amassed over a 4- or 5-year history of aggregating assets, having started in the lowest decline basin in the country. But what you see is that we've got an incredibly broad and deep foundation now of assets that are under that single-digit decline profile that we're really targeting. So as we do acquire assets that may incrementally have higher declines on the front end, those assets themselves begin to mature quite quickly because they're not -- they haven't been developed, all of them, in the immediate recent years, and are moving toward that exponential decline off of their hyperbolic. So they moved from that gray way to which is the higher decline asset into that solid foundation of lower decline. So you can see over the next 5 years, if you just took engineered data, we start to taper back to that mid-single digit as opposed to the upper single. So hopefully, this helps to frame how you should be thinking about asset acquisitions as we move forward and how we think about them, blending into what is a differentiated profile.

Our next question is coming from the line of Simon Scholes with First Berlin.

I've got 2. The first is on hedging again. I mean looking outside Tapstone, and I was just wondering if you could comment on to what extent you've been layering on additional hedges for '22 and '23 over the last month or so, I mean given the high gas price? And secondly, I mean you've pointed out that I think the production weighted average age of these new wells in Tapstone is 12 years, and a mid-teen decline rate in the first year strikes me as being quite high for wells with an average age of 12 years. I'm wondering -- I was wondering if there's anything special going on here?

Yes, what's special is just the accretive value of the deal. I'm just giving you a hard...

I mean the decline rate in production.

Yes. The decline rate is really -- I think, the year 1 decline rate is really attributable to the fact that they've had some newer wells drilled in the last couple of years. So what happens is you got well that -- 12 years, is that an average...

Yes. And Simon, what may be helpful, if you look at the graph...

This production weighted is 12 years.

Yes, yes. Well it's not production weighted. That's just an average for the wells. If you look at Page 12, I think you visually can begin to really put this together -- I'm sorry, Page 4, the graph on the top of the -- or the side of Page 4. What you see is the industry shifted from vertical development to horizontal development. So you had fewer wells that those wells are far more productive than they previously were.

Okay. So it's not production weighted, then?

That's correct.

Because I think in the press release, it said it is production weighted.

It's not. So apologies for that. That shouldn't...

Okay. Understood.

Yes. So there were far fewer wells and yet the basin was still growing production. And so some of those newer wells within the portfolio are the horizontal wells that do come off a bit more quickly.

Yes. And so what you see is the older stuff, it's sitting there with single digits. You've got the newer stuff, it's at a higher percentage. When you average them together, the higher producing -- higher-decline stuff is attributing to more of it, and then it rolls off and it kind of moderates itself. So that's really the issue there. And then on the hedging side, I think you were asking about layering on for '22 and '23. We've layered on quite a bit in '22. I think we're pretty much -- with our existing production anyway. We're pretty much done there. We may have a little bit to do from certain products from April of '22 to the end of the year. '23, we're still doing some. And what we're trying to do, we're trying to layer on as we move up in price. What we don't want to do is to try to do too much at one time and affect the market and not be able to keep a price there that's attractive. So what we're trying to do is just every other day, every couple of days, every 3 days, whatever, we come in and we'll layer in a contract or 2 on natural gas. And then we'll layer in an NGL or we'll do a basis diff along with the Henry Hub price. So that's kind of how we're approaching it. We're even looking out as far as '24 now because '24 prices are looking really good. So it's one of the things where prices have really went high for next year. People are losing track of '23 and '24 because it looks like it's so much lower than '22. But my goodness, it's still way higher than it's been for the last 4.5 years since we've been public. So what we don't want to do is get locked in or what can we -- are we going to lock in hedges in '23 and '24, and we'll lose a $4.50 natural gas price? I'm looking at it more in terms of I'm getting a $3.25 natural gas price. So we better take some of it and take some of the risk off the table in those years.

Yes. I think it's important to remember the fundamentals of supply remain the same, which is that U.S. shale has the ability to turn on if prices remain high, incrementally quickly and bringing additional supply to the market, which is why we think that [ 2 50 to 3 50 ] long-term price range still makes sense. Now what has yet to really fully emerge is how will industry or producer discipline continue to play out in a higher price environment. And will companies really stay the course of moderating growth, even with higher prices and stick to their more fixed variable dividend strategies that they're beginning to articulate, whether the equity markets continue to hold them accountable on the debt capital markets for that matter. But I think, Rusty hit the nail on the head. There are certainly a mindset here that if we can lock in a healthy margin, which is what we've always been focused on, that's what we're going to do rather than wanting to play the speculative game that the higher price curve will continue, even though we know there's incrementally more supply capacity in the market.

Our next question is from the line of Chrysis Aristidou with Sefton.

My questions have been answered.

At this time, I will hand the call to Mr. Rusty Hutson, Jr. for any further remarks.

Yes. So thank you all for coming today. I'll just -- I'll end it with a few remarks as we look out over the rest of this year. As I said earlier, I believe that the market right now is as active as I've seen it. We feel like that the opportunity set in front of us will continue to provide us with lots of opportunities. We have capital. We want to make sure that we're deploying it on assets that are not only fit the mode and the profile that we like, but also are the best value that we can get. Different than other market turns that we've seen in the past, the price of the commodity is not driving the activity or the valuations. Capital availability is driving the valuations. So I think some of the people have asked us, are prices going up, going to hurt the ability to do transactions? And right now, I'm seeing the complete opposite. We're seeing prices go up. So people want to sell. Some of the private equity guys are wanting to divest the portfolio companies. We're seeing activity from some of the large E&P companies that are looking to divest out of areas that are noncore. Same old, same old, really. But the valuations are more based on capital availability, not based on just pure commodity price. And so I think that's very, very pertinent to the conversation. And so the other thing I would say before I leave you is that with these deals now that we've done this year, there obviously is significant accretion in terms of cash flows, which will obviously lead to some type of accretive value to the dividend over the next several months. So we'll also have more conversations around that during Capital Markets Day in November. And don't forget our Capital Markets Day is coming up in November. And have we announced the date yet on that to everybody?

We have not.

We're waiting on...

We have everything reserved, but we're waiting to get confirmation from the State Department that travel restrictions will impact the -- relaxed for the event.

Yes. We're waiting on the Administration to open up travel so -- from the U.K. So anyway -- and Europe. So that's all of my prepared comments. Obviously, if you have any other questions, feel free to call into the Investor Relations group, and we'll answer them. And thank you for your time.

This concludes today's conference. You may disconnect your lines at this time. We thank you for your participation.