Franklin Mountain Energy, LLC (CTRA) Earnings Call Transcript & Summary

Good morning. My name is Brianna, and I will be your conference operator today. At this time, I'd like to welcome everyone to the conference call where Coterra announces the accretive Permian Basin acquisitions. Please note that this call is being recorded. [Operator Instructions] I will now turn the call over to Dan Guffey, VP of Finance, IR and Treasurer. Please go ahead.

Thank you, operator. Good morning, and thank you for joining Coterra Energy's discussion around its recently announced Permian Basin acquisitions. On the line today include Tom Jorden, Chairman, CEO and President; Shane Young, Executive Vice President and CFO; Blake Sirgo, Senior Vice President of Operations; and Michael DeShazer, Senior Vice President of Business Units. Following our prepared remarks, we will take your questions during our Q&A session. The press release and presentation for today's announcement can be found on our website. As a reminder, on today's call, we will make forward-looking statements regarding plans, forecasts, and estimates that are based on current expectations. These comments are subject to assumptions, risks, and uncertainties that could cause actual results to differ from the forward-looking statements. Additionally, some of our comments will reference non-GAAP financial measures. Forward-looking statements and other disclaimers as well as the reconciliations to the most directly comparable GAAP financial measures were provided in the press release and presentation. Additional relevant information can be found in our SEC filings. Today's call will be 30 minutes, so please limit yourself to one question. With that, I'll turn the call over to Tom.

Thank you, Dan, and welcome to all of you who are joining our call this morning. We are excited to announce the acquisition of 2 top-tier asset packages from Franklin Mountain Energy and Avant Natural Resources. To begin, I'd like to briefly discuss how these acquisitions announced this morning clear all 3 of the acquisition hurdles that we have previously discussed and allow us to leverage our expertise in the Delaware Basin, where we've been an operational leader since entering the basin in 2005. I will quickly hit on these 3 key attributes before turning to Q&A. First, this acquisition is accretive to our owners on key metrics, including cash flow, free cash flow, and net asset value per share. Importantly, the durability of the per share accretion and our go-forward net debt remains below 1x EBITDA at $55 oil and $2.50 natural gas. Furthermore, the strong capital efficiency on the acquired assets provides us the opportunity to hold the estimated fourth quarter '24 and '25 oil production flat for years to come with only a 50% reinvestment rate. With the addition of these assets, Coterra's pro forma oil production will increase by almost 50% to 160,000 barrels of oil per day in 2025, and our oil revenue mix increases by 5% to 10% to approximately 55% to 60% of expected revenue. Pro forma, our commodity mix remains diversified, while the increased oil weighting improves our margins and free cash flow generation. As we look into 2025 and beyond, we will remain disciplined and focused on capital efficiency. As such, we expect our total pro forma company reinvestment rate or capital as a percentage of cash flow to be approximately 50% based on the current commodity outlook, down from 60% in 2023 and 2024. Second, the acquired assets generate returns comparable to our overall Permian portfolio and compete for capital beginning day 1. We are coring up the Northern Delaware by adding 49,000 net acres that are adjacent to our existing acreage in New Mexico and creating a runway for capital-efficient development across this new focus area. The inventory contains 400 to 550 net locations targeting the Bone Spring, Harkey, Avalon and oily Lower Wolfcamp/Penn Shale. Importantly, we operate a high percentage of the locations, and there is a significant opportunity for acreage additions through trades, grassroot leasing and working interest increases. Third, on the operations front, Coterra will be able to leverage its operational excellence across this contiguous footprint with potential for row development and simul-frac. We will also be able to drive costs lower and create synergies with consistent activity as we develop multiple horizons across contiguous drilling spacing units, which will allow us to optimize the number of wells per pad and reduce facility and infrastructure costs. Furthermore, we are acquiring 125 miles of pipeline and infrastructure, which will enhance netbacks and economics, not only across the acquired assets, but also on our existing footprint and allow us to control our own destiny on this new focus area. These deals mark the first acquisition for Coterra since its formation just over 3 years ago. As we reflect over these past few years and over other opportunities we have evaluated, we have been consistent in our strategy and messaging that any acquisition would need to clear these 3 key hurdles. One, the acquired inventory must offer returns equivalent to our existing inventory and immediately compete for capital. As we have stated, we do not have an inventory problem to solve. Two, the acquisition must be financially accretive to our owners across all key metrics; and three, provide an opportunity to leverage our organizational strengths and operational excellence to enhance returns. At Coterra, we are interested in getting better, not just bigger. Ultimately, the bar has been and will remain high. These acquisitions hurdle it. The transactions we announced this morning bolster our strong Permian portfolio and better position us for future value creation. Our organization is excited to integrate these bolt-on acquisitions and hit the ground running. With that, we look forward to questions.

[Operator Instructions] Our first question today comes from Arun Jayaram with JPMorgan.

It looks like these deals fit your pistol going back to your conference call. But Tom, you highlighted $2.6 billion of [ PDP ] value at a 73 deck. So it looks like you're paying just under $3 million per undeveloped location using the midpoint of the 400 to 550 net well count. I was wondering if you could provide more details on what Coterra has underwritten at the low end of that net well location count versus the upper end and maybe some thoughts on the Lower Wolfcamp and Penn Shale.

Yes. I'm going to let Michael DeShazer handle that one.

Arun, yes, so what we evaluated in this area was Bone Spring, Wolfcamp, Avalon and Harkey. But the Penn Shale that you mentioned in the Lower Wolfcamp is an emerging play. So we do see a lot of opportunity in that as it continues to grow and expand. So that does represent the higher end of our -- of that net location count as if the Penn and Lower Wolfcamp continue to emerge and be as productive as we think they will be.

Our next question comes from the line of David Deckelbaum with TD Cowen.

I was curious, Tom, and congrats on the deal. As you expand the footprint in New Mexico, it looks like the margin on these assets is quite high relative to your own. Can you talk about some of the logistical outlook here, particularly around saltwater disposal and room for egress of water barrels as you look to increase activity here, which has certainly been sort of a choke point on the industry of late?

Yes, David, we certainly recognize the challenge, and we've been very successful at that elsewhere, and we think this large contiguous footprint gives us really latitude and room to solve some very complex problems. But I'm going to turn that over to Blake Sirgo for a little more detail.

Yes, David. The 2 assets already have a pretty great footprint going -- getting ahead of the SWD issue, including some infrastructure that we'll be inheriting with both disposal and transmission. In addition to that, our operated acreage in this area, we've been working a long time, and we understand the water position really well. And this is part of a greater strategy of how we'll ultimately deal with water in this area.

Our next question comes from the line of Nitin Kumar with Mizuho.

Congrats on getting the deal done. I wanted to talk a little bit about synergies and costs here. The way you've laid out the 2025 CapEx plan, it seems like you're not really including much synergies. You've had some success with row development in Culberson and with this more contiguous asset. Just curious if down the road, we could see an application which could help bring down costs here.

Yes, Nitin, this is Blake. I'll take that one. You are right. We're not stating any known cost reductions yet, but this is the reason we put this asset together. I mean we have a playbook for this. It's a large contiguous position in the Delaware Basin. We own and control it. We'll be leveraging our marketing and midstream portfolio across the whole thing. We'll be centralizing our ops. We'll be running consistent operations. We'll be looking to put pads together that can support simul-frac and even potentially row development. It's a lot of work to do before we can start quoting cost savings on the asset, but we have a playbook for this. And if you look at Culberson County, which is kind of the epitome of getting to take advantage of every single one of these efficiencies, we ultimately drove 15% of the cost out of it. I don't know if we'll get that far here, but we're sure going to try.

Our next question comes from the line of Doug Leggate with Wolfe Research.

Tom, you never ceased to surprise us, and congratulations on bolting on what looks like a great asset. My question is really more of a clarification on your comments. You said that you could hold the oil production flat. I'm looking at the cadence of your prospective capital. We've all been discussing what the next 3 years look like for Coterra. And I guess my question is, what is the messaging this morning on the production cadence for the combined company now? Are you intending to hold the production flat to the oil production flat? In which case, can you give us a kind of an inventory depth at the low end of that 400 to 550 range? How many years of backlog is that, if you like? So I guess there's a part A and a part B in there.

Well, Doug, thank you for that question. We will be updating our 3-year guide when we release in February. But I think the philosophy that you've seen in our past 3-year guides that we released over the last couple of years, we don't see this doing anything other than making our next 3-year guide, as we've said, bigger and better. I think you'll see a consistent approach out of us with really trying to get the maximum productivity out of our assets. And we can hold with these acquired assets. What we said is absolutely true with a 50% reinvestment rate as a stand-alone, we can hold production flat on these acquired assets at fourth quarter run rate for a better part of a decade. So this really will add productively to our updated 3-year outlook. And I think you will see us come forward with one that's robust and durable.

Our next question comes from the line of Neil Mehta with Goldman Sachs.

Congrats, Tom and team. I just had a question about the mix of the business. With this deal, I think more than 50% of the revenue will now come from the oil side of the business. So Tom, as you thought about -- as you think about doing incremental M&A on the gas side versus the oil side, can you talk about how you weigh the 2? And was this an intentional balancing of the portfolio from a product mix perspective as well?

Well, we've been asked and answered several times over the last couple of years that what would we prefer to look at oil or gas. And what we've said consistently is all else being equal, we'd like to balance our oil a little bit. And that's the beauty of this transaction we've announced this morning, all else was equal in that these were outstanding returns, and it gave us the opportunity to bolster our oil a little bit without sacrificing a return profile on our inventory at all. Now we still believe in the balanced commodity mix. I don't want to dissuade anybody from that. I mean we are very constructive on natural gas. We have tremendous natural gas assets and remain poised to strike when we see recovery in the gas markets. We are deeply interested in watching that situation very carefully. Coterra from a return standpoint, revenue standpoint, and opportunity standpoint, retains tremendous optionality around natural gas. And no doors are closed in the future. We remain flexible. We have the balance sheet to do it and the organization to really strike where opportunity takes us.

Our next question comes from the line of Neal Dingmann with Truist Securities.

Congrats, Tom. I've got a strategic question. I'm just wondering, what definitely seems like this morning's deal, as you mentioned, checks all the sorts of requirement boxes you and the team have. My question is, I guess, maybe not instead of, but in addition to this, I'm just wondering, have you all considered or did you all consider in front of this maybe potentially looking at a public company instead of these assets? Why I ask it seems like some of these publicly traded companies that have a fair amount of Permian assets trade almost equally as cheap as this deal today. So I'm just wondering when you ran comparisons, how this deal compared to maybe some of the public assets.

Yes, I'm going to let Shane handle that one.

Yes. Neal, listen, what I would say is as we evaluated this and we stood it up on a combined basis and looked at the profile, what it brought to Coterra, and what the opportunity to invest capital that can compete with our inventory day 1 is we looked at it and we made the observation that if this were a public company, this would be our #1 target on the Board. And we would be all in going after it. So look, we think this is the best thing that was available in the market, and we couldn't be more excited to have it in the portfolio.

Our next question comes from the line of Josh Silverstein with UBS.

I was just curious on the return on capital profile. You guys have been well above the 50% mark for a little while now. Do you think you drive down closer towards that 50% level for the time being just to delever? And maybe what's the long-term number that you want to hold now?

Yes. Josh, thank you for the question. Look, I'd say as we look at our return of capital framework, we're going to continue to be consistent with the framework that we've had for a while now. You're absolutely right. Year-to-date, we've returned roughly 100% of free cash flow to shareholders through the mix of a healthy base dividend and an active share repurchase program. But our commitment is to return 50% plus of our free cash flow over any annualized period, and we'll continue to do that. We have -- and then our second commitment is as we look at our base dividend to try to be consistent in our cadence of annual increases in that. And frankly, this transaction only supports that due to the accretive nature of it. Deleveraging is a priority. We are committed to reducing the pro forma leverage profile by at least $1 billion over the next several years. So some portion above that 50% will get allocated to the balance sheet and deleveraging and getting us back to, as we like to say, getting back to home from a credit profile standpoint.

Our next question comes from the line of Roger Read with Wells Fargo.

Congrats on the deal here. I just had one question, and this kind of gets to the guidance, the $70 oil, $3 gas, gas in West Texas has been discounted relative to everything else. So I was just wondering in terms of the sensitivity to a lower price? Or is there anything you're putting in the structure of this transaction or adding in the way of hedges to kind of narrow that gap between Waha and Henry Hub?

Yes. Thanks, Roger. Shane here. So I'll tell you, those prices, both the 70 and the 3 are index-level prices, WTI and Henry Hub, respectively. So we have put in the appropriate deducts on the gas side that reflect the market today. Obviously, gas, like you say, Waha has been tough. That's very dynamic [ blanks ] in the room. Our marketing team does a very good job of sort of managing that risk and exposure over time. We'll continue to do that for the combined portfolio going forward. As it relates to hedging, we look at hedging on a corporate basis. We've been consistent saying we want to be in that 25% to 50% for the next 12-month period. And on a pro forma basis today, we're probably roughly 45% for 2025. So we feel like we're very well hedged and very well prepared for the market next year.

Yes, I might add to that. These assets we're adding today are very heavily oil weighted. And as you see in our appendix, we have added some incremental oil hedges in '25 and '26 to just put a nice solid foundational floor underneath us as we move forward.

Our next question comes from the line of Kalei Akamine with Bank of America.

I'd like to better understand the acquired location count. You guys call out 400 to 550 locations. Can you kind of bridge that with how Dave talked about their disclosure? For example, Avant discloses greater than 300 future horizontal wells?

Well, the -- of course, there's buyer and seller numbers. The numbers we've put together and released this morning are for the combined transaction. I will tell you that we find those numbers to be conservative as I think that you would expect out of us. We think there's tremendous upside on that number we've released. Without commenting on either individual companies' analysis nor bank analysis, I'll just say we are very confident and prepared to stand behind the numbers that we announced this morning. Those are also net locations. And as we said, we think there's a fair amount of upside to increase our interest in a lot of these portfolios. So we'll stand behind the numbers we've announced this morning.

Our next question comes from the line of Harry Mateer with Barclays.

Coterra formally guided to around $2 billion of debt as a comfortable target for the company. And based on your comment about paying down $1 billion, that would imply roughly $3.5 billion of debt as the new target. Is that the right way to think about it? And how does that factor into your decisions about the debt financing mix between bonds and term loans to have some prepayable debt?

Yes. you've hit on it. Look, we look at the aggregate amount of leverage, but I think sometimes more importantly, we look at what is that leverage relative to the size of the company. So again, you can look at a lot of different ways, but one that we look at it is net debt to EBITDA and trying to get back to that sort of low decimal leverage level. And we're looking at this deal and potential for repayment the same way. So as the company gets bigger, that $2 billion can go up a tad. So -- so I would look at that. As it relates to the mix of the financing in that, we haven't come out with a specific mix yet, but I will tell you, it will allow us to pay down at least $1 billion, probably more over the next several years. And so -- but we're still trying to fine-tune and lock in on an exact mix of term loan and bond.

No, that's a great question. And we have a lot of good debates internally on that. And I think a number of you have heard me say that in a cyclic commodity business, I would say I've never lost a moment to sleep worrying about our debt being too low. And we'll -- I think you're going to see us be conservatively -- have a conservative balance sheet through in, throughout.

Our next question comes from the line of Paul Cheng with Scotiabank.

Tom, can you share with us that what percent of your legacy Permian production and that number of wells that you -- this year you're drilling is in the Lea County? And also that out that the combined pro forma, is there any opportunity that to lengthen the lateral? I mean, 9,500 is not short, but Permian as an average today is over 10,000. So is there any opportunity that to make more of the 3-mile well because of this acquisition?

Well, I'll tee it up and then hand it off to Michael. We'll announce our capital in February. So we're not prepared to give county-by-county allocation. We're still working on that. But obviously, any incremental capital that we're putting forward is going to be on these assets, which are in Lea County as a result of this transaction. But as far as lateral length, Michael, do you want to say anything?

Yes. So we've announced the 9,500 feet. That's what we see on the current asset that's configured. Obviously, our teams are always working hard with trades and reconfiguring drilling and spacing units to get the longest lateral lengths that we think we can achieve. So our operation team is excited to jump into this area and begin to work these assets. And I'm confident that we'll be able to lengthen some of the 1-mile tracks that are in this portfolio into 2 milers through trades as we normally do.

I'm just going to say it's a testament to our industry and the amazing innovation that we're getting a question of why are you only at 9,500-foot lateral length? I still remember when 1,500 feet was a challenge, but thank you for that question. We're going to push it.

Our next question comes from the line of Kevin MacCurdy with Pickering Energy.

Just a clarification, not a question for me. What are you guys expecting for the legacy Coterra 2025 program on CapEx and oil production? And has that changed at all? It looks like you changed some of the language in the presentation that 5% to 10% oil growth from 5% plus previously.

Well, we haven't announced our 2025 plan. But if you look at Slide 7 or Page 7 in our deck, we did break this -- our '25 soft guide up to show that we do show a little bit of oil growth with about $1.8 billion on legacy Coterra assets. And we did that deliberately so that everybody understands that I think that this acquisition makes us better. We're doing this because we like these assets. We like the opportunity and we like what we can do with it. We're not trying to plug a hole in inventory or production. It gives us more oil and less capital.

Our next question comes from the line of Leo Mariani with ROTH Capital Partners.

I wanted to dive into a couple of the kinds of numbers here. I wanted to see if you guys could comment. Is there any incremental G&A coming from this? I'm assuming not really. What's the impact of LOE? Do these assets have a little higher LOE than what you normally have in the Permian, so maybe that ticks up a little bit? And then are you expecting any cash tax shield at all from the deal? You guys have been kind of a full-cash taxpayer, but maybe this shields some of that.

Yes, Leo, this is Blake. I'll take the first one. We're not really expecting a lot of incremental G&A out of this. These are asset deals. That's one of the reasons we like them. As far as LOE, we already have quite a bit in New Mexico production, and these fit in really nicely from an LOE standpoint. And then I'll turn it over to Shane to talk cash taxes.

Yes. And I'd just highlight due to the oily mix here. I mean these are high-margin assets and will be accretive to the overall corporate margin as we move forward. On a tax basis, yes, we expect to get a full step-up on both sets of transactions that are being done here. So it will add a significant amount of tax basis to Coterra on a corporate level on a go forward.

We have no further questions at this time. I will now turn the call back to Tom Jorden for any closing comments.

Well, thank you, everybody, for joining us. Obviously, I think you can hear in our voices, we're very excited about this acquisition. We think it fits everything we've been looking for. And we really do look forward to delivering better and stronger results out of an enhanced Coterra. But thank you very much for your time this morning.

This concludes today's conference call. Thank you for your participation. You may now disconnect.