Evolution Petroleum Corporation (EPM) Earnings Call Transcript & Summary

Thank you for joining us today for a fireside chat. My name is Jeff Robertson. I'm the Managing Director for Natural Resources at Water Tower Research. With us today from Evolution Petroleum, we have Chief Executive Officer, Kelly Loyd; Chief Financial Officer, Ryan Stash; and Chief Operating Officer, Mark Bunch. Before we begin our discussion, I would like to remind participants that today's discussion could contain forward-looking statements as of today, March 20, 2024, Evolution's disclosures regarding forward-looking statements can be found under the Investor Relations tab of its corporate home page. So with a little bit of -- with that bit of housekeeping out of the way, I would like to start just a brief introduction. Evolution's asset base includes non-operated working interest and producing properties located in 7 producing regions in the U.S. The 2 newest additions to the portfolio include the Chaveroo oilfield in New Mexico in the Permian Basin and the SCOOP/STACK play, which is in Central Oklahoma. Both of these assets add an organic component -- or organic growth component to Evolution's asset base. The strategy of the company is really built around a foundation of producing assets that generate excess cash flow, which can be used to reinvest in the underlying asset base to grow the business, delever the balance sheet, if needed, and return cash to shareholders. So that bit of intro out of the way, I'd like to get started. Kelly, thanks for joining us today.

Thank you, Jeff.

And let's just start at a high-level with strategy. Adding organic growth component or growth element to the asset base -- as I said, Evolution has relied on acquisitions of producing properties to build the asset base and support the cash return plans. The organic growth opportunities at Chaveroo and the SCOOP/STACK play provides some additional diversity to the asset base and yours and the Board's capital allocation decisions. Can you just talk about how you think these assets complement your existing asset base and your strategy of trying to maximize total shareholder return?

Absolutely. And first of all, as always, thank you for having us. We're very appreciative for the opportunity to tell our story in your unique forum. So to answer your question, the additions of our Chaveroo partnership and our SCOOP/STACK acquisitions really were made with the specific purpose of complementing our preexisting asset base. And one of them, the SCOOP/STACK, we're able to add significant current production, which will go towards immediately increasing current free cash flow. And crucially, with both deals, we have added highly economic drillable locations. Together, along with our long-life, low-decline preexisting assets, we -- the strategy here is it significantly enhances our ability to return capital to our shareholders for many more years to come.

One of the drawbacks or at least perceived drawbacks of the nonoperative business model is the ability to influence timing of capital outlays and development activity on your assets. How much influence does Evolution have on the capital activity in both Chaveroo and SCOOP/STACK because they're both a little bit different in terms of the nature of the asset?

Right. Right. So I'll start with the SCOOP/STACK. As you can imagine, with an average working interest of approximately 3% across all the acquisitions and acreage positions, we are going to have a great deal of control over capital allocation plans there. That said, we have modeled our CapEx needs from a variety of different scenarios, which range from very conservative to very aggressive, and we're comfortable that with all the scenarios, we're very well covered. In Chaveroo, we feel like we do have a great deal of influence there. It's really a true partnership. So that affords us a level of control and visibility of timing of CapEx that we're very comfortable with moving forward.

When Evolution was considering these opportunities, was there a goal of having a certain percentage of capital that could be allocated to organic growth opportunities, just to complement what you see in the acquisition market, which ebbs and flows in terms of attractiveness?

Jeff, this is Ryan again. I'll take this one and I appreciate as well and echo Kelly's sentiments on having you -- have us on this forum here. But just to answer your question, really, so our mindset hasn't really changed as far as how we think about allocating capital. We look at every single dollar and we put it to the best use that we can for our shareholders at any given time. As some of these projects will come along, we'll independently review each organic development opportunity. And we'll make the best decision for our shareholders at that time really based on our assessment of expected returns for the project itself versus any other potential uses of cash.

So these types of transactions represent any kind of shift in how you prioritize acquisitions between some of the more mature producing properties and assets with a little bit more development opportunity?

Jeff, I mean, honestly, really no. I'd say it was important to us to add to our existing portfolio of drillable locations, and we've done that. Our acquisition focus is going to remain to add the most accretive risk-adjusted properties at the appropriate time when they become available.

When you mentioned -- when you think about risk on assets like this, a lot of Evolution's acquisitions have targeted mature long-life producing properties. These are obviously wells where there is capital that we spend on drilling, how do you think about the risk profile of these types of assets?

Jeff. It sounds like a good question for me to answer. Good to see you here, by the way. We look at this as it's -- we look at it differently between the 2 because it's a lot more risky to drill wells than it is to buy PDP production. It's just a lot like how you would evaluate in an acquisition, if you have undeveloped locations. So yes, you have to have a higher rate of return on stuff that you're going to drill in order to really want to go do it. The real reason we did is just to allow us to -- it kind of gives us different risk profile with the entire company and allows us to distribute our capital in a less lumpy manner.

You indicated, I guess, maybe it was last week in the press release where you updated some of the early results at Chaveroo and talked about the SCOOP/STACK that the company now has exposure to an inventory of greater than 10 years of low-risk development opportunities. How does the inventory visibility or the inventory increase the visibility into the way you think about the dividend?

Yes. So I'll take that one, Jeff. I mean it's definitely enhanced kind of our -- what we view of our sustainability of the dividend. In the past, as you sort of mentioned, we relied on the acquisition market. And at times, when it wasn't viable or there weren't a lot of opportunities, we would have to sit out and sort of wait for those opportunities to become available. But now with our assets and our drilling opportunities, we've enhanced our ability to really offset the natural production declines with highly economic locations, they will provide cash flows and we think it will support dividend for years to come. So we're very excited about this new avenue here we got.

Let's maybe drill down of the phrase since you've got some opportunities to drill down on the assets a little bit more. Can you talk about how these 2 transactions originated?

Sure. Look, relationships in this industry are important. And in the case of Chaveroo, we were approached by someone who knew us and was looking for a solid partner to help with the horizontal redevelopment of the Chaveroo-San Andres field. After initial discussions, it was obvious that there was going to be a way to get to a win-win for both parties. And from there, it was just kind of a matter of ironing out the details. On the SCOOP/STACK, rather than it being more of a negotiated deal, it was sort of down to just being in the flow. It's one of those that came across our desk, and it's one of the many, many marketed deals that we took a deep dive into. Ultimately, we feel -- what helped us close on this deal was really our reputation as a buyer who provided certainty of closing. So a couple of different ways, but very happy with both deals.

Before these 2 assets came along, you had 5 operating areas, essentially with 5 primary operators in each area. In Chaveroo, you're joined with PEDEVCO and in SCOOP/STACK, you're joined with some of the household names in that play like Continental, Ovinitiv, EOG and Marathon. Can you talk about how you assess operator relationships or operator risk as you think about these types of deals?

Yes. That's an interesting question actually because again -- it's kind of really different between the 2 projects you mentioned. For Chaveroo is really important because we have such a large interest being 50% working interest. So what we required out of that was that we had influence over the process, and PEDEVCO has been very good to work with, and they've been very acceptable of having discussions about how to do things. So that's worked out really well. And then on the SCOOP/STACK, that it's more handled by distribution of a number of operators because we have small interest, and we kind of want to have a distribution across the board on that. And you really kind of almost forced into that the way Oklahoma works anyway with forced pooling that kind of stuff. So it's 2 different things, but we feel like they've handled well. And we do like the operators that we see in the SCOOP/STACK for the large part, you have a lot of locations that are actually some of the really big players there.

I think in the early days of that play Continental actually coined the name SCOOP/STACK in one of their investor slide decks they used.

Yes. And they are one of our bigger operators there.

The strategic partnership with PEDEVCO was announced in September of 2023, and that deal covers the Chaveroo oil field. The agreement covers over 16,000 acres and gives Evolution the right to farm into development blocks with an average 50% working interest, as you said, Mark, and the [ farm and up elections ] are on a block-by-block basis. I think in last week's press release, you announced that you all have agreed to proceed with the second block. Can you talk about how much horizontal development has taken place in that area and forms the basis of your economic understanding of the play?

Yes. There's -- PEDEVCO has actually 10 wells -- 10 horizontal wells that they drilled like in the immediate area. They also drilled several others across a couple of the other deals in the area. The lion's share of the evaluation was where we looked back was over on the Central Basin platform because that's where there's probably been over 1,000 wells, if I have to guess, I don't know the exact number of horizontal San Andres wells. The issue, though, that's kind of funny is, it's like most of those wells are drilled as transition wells off the edge of fields. And we had a unique opportunity with the Chaveroo field, which is what we really like. And we're actually drilling within the field limits right now. I mean we're the 400-or-so vertical wells that have already been drilled. And we're just really trying to improve recovery from the Chaveroo field. And so it was a little bit different and did a lot of the development in the San Andres. So honestly, part of it was there's a lot less analogs around the entire Permian Basin for that kind of deal, where you're actually going into a 40-acre spacing in San Andres field and basically putting horizontal wells because most of the times San Andres is either waterflooded or down spaced. And so you have actually less wells to look at. But we did it 2 different ways. We looked at the wells that were done [indiscernible] we have done that were applicable to the process. So we felt like that there weren't things that caused problems in the wells on their learning process. And then we also looked at it another way as to -- we actually looked at Shafter Lake field as an analog because there was some infill -- actually infill drilling on the 40-acre spacing there. It's not a huge number of wells.

Mark, I mentioned that you all have -- or the Evolution agreed to participate in a second development block. Can you just kind of outline how those elections work?

Yes. So the 2 -- first 2 development blocks, we paid for the acreage upfront, that was part of the deal. So the second development block, which has 6 wells and -- based on the performance of the first 2 wells, we're interested in going forward with this. And I believe PEDEVCO is as well. After that, we get a certain -- we get about 90 to 100 days to evaluate the wells after they start production before we were to elect for the next development block. And as long as we keep electing into development blocks, we get to keep -- we have a right of first refusal to keep going with the process. It's a total of 12 development blocks.

Mark, we're adding new production from new horizontal wells into a fairly mature field that was developed with vertical wells from time to time causes infrastructure issues. Are there any constraints in the field from handling new production that Evolution and PEDEVCO have to deal with that could require any real incremental capital?

Well, actually, we're not using any of the vertical facilities, and we're not using any of the existing pipelines because they were put in -- this field was basically discovered and developed in the 50s and the 60s and such pretty old. It's also really too small for horizontal development. So the entire concept that was done here was that we were going to redevelop the facilities as well and also develop in a way that was intelligent for a horizontal play. . And same thing with the disposal system. So it's -- that's actually all been factored in, but it doesn't represent any type of particular problem because we have a good place to disposal -- we have a good source to dispose off water that's very inexpensive, which makes the process work. And we have the ability to put in new facilities that are going to have sufficient tankage, that kind of stuff to handle the horizontal wells.

You mentioned that the first [ 3 ] wells have been drilled and completed, and I think are cleaning up now after having been put on production earlier this year. Can you -- obviously, you've elected to participate in the second block, so you're encouraged. But what can you share about the initial results and how they compare to your initial expectations that you formed last summer?

Well, on average, we -- because you have a variation of production from the [ 3 ] wells. But they're actually coming in better than we actually had modeled them internally from a standpoint of how we model our cash flows. So we're actually really pretty excited about them. I mean honestly, if someone looks at the rights that -- in the San Andres and try to compare with Wolfcamp, they'd be not all that impressed, but they also have to realize that the capital cost per well is about 1/4 or 1/5 the cost of a Wolfcamp well.

Mark, you said the second development block has about 6 wells. Can you talk at all? Or do you have an idea that you can share as far as the timing of when those wells might be drilled?

We don't have a firm agreement with PEDEVCO when everything is going to start, but I think both of our expectations are, it will be in the second half of the calendar year, not our fiscal year but the calendar year, and that we would be starting the process to drill and complete those wells.

Let's shift to Oklahoma. The SCOOP/STACK acquisition, which was announced back in January of this year and closed in mid-February for about $43 million in cash included about 1,550 BOE a day of production as of, I think, the effective date in early November. And that added as Kelly said, about 3% working interest across 3,700 net acres in the play. How do you think about that acquisition in light of the development that's taken place historically and the operators that we touched on earlier, you've got some of the biggest operators in the area. And, I guess, one of the considerations as a nonoperating interest owner is could they drill your socks off by -- with well proposals. But can you just talk about how having multiple operators is an advantage in this play?

Well, we have quite a few locations that are potential drilling locations out there. And so it's nice to not be just stuck with like 1 operator because you see a variation of performance with the operators and also variation in costs. And so I think that when we see it's spread across a big group like this, we get the benefits of everybody's knowledge in the area. So we didn't see any of the operators as being a particular problem overall. But the good news is as we -- even the very big operators, we have a significant position with all of them. So we're not really captured by any one particular operator.

Your fiscal year ends in June, so you'll be coming up on capital planning for fiscal 2025 before too long. How much visibility do you have into the operator's capital plans over the next 12 months or so?

Yes, I'll take this one, Jeff. So we're actually reaching out to the operators right now based on kind of relationships that all of us have being in the industry for a number of years and seeing what their development plans are going to be or what they could share. That being said, since we are only a 3% working interest owner, we're not going to have the same visibility as we do in some of our other areas. We can look at history, history they -- historically, they've had about 12 gross wells drilled per quarter on our acreage. I would say though, given kind of the current slump in gas prices, we would expect the pace to decline a little bit. And we've actually started to see a little bit of reduction in AFEs that are coming in versus kind of historical. So, I guess, we're doing our best to do as much forecast as we can, but we can really only use history as a real guy here in this area.

Based on what you've studied from the well performance of the package you acquired, how predictable are the well results in the part of the SCOOP/STACK play that your acreage is located?

Well, I'll take that one and it's -- it's a little bit more difficult than it is like in the Delaware Basin, where geology is not -- doesn't have as big of a footprint over a smaller area. So we're going to have to take into account geology. We do have over 10 type curve areas for the acquisition. And there's -- a lot of that is change in GOR effects of bulking that kind of stuff. . But when you kind of isolate down on a smaller area where the geology is similar, it's -- it seems to be fairly consistent with where you can build type curves with it. Unfortunately, I don't think we're going to be drilling type curves that have like 50 or 60 wells in it because I think the geology is just going to make it impractical to have that many wells for your type curves.

The acquisition, when it was announced, included, I think, 21 DUCs are drilled but uncompleted wells. I think you mentioned last week that 19 of those have been completed at the [ seller's ] expense and placed on production. Can you share anything about how the performance of those wells has matched up with your pre-acquisition expectations?

Yes. It's kind of interesting. We have -- and the problem is I'm going to tell you some information. We don't have a lot of data on it. But in some cases, it's just essentially 1 data point, the first month of production, but a number of the wells seem to be outperforming our type curves. So I mean, now do they stay outperforming the type curves, kind of little early to tell that. But so far, we're not disappointed.

Ownership from some of these types of plays can be pretty fragmented. Do you see opportunities to add incremental working interest in the assets that you acquired or are there other things in Oklahoma that now become more appealing just given that you've got a presence up there?

Yes, Jeff. So in Oklahoma, it's a very active market, and it is very fragmented, as you said. But I mean, think what they call Wellbore Wednesdays, right, where somebody's got AFE and they don't want to do it, so they're selling off to the highest bidder. You see a lot of transactions there, which we've been approached, frankly, by multiple parties, some of them looking to sell us some or all of their interest and other people looking to buy from us. Like I said, it's a highly active area with transaction seemingly happening all the time. Also, there's forced pooling. It's an effect in Oklahoma. So operator, AFE is a well, somebody wants in and out, you're going to have plenty of opportunities to increase or decrease around the edges, it's a never-ending thing. And it's kind of an exciting place to be for us.

Let's start on the financial impact of these acquisitions, and we alluded to the notion that your fiscal year ends at the end of June, and you'll be in your capital planning cycle for 2025, do you know much yet about how these 2 deals, especially the most recent one, in the SCOOP/STACK affect your capital needs for the rest of this year. And as you start to think about maybe just second half of calendar 2024, which will be your first half of fiscal '25?

Yes, Jeff. So when we put out our last quarter's earnings release, we updated our guidance for fiscal year '24, it would be $10 million to $14 million for that range. And we still think that's a good range. When we include potential capital for the SCOOP/STACK deal, it may push us towards the top of that range. But I think as we've kind of mentioned at this point, this may be a little too early or too hard for us to really predict exactly where that's going to come in. As you did note as well, we'll start our planning for fiscal year '25 kind of after we come out with our results over the summer, really, right? And we'll put that out when we do in September with our results for fiscal year-end. But overall, I wouldn't expect our fiscal year '25 budget to be dramatically different from fiscal year '24. But again, we'll update that at kind of in due course here as we get more AFEs from the SCOOP/STACK asset and as we get a little bit better sense as Mark mentioned on timing for PEDEVCO.

Evolution's 2 largest assets at least in the second quarter of fiscal '24, with Barnett Shale and the Jonah Field up in Wyoming, both of which are almost entirely gas-producing fields. Will Chaveroo or SCOOP/STACK have much of an impact on the hydrocarbon mix in your production profile as you think about it over the next 12 months or so?

Yes. I mean so Chaveroo, is, we probably mentioned it is 90% oil. So almost entirely oil. And so definitely, depending obviously on timing, right, activity level and timing, but overall, we do see increasing the overall corporate mix of oil kind of over time. On the SCOOP/STACK, historically, the asset was about 42% oil, 44% gas and the rest liquids or NGLs. And obviously, that mix is going to depend on the development there, right? So as some areas we have 3,700 net acres, but it is geographic throughout the basin. And so there are some oily areas or some gassy areas, some liquids. And really depends on what gets drilled as to how that impacts it. I would expect in the current price environment, we'll probably see more activity on the oil and liquid side than anyone on the pure gas side, so you might continue to see more oil on that asset. But we really like that asset for the mix. And I think over time, we were historically around maybe 60% gas on a production basis, that might trend a little bit lower to 50%, right, over time to have more of a balanced commodity mix.

The Chaveroo deal, I think, is kind of a fund-as-you-go type of an acquisition with acreage, elections and the development drilling. The SCOOP/STACK purchase price of roughly $43 million was funded with borrowings under the existing RBL. Ryan, how do you think about the impact on the RBL at your next regularly scheduled redetermination?

Yes. So at this point, we don't expect any change to the $50 million sort of really elected borrowing base, right? We could certainly go higher if we wanted to. But obviously, new assets will add to our total reserves, and they'll be supportive of collateral value. And as I mentioned, to build potentially increase the borrowing base if we choose, right? Right now, we feel more than comfortable about where the current borrowing base is and our current structure. So we don't have any plans necessarily to do that. But these reserves are only going to be additive to the borrowing base going forward.

Does capital requirements of the assets and the RBL borrowings to fund, does that change at all how you think about long-term leverage goals for Evolution?

No. I mean we've historically said that 1x net debt to pro forma EBITDA sort of our target, and that really hasn't changed. I mean, obviously, we haven't had -- we paid off our debt fairly quickly from the last acquisition and had some good timing on some of the gas prices there. And we may have leverage out for a little bit longer we did for -- than those assets, but ultimately, our target is still that 1x net debt or under. And so we don't see that changing.

Your RBL, if I remember correctly, has some hedging requirements based on the amount of borrowings outstanding and the collateral value in a formula that's outlined in your footnotes, but Ryan does RBL's balance have an impact on how Evolution thinks about hedging?

No. I mean the company's still philosophy is to remain -- I wouldn't say largely unhedged, but we want to retain commodity price upside, right? That's a better way to say it. And so we're going to be required to hedge, as you noted, based on the borrowings outstanding, which we've already put hedges in place for and it's on a rolling 12-month basis. And we can -- we'll expect to do that as long as we have a certain level of borrowings outstanding. And honestly, we don't -- having some level of hedges to kind of protect against, as you mentioned [ happen ] borrowings, does make sense, but we still want to retain mostly upside on commodity prices.

Kelly, I guess, to wrap up our discussion today, I wanted to ask, how do you think about the Evolution's diversity in the asset base. Obviously, we talked about mature producing assets, which have made up a lot of what you -- what the company owns. And now the complementary nature of these organic growth opportunities in Chaveroo and the SCOOP/STACK area. And really, how do they support the Board's total shareholder return strategy?

Sure. Yes, I love the way you put that, Jeff. Evolution's diverse asset base of mature producing assets in our complementary organic growth opportunities. I mean because honestly, that's exactly how we see the 2 fitting together. Over the last few years, we have painstakingly created a portfolio of assets really designed to participate in any upward dislocation of pricing across multiple largely uncorrelated products and end markets, and some of the best producing areas of North America. Now with the addition of a new set of drilling locations, and they've got their higher returns and slightly higher risk CapEx profiles. We feel this will be a perfect use for a portion of our capital, just to ensure that our dividend machine will have plenty of fuel that it needs to keep producing free cash flow for the next many years. We size these opportunities such that they are going to overstress our ability to continue to pay dividends today. And in fact, we think they're going to meaningfully increase our capital available for use in future dividends, and other accretive opportunities. And the only other thing I want to add, Jeff, to make it clear. Look, just because we added these latest couple of transactions, by no means we're done. If the right opportunity to accretively add to our already robust portfolio arises, and we're here, we're ready to act in the best interest of our shareholders and move forward with those.

I think we'll leave it there for today. We've covered a lot of ground and a lot of detail on the most recent addition to the Evolution portfolio. So Kelly, thank you for your time. Ryan, Mark, I really appreciate you taking the time to join us today, and we hope to convene another fireside chat in the near future.

Perfect. Thanks, Jeff.

Thank you. Bye.