Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

[Audio Gap] Natural Resources at Water Tower Research. Today, it's a pleasure to be joined by Kelly Lloyd, who is Evolution Petroleum's CEO and also as a Director of the company. Before we get started, I'd like to mention that today's discussion will probably include forward-looking statements, and participants can find Evolution's disclosures regarding forward-looking statements on -- in the company's SEC filings and corporate presentation on the Investor Relations section of Evolution's website.

Kelly, I'd like to pick up where we left off from our last fireside chat at the end of July, when we spent a lot of time discussing Evolution's total return shareholder philosophy. Since then, the company's reported year-end -- fiscal year-end financial results and 1 quarter or first quarter fiscal year '23 fiscal results, those results capped off a pretty transformative year in fiscal '22, which saw Evolution closed 2 significant acquisitions: one in the Williston Basin and the second one in the Jonah Field in Wyoming. And then to boot, when we spoke in July, you were at that time interim CEO, and now you're the permanent CEO. So the interim tag has been removed, so I'd like to congratulate you on being named as Evolution's permanent President and Chief Executive Officer.

Thank you, Jeff. I really appreciate that. And you're right. Evolution has had a full calendar and accomplished a great deal over the last short amount of time here. So thank you very much.

Clearly, the Board and management have been busy, as you mentioned, and we're going to talk about a lot of this upcoming. But can you just talk, remind investors how you and the rest of the Board think about driving total shareholder return for -- at Evolution?

Sure. Look, as you rightly mentioned, our goal at Evolution is to maximize total shareholder return. And we're going to accomplish that by optimizing the value of every dollar we invest really on a risk-adjusted basis. That involves us constantly weighing our options in that dynamic commodity price environment. Depending on our situation and expectations for both current pricing and future pricing and costs, we might choose to allocate our free cash flow towards repaying debt, increasing dividends, buy back shares, participate in drilling or workover activities or make acquisitions that are designed to increase our then and future dividends and/or share repurchases. So that's -- it's a whole dynamic fluid situation with a large toolbox from which we can choose.

Evolution has focused on acquiring nonoperated assets. At one point, the company was a one asset company with the Delhi Field in Northeast Louisiana, which is operated by Denbury. Are there certain characteristics of being a nonoperated interest or working interest partner that you think support the total return shareholder philosophy, as you all laid out?

I do. Look, I think there are definitely certain advantages to being a nonop working interest and royalty interest owner. Being nonop, it allows us to run more leanly than an operating company from a personnel perspective. As an operator, if you want to move into a new area and diversify where you are, you're generally going to have to get a whole new team to manage that, you're going to have to put boots on the ground and you're going to have to build out a large deal. For us, look, we need to dedicate our time and energy to due diligence, to energy, to financing and accounting for an area. But we don't need a local office, we don't need to hire people in the area. So you'll see operators, they tend to want to focus on bolt-on acquisitions around where they already are. Or if they make a deal in a new area, it's got to be of a critical mass that allows them to go in there and justify the additional personnel. From our perspective, we can greatly diversify our asset base and have proven that and done so over the last couple of years without massive increases in overhead. So yes, we do like being nonop.

So I mentioned that the company at one point was essentially a one asset company with the Delhi Field. Since then and including what the company did in fiscal 2022, the company now has positions in 5 operating areas: Hamilton Dome in Wyoming, which is an oilfield; the Barnett Shale in North Texas; and then the fiscal '22 additions in the Williston Basin and the Jonah Field. So the company now has 5 operating areas with 5 primary operators in all 5 of those different regions. At June 30, your fiscal year-end, you had 36 million BOE of proved reserves and about 90% of it was classified as proved developed producing.

That's right.

How do you think about the diversity that you all have a [ symbol-led Evolution ] over the last several years? And for 2 things: one, providing scale for the business; but also scale to support your dividend over, let's call it, a 5- to 7-year-type period?

So yes, there's a couple of points I want to make about diversity. First of all, if you have -- when we were the one asset deal, right, it was on the Gulf Coast. Hurricanes happen. You could have bad weather. It was oil, right, until we added the NGL plant. So it was considerably riskier than what we wanted to be and where we are now. Now we have natural gas as roughly 44% of our production, same as crude and NGLs make up the difference. And our revenues will fluctuate as to who has the lion's share based on the different commodity pricing environments, which means if one of them goes -- does really well, we're in a position to take advantage of that. And also geographically, if anything happens weather-wise in an area, it's only going to affect a little bit of our stuff, not all of it. And look, we make sure when we do these, we go to good markets. So the diversity of being able to produce into a market that we expect to be strong is very important to us. And as for the other question, as far as supporting the dividend for next period of time, look, obviously, we prefer to be largely unhedged. So a great deal of the answer is really dependent on commodity prices. But that said, look, we tend to look at the world through a conservative lens, and we do so when we make acquisitions, especially with regard to our future price incentive. So even with the expectation, our conservative price expectations, when we make an acquisition, we do it -- we expect to be able to increase the dividend or support it for many years to come or ideally do both. So that -- we think that's very important.

I guess to that point, Kelly, as I said, your year -- your fiscal year-end 2022 proved reserves were about 90% proved developed, much of that proved developed producing. So that implies a pretty mature, long-life production base. Do you think about it? Does the Board think about how to best manage the company's production decline curve through the combination of participating in exploitation of development projects on your existing assets, looking at incremental acquisitions and the characteristics that those might bring in terms of commodity mix and the production profile just to support the sustainability of your shareholder return program?

Sure. And exactly as you mentioned, our asset base is largely comprised of mature long-life PDP assets. And that's by design. And I think it really differentiates us from a lot of our competitors. I'd like to think about it this way, Jeff. So if we go to the gym, you see 2 people working out on treadmills. The one guy has it at the max incline, and he's really sprinting, going as hard as he can just to try and stay in the same place on the treadmill. I see equivalent of what a lot of our competitors do with their flush production, high-decline asset base. At Evolution, on the other hand, we're like the person standing next to him who you kind of make fun of because their treadmill is basically flat. And all I got to do is walk to keep up. That means we can stay in the same place, keep our production flat or move forward due to our low-decline asset base, and we can be very selective with the deals we do. And we don't have to exploit or develop our assets if the pricing and cost environment isn't where we want it. And we're really not going to have to stretch to make acquisitions because we're not in a rush to do so like the other guys on those steep treadmills.

So it's -- maybe you think of it as a long-distance runner as opposed to a sprinter to deliver sustainable dividend for shareholders?

I like that analogy. But look, every now and then, we're going to have a little burst of speed. It doesn't take a lot for us to make a meaningful growthy kind of acquisition. It doesn't -- there are small ones, and we've proven our history that we've been able to do that. So...

So I think you showed in '22 that you can add meaningful scale through acquisitions, which didn't support attractive dividend increases.

That's right.

So you all -- as we talk to you all focused on nonoperated assets, how does that focus or those types of assets affect your ability to scale both the asset base and the organization while you concentrate on maintaining a lean cost structure?

Yes. I think it helps greatly. Again, we briefly touched on it, but our same team of excellent professional individuals with just maybe a few minor tweaks, we can scale this up from where we are significantly without having to add a whole lot of cost. So it's 100% something. We're very happy to be in that position, and we're there on purpose.

Earlier, you talked or you alluded to the notion of capital allocation between different types of investment opportunities. So you obviously have paid down debt this year. There's not a lot more debt to -- or on the RBL currently to pay down. You've increased the dividend. You have a share repurchasing program -- plan in place. You participate in exploration or exploitation of development projects and the assets that you own, and the Williston Basin asset added some proved undeveloped and potential drilling locations for the future. When you think about all of those different investment opportunities, how does the development drilling in the Williston kind of play into that when you think about where you are in commodity cycles and all the options you have?

Yes, sure. So look, it is -- as I mentioned, we have a large toolbox. And depending on our expected results, when you look at price -- future price expectations and when you look at the current cost of what it's going to take to complete these wells, they're all factors that you have to look in. And so at any given time, it might be the best project, and it might -- as it's competing for dollars, it might fall down the risk. So I think if we determine that participating in drilling new locations is the most accretive use of capital, then you'll see some activity. But right now, we're still in the planning phase on that.

When we spoke in July, I think you and Bob both mentioned investment options at different parts of the commodity price cycle. So obviously, when prices are high, there may be a preference for one type of investment; when prices are low, depending on what's going on with costs and acquisition prices, you might have other uses of capital. Is it safe to say that any kind of development drilling has to compete with everything else you have in the tool kit as you think about capital?

For sure. And there's -- one of the reasons for that is, I think, 90-plus percent of the acreage in Williston is held by production, meaning there's not a time clock about to run out and you're going to lose it. So it truly is a competition for capital. We're not forced to get something done to hold it or anything like that, that you'll see out of some other guys. So look, the best return really might be buying our current shares. It could be increasing dividends. It could be making an acquisition or it could be drilling. It all just depends on where we are at that point in the cycle, as you mentioned, where we have our future expectations. So...

Before we leave the notion of the corporate decline curve, does all of that also -- does that decision framework also play into how you think about maintaining a corporate -- overall corporate decline rate to support the business model?

It very well could, right? We could absolutely drill a couple of wells here and there and try to maintain our corporate decline curve to flatten it out. Additionally, we could make acquisitions to do so. But critically, and I want to make sure you understand this, we're in a position now where we, again, given a reasonable assumption for commodity prices, we can maintain our dividend for multiple years. So we're not going to be put in a situation where our backs are against the wall and we better go make an acquisition to be able to maintain the dividend for the next quarter, or we better go drill some wells to be able to do that. That's not the situation we're in at all. We are in a very solid position right now. Not to say we're not always looking to increase our production and replace our reserves. We are. But we will make sure that we do that on our terms and not someone else's.

So it sounds like a shallow decline curve gives you the flexibility to pick your spot with respect to how you think about production-related investments.

Absolutely.

And let's talk about that...

Jeff, I was going to just mention, that can be very different from some of our peers or competitors. So it's something we're proud of, and we're very intentionally and happy to be in that position.

Let's talk about capital allocation. As we said, you all have nonoperated assets and 5 primary operators of those assets. Right now, all -- most all E&P companies are in their capital budgeting process as they think about their 2023 capital plans. As a nonoperator, can you help investors understand how much visibility and input you have into activity on your assets?

Yes, absolutely. So I mean I want you to think about it this way. So we are in constant, consistent regular conversations with our operating partners, right? And we call them partners because that's how we want to -- want them to view us and we view them. And so we're very involved and we understand where their forward plans are. There are going to be certain things where they need to get approved at their budgeting cycle, and we know what those are and might potentially be. And we're prepared for those however they go. So...

Do you all evaluate your assets in-house to the point where you can propose activities? Or you have made a decision whether if an operator comes to you and says we want to work over this well or do this project, you've already -- you've got the economics to understand how you want to participate?

We do. Again, we have engineers here at Evolution that are very, very good. And they're -- I think they're as good as they are in the industry of what they do. So a proposed activity comes across, we can model it as well as anybody and understand what the likely outcomes of that will be based on assumptions, which everyone is going to make and we'll work with the operators. A lot of times, we'll say, "Hey, would you look at it this way?" And they'll say, "Well, we want to look at it this way." So what we'll do is we'll go back and forth. And we'll do a lot of hard work, do a lot of hard work. And at the end of the day, we're all looking at the same data. So the hope is that the most logical choice of action will be something we agreed on. However, look, if we find something we really want to do, in some cases, we can propose those actions ourselves. In some cases, if they do something we don't want to, we can either choose to nonconsent or we can actually veto. So there are -- having these protections is important because different companies might be in different situations at different times. But in general, we want to work together and again, it's data. And then usually, the right decision will come out of that, that will be for everybody.

You all -- Evolution recently declared a dividend for the second fiscal quarter, which for Evolution ends in December. That dividend was increased 20% to $0.12 a share from $0.10 a share. And the Board has also authorized, as I referred earlier, a $25 million share repurchase program. How does -- can you give a little bit of a framework in terms of how the Board thinks about the attractiveness of dividends versus share repurchases?

Sure. Look, it all comes down to where are we going to get the best bang for the buck. When we're looking at investing our investors' dollars, it's all about which one wins in the competition. So we consider everything from the intrinsic value of our asset base to future expectations using base, upside and down cases and weigh them all. And so that's really where the choice is made there.

Just with respect to share repurchases, do you consider trading liquidity as a meaningful factor when you think about share repurchases?

It is something we look at, right? You kind of have to, but definitely more important to us is the value creation of using that dollar for any given corporate action. And if we've decided that a share repurchase is it, then it will probably outweigh the trading liquidity consideration.

Let's go back and touch on acquisitions for a minute. Oil prices have declined. Today, I think -- or recently, they were below the levels last year before Russia invaded Ukraine. Can you talk about the depth of opportunities in the acquisition market for assets that fit what you all are trying to accomplish at Evolution?

Yes. So the M&A market, it's sort of been dominated by larger deals. I think something like $11 billion of the roughly $16 billion of third quarter upstream M&A deals was accounted for by just 3 deals. As far as the smaller, more asset acquisition-type deals versus corporate mergers, that -- it's remained a little bit slower. A lot of companies are still generating a healthy cash flow. And this leads to buyers being reluctant to make bids and choosing instead to shore up their balance sheets and return capital to shareholders, i.e., copying Evolution. And look, sellers who aren't generally desperate because they are cash flowing, are sort of -- right now, they're seeking maximum pricing. I think we'll start to see this in the last month or so, as you've seen some prices come down a little bit. I think we'll see a little bit more come together of the bid-ask. But right now, look, there are still some great deals out there. It's just harder to find, which honestly is okay with us. Look, we've got the right team and we've got the liquidity to transact if the right deal shows up.

Kelly, the forward curve is a lot lower than it was 6 or 9 months ago. Is there a -- in your experience looking at deals or looking at acquisitions, is there a -- how long does it take sellers to catch up with the forward curve in terms of expectations? And do they just reach a point where they say, "Look, prices are down. I'm just going to sit, not transact at these prices because I'm optimistic they'll go back up?"

Yes. Look, there's definitely some of that. And then there's also -- when the prices are high, they think it's going to be there forever, so how do you shake them off that ground? Look, a lot of times, they'll just need to sell. I mean that's been an issue in the past for sure, especially companies that have borrowed money, they'll have to sell. As for anyone else, people that are lowly levered in transacting when commodity prices are volatile, it's just interesting, what you see in a volatile commodity price environment. Some people, they just get scared and want to get out because they think, okay, it's gone to $70, it's going to $40, right? And you just have to kind of be there, be in the game, be ready to take the swing when it comes around.

Evolution is a bigger company than it was this time a year ago with acquisitions, but you're still small enough that a lot of different acquisitions can have a meaningful impact on the company. Are there -- in terms of nonoperated assets, one is, are there a lot of assets or do you anticipate a lot of packages on the market? And then secondly, what's the competition look like for the types of assets you all are interested in?

Yes. I'd say we're kind of in a little bit of a sweet spot. I think the bigger deals are generally dominated by the bigger companies, but they have often strategic reasons for buying those, i.e., they want to add a nice bolt-on or, as I mentioned earlier, they want to move to a new area, but it has to be of enough critical mass to do that. So the larger deals, they might sort of trade at a premium. And the smaller deals, right, guys wanted to cut a check for $1 million to $5 million. A lot of people can do it so there's a lot more competition there. But in the area where we've done deals, we've transacted, the $20 million to $50 million range, it is a smaller subset of buyers. So there will be times when we have an advantage. But listen, as you mentioned, we've increased our scale. So look, we could take a bigger bite at the apple if that was the right deal. So look, I'd say I think we're in a really good spot from that perspective, just have to get the timing right.

Kelly, we've covered, I think, pretty well the capital allocation framework and the shareholder return philosophy that Evolution had and still has with you now as the permanent CEO. So I guess I'd like to close or bring this fireside chat to a close. When we talked in July about the strategy and with Bob, Evolution's Chairman and you about strategy and shareholder return, can you just give us an update as we're in -- almost in December of 2022? How do you think about delivering shareholder return for investors as you look at the rest of your fiscal year and into next year?

Sure. So look, I'll just give you a little bit of a rundown on what we've accomplished and where we are. And so at the end of the day, look, barring any new acquisitions, we're going to have zero debt by the end of the calendar year. We have a proven stated corporate philosophy of remaining under 1x debt to EBITDA, which means we're not going to be risky. We have a long-term history of paying a dividend, and we have a current dividend yield of 6%, 6.5%, which is well above the S&P 500 average dividend yield of around 2%. Assuming reasonable commodity prices, we can generate sufficient cash flow to keep this dividend there for years to come. Our low-decline asset base allows us to be patient and not be forced into drilling or making any acquisitions at inopportune times in the commodity cycle. We've got the optionality to grow organically through participating in drilling and workover activities if it's the right thing to do. We can also meaningfully grow cash flow with only smallish-type acquisitions, only though if we are presented with the right ones. We are not up against a steep decline or up against some kind of debt limit where we have to do that. Look, we're a low-risk company with a consistent high current yield, plenty of dividend runway, a highly diversified asset base with a proven strategy of growing the company meaningfully without ever putting the company at risk. I don't know, Jeff. I hope that helps you understand sort of how we look at the world and what we've accomplished on a total shareholder return basis. And I appreciate you giving me the chance to talk to you about it.

It does. It's a powerful combination of low leverage, low decline, which gives lots of options about how you invest your capital, including investing in the asset base and returning cash to shareholders. And I think that's a difficult combination to find with smaller oil and gas producers.

Yes. I agree. And it's taking a lot of good work to get here, and we're proud of where we are. So thank you.

Kelly, I think we'll leave it there for today. I'd like to thank you very much for joining us, and look forward to another fireside chat in the not-too-distant future.

Terrific. Thanks, Jeff.

Thank you.