Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

Jeff Robertson. I am the Managing Director for Natural Resources at Water Tower Research. With us today for a fireside chat are Kelly Loyd, who's -- sorry, Evolution's, President and CEO; and Mark Bunch, who joined Evolution in February as Chief Operating Officer. Before we get into the conversation, I would like to point out that today's discussion may include forward-looking statements. Viewers and participants are encouraged to look at Evolution's website [Audio Gap] company's presentation under the Investor Relations tab, where you'll find Evolution's disclosures around such forward-looking statements.

So, now keeping out of the way, let's dive into the conversation. Evolution is a company that has grown through acquisition of long-life mature properties with the focus of maintaining a strong balance sheet and return on capital to shareholders. Evolution closed 2 significant acquisitions during the first half of calendar 2022. Its fiscal year ends in June. And those 2 acquisitions expanded the asset base to include 5 geographic areas, each operated by 1 primary operator. Kelly, can you talk a little bit about the thinking of adding or creating the Chief Operating Officer role in light of Evolution's increased scale?

Sure. Yes. First of all, thanks for hosting us, Jeff. I hope everybody will enjoy our fireside chat here. To answer your question, our desire to hire Mark as the COO wasn't just a fill-in niche, right? Mark is someone we've known as a consultant for several years. We feel his unique skill set, capabilities and connections will really help us drive our efforts to maximize the value of our existing cash flow producing properties. He's built and will continue to build strategic relationships with our operating partners. He brings with him a wealth of knowledge and proprietary data owned from his decades of having consulted and research and operating and dealmaking across numerous basins. This will be invaluable in leading our team as we go forward and execute on further targeted growth opportunities in the future.

It's more about the niche skill set that Mark brings to the company as opposed to just needing that role field because of the increased scale from the last couple of acquisitions?

That's right. It was really created to allow us to receive the full benefits of Mark's unique background.

Held -- with the Chief Operating Officer in place, so you've been current CEO for 6 months or so now, but how does -- the COO role does it help? In that, how should investors think of it helping Evolution stewardship of their capital that they've invested in the company.

Yes. So a great question. And I think, well, the answer to that is, within the oil and gas -- domestic oil and gas industry, if it's been done, Mark has either done it, consulted for someone who did it, know someone who did it or has researched it extensively. So this depth of knowledge and connections that he has is going to allow us to avoid many pitfalls that some others may step in. And it will often open up opportunities for us that others may not even have a chance to see. So I think it's very valuable for our shareholders.

Mark, in your background, you have provided consulting services to Evolution over a number of years, including on some of the company's acquisitions. Can you talk a little bit about what motivated you to join Evolution today in this role given the -- in light of where the company sits from a strategic standpoint?

Yes. Sure thing, Jeff. First, I'd like to thank you for inviting me here today. Looking forward to this. Basically, I was spending a lot of time working on Evolution product mix. But the funny thing was I noticed there was a lot of things that I could have been involved with that I just didn't have the chance to work on. And so it kind of was just a natural progression to actually come on full time with Evolution.

How involved have you been over your career in actually working on acquisition evaluations in trying to identify value either or you can help an operator or help the company lower cost and/or look for incremental activities that would add production potentially and add reserves.

Well, I've evaluated acquisitions for most of my career in major basins throughout North America. It has been roughly [ 30 ] years where I've worked. And I evaluated and bought properties for myself, for my consulting firm, for -- as an employee for oil and gas companies over that time. And specifically when -- as a consultant for Evolution, I was brought in to help them do the Barnett acquisition. I was really involved in that one and then somewhat less prediction on the others. Usually, I was brought in, in order to -- when they were kind of in the [ Jonah Field ] acquisition and they needed a set of experienced guys to kind of look over -- to make sure that we're making an appropriate bid. We're also, in some cases, really trying to find can we put and get -- find a little bit more upside value to this so we can actually get the deal done.

We've talked a lot on the prior fireside chats and just Kelly talked about in the context of Evolution's business strategy. The company has been built at least so far on acquiring nonoperated working interest in mature long-life properties that still have stable cash flow to support the company's goals of paying out a sustainable and steady dividend. Mark, can you talk about how do you think about characterizing the relationship between an operator and a nonoperator on assets? And how you think about that going into an acquisition?

Yes. And you kind of have to say it depends. And that's because I'm going to kind of talk to you in ways that Evolution would prefer to -- the way we prefer to do an acquisition. And it's really involves -- it goes back to Evolution likes to have a really nice size, nonoperator position say, 20%, 25%. And that way, the operator really needs to work quick with a strategy to buying on their actions. And we have like a working interest partner with that kind of interest. They really need you involved in the process. Otherwise, things don't cover well. If Evolution has a good nonop working relationship with the operator and it's proven it can provide value to that process and the operator generally listens to us and considers our input, which is a benefit to both the parties.

So the key is, what you said, I think, is that you want to have a working interest ownership in the assets and make sure you matter to the operator, so you all work together for the benefits to both you to maximize cash flow in the assets, is that fair?

That is correct.

Okay. Along those lines, Mark, can you talk a little bit about how you all work with operators to try and maximize production and minimize costs?

And Yes, I would be happy to, Jeff. [Audio Gap] [Technical Difficulty]

I think, Mark, may have frozen. Well, I can answer that for you, just from having had a chance to speak with Mark. He's done those several times throughout his career and he's been able to develop relationships with the operators. And they know he has a wealth of experience. They understand his background. So it's a real solid backing for and that really comes from a level of trust that's earned, not just assumed. So...

Okay. So let's -- waiting for Mark to try to relog in, I think, since he's frozen up. The second quarter, we -- you all talked about geographic diversity, and it really showed the benefit in the second quarter with your financial numbers, in particular, the gas prices you all were able to receive or realize in the Jonah Field. Can you talk about just the way you think about asset diversity and exposure to different markets with the company's asset base?

Yes, absolutely. Like if you're a nonop, it's really -- it's easier, cheaper to become geographically diverse than if you're an operator. You don't have to hire out a full team for each area you move to, you don't necessarily have to achieve the same scale. And so we want to make you -- if they achieve goal of ours and we made sure we did it, and it will continue to be, like, different areas across the country are going to be exposed to different risks. You're going to have pricing anomalies or weather anomalies, like, hurricanes or you should bear winter in its forms. And we aim to make sure that we're exposed to a variety of markets so we can mitigate that risk, like, having multiple strong operators also reduces our sort of idiosyncratic risk, which, at times, I think they can be very important. So having operator in geographic and commodity mix. Diversity, it has been and will be a goal of ours.

We've all seen a lot of the -- we've seen a lot of volatility -- along those lines, we've seen a lot of volatility in commodity prices over the last 6 months. Natural gas prices at least trending up have fallen, I think, more than 70% now. Oil went from in the [ $90s ] to $60 and now back up at least in the high [ $60s ]. As volatility had much of an impact in your business development activities in terms of either opportunities that you might have seen that might have been pulled back or opportunities that are coming out or can you characterize specifically the acquisition market just given the recent volatility, Kelly?

Sure. Look, the volatility always kind of makes things a little more difficult to get things done. If you -- again if you're recently real at high, seller is going to want to maintain that high. And if you recently gone down really low, sellers aren't going to believe it's going to stay very low. So you have to be a little more creative, you have to work a little harder to try and get a deal done. But, look, if the current prices sort of level out anywhere near where they are and volatility comps and little bit at some pace, then the sellers are really going to begin to accept the strip pricing as real. And I think that will loosen some things up for deals to get done.

Back in terms of geography, does the asset mix that you all have now, we've spoken before about some of the undeveloped drilling activities in the Williston. But, just in general, does the diversity of the -- does the geographic diversity had also a significant impact on just the types of [ exploitation ] development projects, one might make sense given where you are in a commodity cycle or where you are in the cost cycle in a certain area?

Yes. So a couple of different things in there. Our geographic diversity also comes with a commodity mix diversity. So -- for instance, in early to mid-2022, natural gas prices were pretty elevated, the market was tight. So we worked with Diversified, who's our main partnership operator, to return as many wells as we could to production. It made sense to do the work. And it was a great project we worked together with them on. Again, it's gone really well. So, right now, we're working with Foundation, who is the operator for our Williston Basin asset on a couple of projects that we think could add some more oil production. So, I think, having that diverse asset mix is really important to have. But on the acquisition front, listen, we're typically kind of agnostic as to which the dominant product is. We believe in making the best acquisition we can for -- what the best deal is at that time for our expectations of where the commodity is going to be going forward. So if you do this, it's going to end up just because at various times in the cycle, what commodity is going to be advantaged over the other. And so if you do this over time, you're going to end up having a diversified portfolio.

Can you talk about the characteristics just in general terms, where Evolution is today versus where you were, let's say, 18 months ago even before you bought the Barnett Shale asset. What did generic characteristics for that asset make the most sense for Evolution today?

I'll give you a couple of things. So we are currently and what we've done in our recent acquisitions, one of the important things that we want to look at is the long-life, low-decline. And, I think, you've heard me say that a few times before, but what that really means is we have an asset base which isn't on a steep sort of fast treadmill where you're constantly having to make acquisitions to replace large amounts of depleted production and reserves. If you have a long-life, low-decline, you can be a lot steadier, you can be a lot more opportunistic. You're not forced to go, make acquisitions or to drill in times when it's inopportune. So in general, that is our focus. We do want to make sure we can buy at a significant discount to what we believe the processing ought to be. So we can make a return even if things go down some. And additionally, we want to make we're not landing ourselves on a steep treadmill. So these are important things for us.

All of those characteristics support the overall corporate goal of maintaining steady cash flow and generate excess cash flow that you can then reallocate to what you believe is the best purpose?

Yes, I agree.

How do you...

Totally agree. Absolutely. That's -- we have a machine that we've tried to put together that is here to generate cash flow. And in our levers that we can use if we had debt outstanding, which we don't because we paid it all off. But if we did, that's one lever to use our free cash flow for. And then next, you can go to paying dividends. It's been very important for us. You could do the share buyback, which we've done. And then last but not least, of course, you have to opportunistically add more COGS to the machine to make more free cash flow. So these are things the Board and all of us here are constantly managing in trying to make sure that we get things right there.

It's like Mark rejoined us now. Hi Mark.

Hello. I have no idea of what we're talking about.

So we'll try to bring you back in gracefully though.

Okay.

Mark, we talked -- Kelly talked a little bit about geographic diversity and project diversity. And one of the things Kelly touched on it really was a highlight of your second quarter results was the Jonah Field and the gas price realizations you sell out there. Do you see other basins offer -- that offer kind of some sort of hidden value that you might be able to realize that you don't pay for when you look at acquisitions?

Yes, we're kind of bullish on gas prices right now for the obvious reason that the gas prices are down a lot and so the upside doesn't really factor into [ biddings ] process. And we try to avoid though -- we're always trying to avoid process where there's a lot of competition because it really makes it hard to make a good acquisition because you're really just end up having to pay too much.

Mark, I think, when you jumped off we might have been talking about the operator-nonoperator relationship when you got -- froze up. What I wanted to get a feel for is in your role and your consulting background, how do you evaluate the operators of the assets that you want to get involved in because there's good operators and bad operators, and you obviously don't want to get in bed with a bad operator.

Yes. We really look for experienced operators with a good reputation because, yes, that's a key to really being successful if not, you can't be successful with a bad operator. And so it's important for Evolution that we partner these kind of people, but -- and that's be highly accomplished if operations relates, but they also need to have excellent environmental and safety record. And a lot of times, companies overlook this. I've been in deals where people don't really think about this before. And beyond the obvious ESG that fits for us as a publicly traded company, it's just good business to have people to take care of their business in a safe and environmentally friendly manner.

Are you able to learn enough about an operator's history in the time you're able to do due diligence on an asset, is that -- I presume that's part of what you all try to understand.

Well, yes, and that's a really good question because I've been in the business for a really long time. And so I'm really quite familiar with a lot of the operators. And those that I not, oftentimes, I know people who know them. So we're going to call around and make attempts to try to figure out if it's somebody is not -- that we don't know really well, we'll try to make some inquiries about how good they are with the people that have actually worked with them. That's the beauty of being in this business for so long. Actually, know almost -- I can know somebody that is almost [indiscernible].

Mark, you mentioned the notion with -- in terms of acquisitions for Evolution of owning a large working interest that your opinion matters to the operator in terms of getting things done. Can you just kind of elaborate on that and talk about how much influence Evolution has on trying to push an operator for -- to be more efficient and be mindful of costs or try to encourage them if you see a -- workup of that project or some sort of activity that makes a lot of economic sense to add production to get their attention that they might want to think about?

Yes. That's really what we aim to do is to make -- develop a relationship with the operator. This is what I told the Board probably over a year ago is that this is the way I look at doing our business is developing a relationship with the operators, convincing that you have something worthwhile to offer to the team that you're not just a checkbook. And then -- and so really, once you develop that relationship and they realize that you could benefit with it most of the time and the operator we do listen, they think, listen to us and will consider the things that we have -- that we suggest, in fact, they actually govern the change, some of them change their minds on things, so even while it was being modest consultant for the company. And, yes, it just makes for a better product for both of us. So it's -- but you have to develop that relationship first. You can't just come in cold and you're not welcomed.

Mark, having your skill to Evolution, which is the technical feature, does it make you all -- any more inclined to consider acquisitions of operating properties than you might have been before -- than the company might have been before?

Well, I think they always would have considered doing that. But -- and this is a really, really good question, Jeff, that you have because one of the things that Evolution registered me as Chief Operating Officer because they saw that I had provided them the opportunity with in-house to do operations. We would actually make an acquisition like that. And the people -- I can build that team and manage it because I've actually done that a number of times over the course of my career.

An operator asset acquisition, though, would probably mean a little bit more scale, sort of little bit bigger size to get a big enough footprint for being the operator to make sense. Is that the right way to think about it?

That's absolutely correct. I mean -- I really to pushed them in before in talking to the Board about this is that we -- it needs to be a significant asset that we would acquire because to become an operator of 1 well or 100 wells, you're going to significantly change the size of the company because there's a step you have to have that you don't have to have start off.

One of the things, back to Jonah, can you talk a little bit about where -- since that was such a big impact in your second fiscal quarter in the December quarter gas prices. Can you share any thoughts or any intelligence on what prices have been so far in the third quarter?

Yes. I mean I can tell you that the prices out there on the Kern River are. They're still much better than Henry Hub. So we're not in the level that the Henry Hub is at. Now unfortunately, though, it's not quite as busy as it was back in December when it's sold for a few days at $40 MMBtu.

Jeff, can I just add something here? We talked about it a little bit before. But to me, this is sort of great evidence of why geographic diversity is a strategic goal of ours. Like, I wish I could tell you that we knew Western pricing would be so strong this winter, I can't. But I can tell you that we knew it was a largely uncorrelated market, and we wanted to make sure we had exposure to it. So while the pricing at [ Hamilton ] Dome, Barnett, Williston and other acquisitions are about to the same level they were when we first negotiated with them, Jonah has remained elevated. So each of our fields has the potential to say that like this based on the then market conditions.

What clearly those benefits to have a different market in [ South Western ] and Gulf Coast market, where we see -- as we sell a company and report second quarter results, some of the Permian producers reported natural gas prices that were roughly [ $1 ] in some areas -- in certain areas before. So...

Yes. It's -- I mean, Mark, will tell you, these are things that not only is the asset itself and the operator and their safety and environmental record as well as their sort of efficiency record are all things considered. But very much we consider the market in which to we're going to sell our product into. So...

Kelly, let's talk -- on previous fireside chats, we've talked a lot about how the Board thinks about capital allocation, especially across the business, maybe the commodity price down graph we've had is one way to think about how you adapt to different commodity price cycles and different cost cycles. Your goal that you've talked a lot about and for a lot of years, so it hasn't changed recently is to maximize total shareholder return -- returning share -- returning the cash to shareholders through a dividend has always been an important part of that since December 2013. Growing that -- so you can deliver value to shareholders by dividend, I think, the current dividend yield is about 8.5%. You can acquire assets to grow the EBITDA of the company that way, which should -- could result in equity value increase. Underlying all of that is retaining a very conservative balance sheet, and the Board in September adopted a new tool of shareholder -- share repurchase authorization for $25 million. Given where we are in the current environment and with the yield where the -- on the equity, how do you think about sustainability of cash flows in light of the current commodity price environment?

Yes. So thanks, Jeff. I'm glad you brought this up. I wanted to talk about this. So listen, right now, if you remember what I said, at our recent acquisitions, they were either made or negotiated around these commodity prices that we're experiencing right now. And so we entered into these transactions with an expected accretive return based on to a significant discount to where the commodities have pulled back to. And so the difference now, though, is -- we have paid off our whole revolver, roughly $37 million between April and December. So we're debt free, and we've put all the remaining free cash flow towards a combination of returning cash to shareholders, as you mentioned or accretively growing our asset base or obviously both.

So the acquisitions that you -- just to make sure investors are clear when you evaluated the acquisitions and the price you're willing to pay was based on a commodity price that's much more akin to what we're seeing in the market today. And the run up in prices since those deals were announced has really been secret sauce in terms of being able to pay off or pay down leverage much, much faster than you thought you might be able to when the acquisitions were announced.

Well, yes, I don't know if I go much, much, but definitely faster, how about that. Yes. Well, listen, we had a view on prices for when we made and negotiated those deals. These are cyclical, right? So at some point, we're not meant to be speculators, but you can sort of understand where you are in the commodity cycle, are you closer to the bottom or the top. And when we made these and negotiated them, the prices were sort of around this level. So, yes, the run-up in prices was great. It allowed us to pay off our revolver faster than we had expected and leaves us with a position today where Evolution can act swiftly and efficiently if the right kind of deal comes around because we have a pristine balance sheet.

We talked about -- I mentioned some of the levers that you all have to pull, and you've mentioned some, but -- can you talk about the relative attractiveness at least as we sit here today, where you think the best opportunity to drive value in the cycle?

We have a Board meeting coming up. So these are always decided as we look at the situation we're in at that time. But I'll say that we concurrently just with repaying our borrowing base completely, right? We also announced a dividend, which is payable on March 31. This is our 38th consecutive quarterly dividend. We haven't missed one, up cycle, down cycle, we paid a quarterly dividend. This will be our third consecutive quarterly dividend at $0.12 a share, $0.48 a share annualized. So that should tell you that the dividend remains a strong priority for us. Also, we recently announced that we entered into a 10b5-1 plan as part of our announced $25 million share repurchase program. And then lastly, we are very much in the deal flow and even more so with the addition of Mark. So we're evaluating numerous opportunities to accretively grow our asset base. But we're not in a position at all where we have to do something. We want to do things opportunistically and accretively in the right deal.

We -- I mentioned that the current dividend yield is roughly 8.5% on the day it's been the last couple of weeks. Can you just kind of -- if you want to summarize how do you think about Evolution's value proposition for shareholders who might be looking at the company today?

Yes. It's great. So, look, we thought we were a great low-risk, high-return opportunity when we are yielding a lot less than we are right now. So we only feel stronger about our value proposition today. If you were to compare us to each of the sectors of the S&P 500, we stand out as having a higher yield, combined with negative net debt. We're also trading at a lower multiple than the sector components. And yet we have a higher-than-average 3-year EBITDA CAGR. But, you tell me, we're lower risk from a leverage basis with a higher yield, and we get a lower trading multiple, yet we've proven to be an EBITDA grower, and we haven't diluted ourselves to get to where we are. So, I think, we're sitting pretty -- listen, we had a best-in-class team here. The folks at Evolution, we're lean, but we really have an incredible team here. And with the addition of Mark, it's only stronger. So, I think, our value proposition is very strong, Jeff.

[indiscernible] A company with a strong balance sheet and a very manageable corporate decline curve has a lot of flexibility to pay a dividend, like, in your goal to acquire assets and potentially to buy back shares, if that makes more sense just given what's going on in the market and the disconnect in value. So underpinning all of that, to be able to act as opportunistically as you can, the balance sheet really is one of the important key. So you're never out of the market in terms of what you can capitalize on opportunistically.

You said it very well, Jeff. Perfect.

Mark, I'd like to thank you and Kelly for joining us today. Now that you're back from your trip out in the cyberspace, we will look forward to hosting another fireside chat with you all, hopefully, in the next couple of months.

Thanks Jeff. Thanks, Mark.