Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

Good afternoon. I'd like to welcome everybody to our fireside chat today with Ryan Stash, who is the Chief Financial Officer of Evolution Petroleum. Ryan, I'd like to take the opportunity to thank you for joining us today. Before we get started, I would like to mention that we will have reference to forward-looking statements during today's discussion. Viewers can review Evolution's disclosures around forward-looking statements in their latest corporate presentation, which can be found on the company's Investor Relations section of their website. So Ryan, let's get started. We're pleased to have you join us today. Ryan, as I think I said, is the Senior Vice President, Chief Financial Officer and Treasurer of Evolution. So thanks for joining us.

No, I appreciate it, Jeff. And we had a lot of fun on the last call that we did and looking forward to this one as well.

So we did a call for about a month ago that people can access that's available online, and this is a follow-up to that call. So just to refresh, Evolution this year has closed 2 significant acquisitions, one in January in the Williston Basin and one in early April in the Jonah Field in Southwestern Wyoming. The Williston Basin assets were acquired for about $25.9 million. The Jonah Field was about $27.5 million. And both assets added new operating areas, relationships with new operators and new opportunities for the company. The Williston Basin, in particular, added a sizable inventory of proved undeveloped drilling locations, which can be used to augment Evolution's capital program over the next several years at least. And the Jonah Field was essentially a PDP natural gas-based asset that is almost fully developed. So Ryan, I'd like to start in your CFO role and just managing the integration of those assets. Can we talk a little bit about how the company approaches integrating non-operated assets into the asset base?

Sure. It's -- honestly, it's one of those where it's always the answer is it depends, right, with everything. But really, it kind of starts with the accounting piece in the back office, making sure that, that's all in check. And we make sure we can receive revenue, pay expenses from the various operators. Once that's sort of completed, we're kind of ready to go. I mean, that's kind of the beauty of the non-operated model is there's not a lot of back office for us to really need to do. We do like to make contact with the various accounting teams at our operators, and we've been really deliberate in making sure that we have good relationships there. As you're aware, especially in the non-op piece, we're kind of on a 1- to 2-month lag when we receive actual revenues and expenses. So it's important to be able to get real-time information. And we generally do that by having good relationships with the operators and making sure that we have good communication protocols as well.

So Evolution's asset base now has 5 assets or interest in 5 operating areas, 5 different operators. How familiar were you? Or how did you become familiar? How familiar were you with Foundation, who's the operator of the Williston assets, and Jonah Energy, who's the operator of the assets in the Jonah Field?

Yes. So Foundation was interesting. The Williston asset itself, it actually wasn't a marketed process. So we were introduced to the principals of Foundation through one of our Board members that had a prior relationship that worked with the CEO there of Foundation before. And we got to know those guys over, call it, a few weeks, months. And really, it became a relationship, and we ended up liking them and wanting to do business with them. And they had an asset in the Williston that they had just bought, and we ended up buying 50% of that. So that was really kind of a deal that was sourced from prior relationships, and we actually knew the operator pretty well by the time we actually bought the asset. Jonah, that was a marketed process. We knew Jonah by reputation. They have a great reputation in the industry for being really responsible. They've done great on kind of all the ESG side of things. That's really been a big focus to them. Actually, interestingly enough, when I was a banker at Wells, I actually covered Jonah Energy. So I got to know the CEO and CFO there at Jonah. So I actually have familiarity with them as well. So it doesn't always work out that way. But I think with those 2 acquisitions, we were familiar with the operators.

You mentioned working with the accounting teams at -- on the new assets. But can you talk about how you -- now that you've closed the assets, how do you work toward building a relationship with the operators where you can integrate yourself into plans for field development, the capital allocation process for field development? How the -- project selection? Any -- how do you work with the operators around some of those types of issues?

Yes. So I think we've been focused on making it be collaborative, right? And I think we've done a really good job at that. With Jonah, with all of our operators -- and we're probably going to do this with Jonah as well, our newest asset we're going to have. We have monthly operations meetings with our major operators where we talk about what's going on in the field and what production has been, what we expect it to be, any fees that we can expect coming out. We also have an annual working interest -- a large meeting. We held that here in March with -- we actually -- we had Foundation close, so we held it with Foundation, Diversified, Merit. So we had -- with the exception of Denbury we did before that, but we have basically done all our operators. And we hopefully do that with Jonah as well on an annual basis where it's a deep dive into all the operations to get to meet everyone face-to-face. And it's worked out great, right? I mean it allows us to have real-time information into what we can expect coming. That way, we can approve things faster, right? They know who to call if they have an AFE, if they have an emergency work-over to do. We can act quickly because we already know the people involved, and we're pretty up to speed on what's going on. In some areas, specifically, and I think Jason has mentioned this, like the Williston, we do have the ability in the Williston through the joint operating agreement to actually propose wells themselves, right? Even if Foundation doesn't want to participate, but we can have them operate it for us. So that's a little unique in that situation. And in other areas like in Delhi, the operator needs our consent to do really any capital project. So it's important for us to have this relationship so we can get things done.

Is it fair to say, Ryan, that even as a non-operator, I think -- and I am going to ask this because I think I've heard Jason allude to it in the past, that Evolution develops your own technical understanding of the assets where you operate. So when there is an operator meeting or let's do a work-over, let's drill this well, you've got your own understanding of the merits of how that -- of how you all think about it, independent of what the operators are telling you.

No, that's 100% correct. We've done -- we've -- on some of these assets, Jonah itself, as you alluded to, was more of a PDP kind of asset. But as I mentioned on the earnings call, interestingly enough, we've gotten some recent kind of re-complete AFEs there for Jonah. But we do take the time to do a deep dive on all the operations and geology. So to your point, if something comes out, we'd make our own independent decision. So any AFE that we get for a re-complete, really not a lot of new drills right now, but we'll do -- we'll run our own economics, right? And we'll make our own decision on whether we want to consent and agree with the operator or not. And we need to be able to understand the asset to be able to make those decisions.

You all have, as we talked, added scale in the Williston Basin and in Jonah Field. Has that added scale put any strain on the organization as you've tried to integrate the assets, both operationally and financially?

No. I mean I think -- and Jason actually mentioned this too on the earnings call. We recently hired kind of experienced accounting team to sort of build out that function with really the intent to put infrastructure, if you will, in place for the recent acquisitions and for future acquisitions, right? We want to be able to have operating leverage and able to grow the business. As we sort of talked about, having kind of the non-op model, the ability to add assets with minimal overhead is sort of what we're trying to get at. And we put the team in place to be able to do that. We're also looking at ways to optimize things from our system standpoint, the things we can be more efficient from a system standpoint to be able to integrate these acquisitions from an accounting side, too.

Let's talk a little bit about your role as a non-operator in some of the controls that -- or some of the impacts you all can have on marketing for your oil and gas production. Evolution's asset base before these recent acquisitions ranged from a CO2 oil flood at the Delhi field in North Louisiana. You had an oil-producing waterflood up at Hamilton Dome in Wyoming. You, of course, have the Barnett Shale natural gas assets here in North Texas. And now you've got Williston Basin oil and Southwest Wyoming gas. How do you all work to market and try to realize the best margins on the incremental production that you can? And how much control do you really have over where you're -- let's say, where your gas goes to seek a higher market?

Yes. So I mean, really, it kind of varies asset by asset, right? So most assets will -- it will be governed by the joint operating agreement, right? In a lot of joint operating agreements, especially our assets, non-op parties do have the ability to take their gas in kind, like we do at Jonah and the prior owner did, and market ourselves. To some extent, you can also go through the operator, right? And generally, when you go through the operator, they'll sell the gas for you on no worse terms than they have. So -- to the extent that we do take our gas in kind like Jonah, we do have more control. We get to choose who we sell it to. We have separate contracts on the processing side. In the Barnett, we're letting Diversified market it. And we've thought about -- actually, the prior owner of Tokyo Gas did take their gas in kind at one time. And there is the ability for us to do that at the Barnett too, but there are some existing contracts that would have to roll off in a few years before we could actually do that. But they're certainly, like I said, it varies asset by asset. But it's not like we have 0 control over how we want to market it.

Do you see many asset packages as you all look at acquisitions where you can identify some flexibility or where you might be able to add value by maybe doing something different from a marketing standpoint than the prior owners?

Yes. I mean, we've recently started thinking about that quite a bit more, I would say, especially with the gas assets that we've been looking at that we bought. I think we mentioned on our last call or chat that specifically for Jonah, it sort of opened our eyes to kind of that area of the country from a gas perspective that we hadn't thought about it before and the ability to get gas to Western markets that can have a premium. So there have been some recent deals that we've looked at where have been in that area where we've sort of asked our marketing experts and really thought, hey, is there something different we can do with this gas production, right? Can we do something to get it to the West or get it -- sell it to different markets than maybe the existing operator is? So it's certainly something we're starting to take a look at much more now.

So you all had your first quarter earnings call a week ago, and that quarter included most of the quarter's contribution from the Williston Basin but not Jonah. So the second quarter will be the first full impact of the Jonah Field asset. Kind of going back to the variety of assets that the company owns now, can you talk about the -- how you see the impact on production costs as you move forward with a little bit different mix of assets than what you've had before?

Sure. So our gas assets are not unlike what you'd see kind of in the industry in that the nice thing about natural gas assets is just lower lifting costs, right, which we would expect to see on our assets, too. The obvious upside is generally, margins on the gas assets aren't quite as good as oil. Although I will say at the current strip, our assets actually -- our gas asset's going to compete with our oil on a margin basis where the current near-term strip looks like. But to answer your question, we definitely would hope to see overall LOE per barrel drop from what we saw in kind of our fiscal third quarter on the order of, let's call it, maybe 20% or so. We're hoping for a drop when we're adding in kind of the lower cost Jonah lifting costs. But lifting costs, I would say, in the gas assets we have are roughly half of what the lifting costs are in kind of our legacy oil assets at Delhi and Hamilton Dome. And those are probably on the higher side as you would see in oil assets because they're secondary, tertiary recovery operations, which generally do have higher lifting costs. Our Williston assets are going to be a little bit lower on the lifting cost than Delhi and Hamilton Dome, but clearly higher than the Barnett and Jonah.

You mentioned strip pricing and the attractiveness and the impact it's having on your gas production, in particular, right now. Strip has increased -- or near-term strip especially has increased pretty substantially since you bought both the Williston and Jonah. Can you just talk about the -- I think you all previously mentioned the pricing at strip. Can you talk about the incremental return or the incremental ability to delever the balance sheet with where prices are today versus where they were when you announced those acquisitions?

Yes. So it's -- sometimes, it's nice to be lucky in terms of timing for some of the acquisitions. Actually, the Barnett acquisition that we did back in May actually just paid out this month. It's on a 12-month payout, which was pretty incredible, and less than we had sort of modeled the payout on. I. Would say the Williston and Jonah deals, from when we modeled the acquisition economics to now, they're probably going to -- at current pricing, as you mentioned, they're going to pay out in probably half the time that we actually thought they might so. Certainly, it's looking very good there. And on the balance sheet side, assuming we don't have another use for cash and we just apply everything to pay down debt, which the Board generally will want to do to keep a clean balance sheet, we expect to be able to be paid down fully by the end of the year and, I think, before that actually at current strip. So our balance sheet and liquidity is going to look in pretty good shape here real quick.

When you look at acquisition opportunities in today's world or with today's commodity prices, how do you -- is there any guidance you can give on how Evolution thinks about a PDP-type hurdle rate that's attractive to you to leave yourself some upside for pleasant surprises and protect you from unpleasant ones?

Yes. I mean, that's a good question. And we -- this is a fun debate we have kind of at the Board and management level on how should we really think about acquisitions and value. What I would say is generally, we focus on free cash flow per share accretion, what the deal is going to do to our dividend coverage and outlook. So that's kind of primarily -- it's got to check that boxes first, right? If it's not going to provide a meaningful level of free cash flow per share accretion, then it's not something that we would really look at. Beyond that, we certainly will look at all the relevant metrics that you'll see out there, expected PV, rate of return, payback period, production EBITDA multiples. And honestly, depending on the asset, we might pay -- depending on the asset and the market, I'll say, we might pay around, call it, a PV-15 or 20 or potentially, it could be closer to PV-10 for the right kind of long-life, very low-decline, high-margin type assets. So it's not a real exact discount rate that we look at. It's more the asset itself and accretion. But certainly, we'll look at downside pricing scenarios, too, just to make sure that we're not going to get in a position where we've overpaid.

Do you think at all -- so you -- I think Evolution wants to invest -- reinvest about 50% or less of cash flow into the asset base and use the balance to support the dividend, incremental acquisitions. If you think about a capital budget for Evolution and the opportunities in the acquisition market, plus what you look at or evaluate the development opportunities in the Williston Basin, how do those blend together in your thought process? And I'm sure it's opportunistic driven on the acquisition side, but can you give some insight on how you think about that?

Yes, I think it's kind of -- it's a real-time sort of topic, right? I mean -- and they'll probably go on to our discussion, I'm sure, on the dividend. But I think all of that fits together. Certainly, we have a declining asset base, so we want to continue to look for opportunities to grow, and it is opportunistic on the asset front. And we're actually evaluating, on a real-time basis, drilling opportunities in Williston, which could swing the capital budget one way and also planning for things like Jonah that we had not -- that was going to actually have capital deployed that does. But I think you're right. From a general framework, we're looking at less than 50% kind of our cash flow that we're going to retain for a combination of potentially drilling in the Williston, work-over-type activity in our other areas or acquisitions, right? To the extent that we don't find the acquisitions, then we'll look at other ways to potentially return cash to shareholders. But I think it's that kind of balance that the Board sort of -- the Board is weighing right now, right? And frankly, being in kind of a new price environment where we're not alone and that you're seeing a lot of companies in the industry are generating a lot of cash and, quite frankly, figuring out what exactly is the most efficient use of that capital.

Ryan, you've done 2 recent deals, which have added scale to Evolution and the balance sheet, for that matter, just with the increased size and scale and the amount of cash flow that the company can generate. You mentioned that you all can delever the acquisition-related debt in relatively short order. How should investors think about the -- as you -- the capacity to fund incremental acquisitions and maybe bigger acquisitions since you're of a larger scale now?

Yes. So we've been -- certainly, we'll have the ability and probably have cash on balance sheet like we had before, which we think has been a competitive advantage, frankly, in allowing us to acquire the deals that we did. We've currently got a $50 million kind of credit facility with a single bank, MidFirst, who's been a great partner. That's actually -- given the size of our asset base now and the outlook, we could support a lot more, right? I mean they've done some collateral value analysis, which they do for our hedging covenant, and we can probably support in excess of $150 million borrowing base today. So there's clearly some incremental capacity out there. And I've certainly kept my ear to the ground and talked to various banks out there. And so I feel good about if they were the right kind of deal, we could certainly find the adequate liquidity, at least on the debt side, if we needed to go out and prosecute that deal. And obviously, equity is there, too. I would say on the equity side, it's going to have to be the right deal. It's going to have to be accretive on a long-term basis. The Board and management, frankly, we view our currency as very valuable, especially with the dividend. And so it's going to have to be the right kind of deal for us to end up using equity. It would have to be a high-return kind of drilling potential deal like in the Williston, where it would be high-return, low-risk locations to prosecute or potentially a merger. We've talked about that in the past, and it's something we continue to evaluate as long as the valuation metrics between the 2 companies would work out and it looks good from a long-term basis, right, for our shareholders.

Ryan, you talked earlier about the increased scale of the company and being able to add Jonah and the Williston with some incremental cost. But the bigger you get, maybe the -- you can add incremental acquisitions without a lot of incremental costs, which ultimately improves the free cash generation of those assets, which brings the question of -- you touched on it. What do you do with allocating free cash? A consistent sustainable dividend has been core to Evolution's business model for quite some time, I think, going back to the end of calendar 2014. How do you think about dividend sustainability when you look -- when you're evaluating acquisitions and the duration of that sustainability?

Yes. So I think we've talked about quite a bit in the past and Jason's definitely mentioned a big focus of the company and the Board was to get back to the pre-pandemic level of $0.10 a share. The company has historically paid out that dividend, and it was important for us for our legacy shareholders to get back there. I think now that we've gotten there and that we've proved that we can integrate acquisitions and keep our leverage low and have a much larger asset base now, we now have the high-class problem of how do we allocate that free cash flow. Clearly, we're going to pay down some debt. The Board wants to keep the debt very low, and we want to maintain flexibility to -- like we do with our prior deals to be able to act on opportunities that we see in the market. I think beyond that, we certainly, at the Board and management level, when we look about -- think about dividend policy, we look over multiple years, right? And we also look at kind of a mid-cycle price deck, more of a [ $60 and $3.50 ] kind of price deck. And in the past, we've looked at [ $55 and $3 ], those are sort of -- those types of price decks, we'll look at over the long term. When we set a dividend mix, so look, we want to be able to pay this dividend for many years where we don't have to just cut it, absent an anomaly like COVID, right? So we will look at, again, a lower mid-cycle price deck because sustainability of the dividend is very important.

I think if I remember on the earnings call, you mentioned kind of a 5- to 7-year time horizon that you like to keep in front of you in terms of that sustainability. Is that -- am I remembering that correctly?

Yes. No, that's right. Actually, we model everything out 10 years at least. So ideally, it's -- we'd like to sustain it at least 7 to 10 years, but we generally look over that mid-cycle price deck about that 5- to 7-year time period as a good way to think about it from the mid-cycle deck.

When the Board thinks about it, are they thinking in terms of a yield -- a target yield for investors? Or are they just trying to -- is the company more geared toward trying to deliver a combination of a growing asset base, growing EBITDA in an attractive yield, to keep investors engaged in the company?

Yes. There isn't necessarily a yield per se that we look at to where -- if the yield gets to a certain level, we'll raise the dividend. It's really more of, again, kind of looking more at kind of balancing what we want to pay off from a dividend standpoint versus what opportunities we see versus where we want the balance sheet. So the conversation's generally focused more on that. We kind of think if we generally raise the dividend, which the Board is obviously is looking at, and we're looking at it as we sort of go on and get these assets integrated, we think the yield will come, right? I mean if we continue to raise the dividend and the outlook looks strong, then the stock should go up, right? I mean that's -- we've seen that happen in the past. So there's not really -- again, there's not really a yield that we look at when we target a dividend.

So just to wrap up on the dividend and the topic of hot discussion on the earnings call, but as the question came up pretty frequently is, would you raise the dividend? And I guess, obviously, that's a function of your long-term view of the sustainability of the dividend. But let's say we get to early 2023 and the acquisition market is difficult because of commodity prices or it's difficult to find something to transact on. How does the dividend -- how would a dividend increase compete for capital with acquisition opportunities and what you see from maybe some development opportunities in the Williston Basin?

Yes. I mean it's the right question to ask, right? And I think a dividend increase is something that's very much something the Board is going to think about and consider. But we're going to be very thoughtful and measured. The last thing, as you know, in covering kind of companies for a long time, the last thing you want to do in a yield kind of type company is really to lower the dividend because you raised it too fast, right? Certainly, investors can understand things like COVID and commodity price crashes, but you don't want to be -- you don't raise it too high, too fast. But to your point, if you get through kind of this calendar year and the acquisition market just isn't there, I think it's certainly something that shareholder returns and dividends are things that will probably move higher on the list, right? That, along with the Williston, right? I mean I think Jason's talked about it a lot. One of the reasons we really like the Williston is to have that ability to put capital to work and grow [Audio Gap] market really isn't there. So I think if the acquisition market isn't there, certainly, the Williston and potential drilling opportunities will be more important for us. And we'll probably look a lot harder at it even -- not to say that we're not looking at it right now. And the dividend is going to be a discussion point, but I don't think you necessarily need to see the acquisition market dry up for the Board to consider to do an increase.

Ryan, I think for our discussion today, I think that's -- we covered a lot of topics about integration and the asset base and capital allocation and potential for the dividend in the future. So I'd like to thank you for joining us today, and thank you, everybody, for viewing. So we appreciate your time today, Ryan.

Yes. No, I appreciate it, Jeff. And thanks to everybody for listening in. And as always, management is always open for discussions with investors.

Thank you. We'll look forward to hosting another fireside chat with you soon.

Look forward to it. Thanks, Jeff.

Thank you.