Hess Midstream LP (HESM) Earnings Call Transcript & Summary

Good day, ladies and gentlemen, and welcome to the Hess Midstream Investor Update call. My name is Kevin, and I'll be your operator for today's call. [Operator Instructions] Please be advised, today's conference is being recorded for replay purposes. I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

Thank you, Kevin. Good morning, everyone, and thank you for participating in our investor call to discuss our definitive agreement with Chevron to establish Hess Midstream as an independent multi-basin midstream company. Our press release announcing the transaction was issued yesterday and appears on our website, www.hessmidstream.com. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements. These risks include those set forth in the Risk Factors section of Hess Midstream's filings with the SEC. Also on today's conference call, we may discuss certain GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the press release. With me today are Jonathan Stein, Chief Executive Officer; and Mike Chadwick, Chief Financial Officer. I'll now turn the call over to Jonathan Stein.

Thank you, Jennifer. Good morning, and welcome to the Hess Midstream Investor Update Conference Call to discuss the transaction that we announced yesterday. I'm going to review the transaction and our go-forward business strategy, and then Mike will discuss the finance strategy going forward and provide initial guidance. There is also a presentation on the website to be viewed alongside our call comments. Starting with Slide 3 of the presentation. We are excited to announce today entry into a definitive agreement for a significant transformative transaction that will create a new independent multi-basin midstream company with leading positions in the Bakken and the DJ Basin. For Hess Midstream, we are now well positioned for the long term with Chevron as an anchor customer and a solid foundation for independent growth while maintaining shareholder returns. Looking at the elements of the transaction, Hess Midstream has agreed with Chevron to simplify our Bakken commercial agreements to support ongoing investment. This includes reducing our rates for 2027 through 2033 while extending the contract to 2045 and replacing multiple volume-based MVCs with a single basin-wide minimum revenue commitment, or MRC, that allows for more flexibility in volume levels while continuing to provide our hallmark downside protection. The MRC will be established 3 years in advance. And once the MRC is established for a given year, it can only be increased and not decreased based on updated annual development plans provided by Chevron. MRCs from 2027 through 2029 have been established on a 2-rig program. All of our fees will now be on a fixed fee basis and continue to have inflation escalators. In addition, Hess Midstream will pay Chevron $200 million at closing, which we expect to fund from our revolver. In exchange for the Bakken commercial agreement simplification and cash payment, we will be acquiring DJ Basin midstream assets from Chevron as well as 100% of Chevron's ownership in HESM, including the general partner. The DJ Basin midstream assets include crude oil gathering and storage assets, gas and water gathering systems, 100% of the Black Diamond Gathering system and 20% of the long-haul interstate Saddlehorn pipeline. In terms of Chevron's ownership in Hess Midstream, this represents a complete exit by Chevron from Hess Midstream and will significantly reduce the total unit share count by approximately 40%, reducing total distributions and supporting transaction accretion on an adjusted EBITDA per share basis. With the complete exit of Chevron and acquisition of the general partner, Hess Midstream will transition to a completely independent midstream company owned 100% by the public. I am excited to continue as CEO of this new independent company. I will be joining the Board of Directors, with the initial size of the Board set to 7 members, including myself. The 3 current independent directors will remain on the Board. And John P. Reddy, one of these independent directors, will become Chairman of the Board. We will begin the search for the remaining 3 directors as soon as possible, and directors will be elected by the public starting in 2028. In addition, both Hess Midstream and Chevron are aligned during this transaction through multiyear shared services agreement that support the establishment of an independent organization while allowing us to maintain safe and reliable operations. Turning to Slide 4. After this transaction, we will have created an independent multi-basin midstream company that is well positioned for growth and returns. The addition of the DJ Basin assets will significantly diversify and increase the footprint of our business, approximately tripling our crude gathering throughput and grow our gas gathering throughput by more than 30% while also broadening our asset base with ownership participation in a long-haul crude pipeline. Our volumes are underpinned by long-term Chevron production plateaus in both the Bakken and the DJ and will continue to be backed by strong commercial contracts with Chevron that now extend through 2045 and a 100% fee-based with inflation escalators. In addition, primarily through our new MRCs in the Bakken and Chevron ship-or-pay commitments on long-haul pipelines in the DJ, approximately 70% of our revenue is downside protected. With Chevron as our anchor customer in both the Bakken and the addition of the DJ Basin assets that include significant third parties, our third-party volumes will increase to approximately 20% of total volumes. Most importantly, leveraging the stable volume platform, we have the ability to focus on accretive growth opportunities which we plan to prioritize as part of our go-forward capital allocation priorities. We will continue to maintain a solid financial foundation with an expected 75% adjusted EBITDA margin and low ongoing capital requirements that support our volumes and drive sector-leading free cash flow conversion. With this free cash flow generation, we will continue to target distribution growth of 5% per Class A share on an annual basis through the fourth quarter of 2026 and expect our 2027 distribution to be maintained at that level, representing an approximate 2% annual distribution per growth rate that is fully funded by our adjusted free cash flow. Looking forward, we expect to have the ability to continue to fully fund distribution at that level, remain free cash flow positive after distributions and maintain leverage in the range of 3.5x in to 3.75x adjusted EBITDA on a long-term basis. Turning to Slide 5. Following the transaction, Hess Midstream will have a sector-leading gathering platform and adjusted free cash flow conversion. We will gather Chevron's second largest production platform, and we expect to be the largest gathering platform in the [ Rockies ] by volumes gathered, providing scale and efficiencies to compete effectively for new third-party business. And we expect to maintain our sector-leading adjusted free cash flow conversion. With an established asset base and significant historical investment, we expect to have one of the lowest reinvestment rates in the sector with low ongoing required capital needs. Turning to Slide 6. With the addition of the DJ Basin platform, we will own the largest crude gathering system in the basin, operating a unique and irreplaceable system that gathers almost 100% of Chevron's DJ Basin oil gathering volumes. This platform provides a stable cash flow base and a growth platform to capture nearby opportunities with minimal capital investment from a dominant position. The 2 gathering systems, including the Black Diamond Gathering system, have approximately 400,000 barrels a day of [ 2,000 ] throughput capacity, 300 million cubic feet per day of natural gas gathering capacity and 2 terminals with a total of 420,000 barrels of storage capacity. These systems are competitively advantaged and have direct connectivity to every major pipeline in the DJ Basin, including Saddlehorn, White Cliffs, Grand Mesa and Pony Express. Turning to Slide 7. In addition to these gathering systems, Hess Midstream will also own a 20% equity stake in the Saddlehorn pipeline, which is the largest crude oil pipeline out of the DJ Basin, connecting Colorado to the Cushing storage hub in Oklahoma. The addition of long-haul pipeline ownership to Hess Midstream extends our participation in the midstream value chain and provides an additional source of stable and predictable cash flows supported by ship-or-pay commitment. Turning to Slide 8. The Bakken remains our historical base, where we have a high-quality integrated portfolio with meaningful scale. Chevron intends to move from 3 to 2 rigs this December. For Hess Midstream, we now expect volume -- Bakken volumes to decline by approximately 5% through 2027 before plateauing in 2028. Our midstream assets remain best-in-class in the Bakken with an integrated platform of 500 million cubic feet per day of gas processing capacity, approximately 500,000 barrels a day of crude oil [ terminaling ] capacity, approximately 700 million cubic feet per day of gas gathering pipeline capacity and approximately 300,000 barrels a day of crude oil gathering capacity. Putting it all together, this significant and transformative transaction creates a unique multi-basin midstream company with a long-term platform supported by Chevron as an anchor customer and a solid foundation for accretive growth and ongoing shareholder returns. With that, I'll turn the call over to Mike to talk about our financial strategy and guidance.

Thanks, Jonathan. I will go over the transactions as well as our preliminary guidance. As Jonathan said, we are excited to deliver a transformative transaction to our shareholders that we expect to position Hess Midstream for strong performance in the future. Starting on Slide 9. While Hess Midstream will transform into a new multi-basin company, we will also retain our hallmark downside protection, and we expect our contract terms, combined with enhanced duration, a fixed fee structure and acreage dedications in the DJ Basin to provide long-term throughput visibility for Hess Midstream. The fee structure for all assets will continue to be fixed with inflationary protection. In the Bakken, minimum commitments have been set on a revenue basis on a 2-rig program through the end of 2029. They will continue to be set at 80% on a 3-year rolling basis, and once established for any year, cannot be decreased for that year in the future. All currently in place cost of service contracts in the Bakken will be converted to this fixed fee structure. In the DJ Basin, Chevron has ship-or-pay commitments mainly through the Saddlehorn pipeline. Overall, post transaction, approximately 70% of our total revenue has significant downside protection. In terms of throughput and visibility, Chevron will remain our anchor customer, and we will handle approximately 100% of Chevron's Bakken and DJ Basin crude gathering volumes. Turning to Slide 10. In terms of our financial policy, we have updated our capital allocation priorities to reflect our new independent status following closing of the transaction. First, we expect to grow our distribution at a targeted 5% rate through the fourth quarter of 2026 distribution, which will result in approximately 7% growth year-over-year in 2026, followed by approximately 2% growth in 2027. We plan to maintain the distribution at Q4 2026 levels in 2027 and expect to maintain that level while remaining free cash flow positive going forward. Second, from our larger operational base, we plan to pursue accretive growth opportunities, which includes capturing additional third-party volumes as well as potential M&A opportunities. Third, we expect to maintain our balance sheet strength and are targeting long-term leverage in the range of 3.5x to 3.75x adjusted EBITDA, which is within the boundaries of our peer set. And fourth, we will assess incremental shareholder returns, including distribution increases and/or share repurchases. Turning to Slide 11. We have issued preliminary 2027 guidance, which refers to ongoing baseline adjusted EBITDA of $900 million at the midpoint. This guidance includes an estimate of the net incremental revenue related to the contract liability associated with our new Bakken commercial agreements. We anticipate spending $125 million in the Bakken and DJ Basins, which consists of approximately $75 million in the Bakken, which includes the scheduled turnaround at Tioga Gas Plant and $50 million in the DJ. We expect to continue to have sector-leading adjusted free cash flow conversion with a 75% gross adjusted EBITDA margin, leveraging significant historical investment in both basins and low ongoing capital needs. This strong financial basis should provide flexibility and position us well for future growth. We plan to issue updated 2027 guidance after the expected closing of the transaction at the end of the year, and updated 2026 fiscal guidance can be found in the appendix to this presentation. Again, we are excited to deliver a transformative transaction to Hess Midstream holders and look forward to becoming a multi-basin independent midstream company with a long-term platform supported by Chevron as an anchor customer and a solid foundation for accretive growth and ongoing shareholder returns. With that, I'll hand the call back over to the operator to open the line for questions.

[Operator Instructions] Our first question comes from [ Ben Lund ] with Goldman Sachs.

Maybe just starting on the 2027 guide, you're pointing to the midpoint of $900 million and with the contract liability included in there. First, can you maybe help us frame up roughly how much of that $900 million is cash versus noncash recognition of -- from that contract liability? And then maybe second, maybe frame up what the DJ opportunity looks like in 2027 and maybe longer term?

Thanks, Ben. I'll tackle the first part of your question, and then I'll hand it over to Jonathan to tackle the second part. And let me just walk you through some of that accounting on the noncash piece. So GAAP accounting rules for contract modifications like ours require that the substantial consideration for the transaction be recorded as a deferred revenue liability on the balance sheet. And that will amortize to income over the contract term, which is about 19 years, to 2045. So revenue from the new Bakken fixed system reservation fees will also be treated for GAAP purposes the same way. They were negotiated as part of the same overall transaction. The net of these movements on these deferred revenue adjustments to EBITDA, they substantially offset each other, such that the net impact to 2027 EBITDA is expected to be relatively small. So this required accounting for deferred revenue does not affect the cash we expect to receive, and we expect adjusted free cash flow to not include the impact of deferred revenue accounting adjustments. So if you work back from the midpoint of our adjusted free cash flow guidance of $575 million, with about $125 million of CapEx, interest costs similar to 2026 based on flat debt and with no material cash taxes, it brings you back to the midpoint of our adjusted EBITDA guidance range. I'd like to just stress that even if we removed the cash from fixed system reservation fees, our adjusted free cash flow is sufficient to fund our distribution for the foreseeable future. I hope that helps clarify how the noncash portion of that deferred revenue adjustment found its way into EBITDA. We're not expecting it to have a material impact in 2027 because the way and the direction of the contracts offset each other. I'll hand it over to Jonathan to answer your second part of the question.

Thanks for the question. I mean, in terms of the DJ, we're super excited to be adding that to our portfolio. As I talked about in my comments, it really diversifies our platform. It's a platform that Chevron themselves has continued to grow their position over time through successive acquisitions. Like all the basins in the Chevron portfolio, they continue to improve their economics as they have -- bring new technologies and efficiencies and things like longer laterals that drive down breakeven. So really, with all those improvements, we're really looking at a long-term plateau that underpins our volumes from Chevron. And at the same time, the DJ Basin itself is really well positioned for third parties. It includes, as I mentioned in my comments, already includes significant third-party volumes. That results in an increase in our total third-party volumes to about 20% of our volumes going forward. Similar to the Bakken, where we have significant optionality there as well, the system is largely built out in terms of the asset base. So that allow us to continue to competitively bid on third-party opportunities. And combined with, as I mentioned, the connectivity that we have to every long-haul pipeline, we expect to be strongly positioned to win new third-party businesses there. And look, I think it's important to say that like now as an independent company, we really have just -- the DJ in itself really summarizes, I think, one of the really unique elements now of our business model going forward and really makes it a differentiated business model, which is that our -- we have base volumes supported by Chevron as our anchor customer with low ongoing CapEx, support significant free cash flow generation, as Mike said, even after distribution and taking away free capital after dilutions will fully fund our distributions going forward for really the foreseeable future. And that means that we have like a sponsor level [ customer in ]. But at the same time now as an independent company, we have the independence to prioritize the capital allocation for growth opportunities and pursue third parties in a disciplined way.

Awesome. That's all clear. Maybe if I can just ask one more on the distribution. You mentioned you're expecting to grow 5% annualized through the back half of this year and then holding flat through '27. I guess, I'd just be curious on what has to happen for growth to resume on the distribution. Is that a certain leverage level you want to get to or a coverage ratio you look at? Or is that kind of a longer-term strategic decision to keep it flat?

Yes. Thanks, Ben. I'll tackle that, and it's really driven by our new financial priority and those -- that hierarchy of priorities. As we think through it, we're going to be sustaining that distribution at the Q4 '26 levels. and that will be funded, as we say, out of adjusted free cash flow for the foreseeable future. So that's priority number one. And then after that, we'll look to grow, and we'll do that in a disciplined, accretive manner. And thirdly, we'll try and maintain our balance sheet strength and focus on keeping within that target range of 3.5x to 3.75x leverage. And so those are the first 3 priorities. And then fourthly, out of any remaining adjusted free cash flow after distributions, we'll look to evaluate whether we want to do shareholder returns, and that might take the form of increases to the distribution or additional buybacks. But it will be in that order of priorities that we focus on how we allocate the surplus capital.

[Operator Instructions] Our next question comes from Doug Irwin with Citi.

Maybe just one follow-up on the kind of cash versus noncash piece of the contract structure. Understand kind of your commentary around '27, but just to be clear, I guess, can you talk to kind of how that cash versus noncash dynamic might shift over time? Just essentially wondering if there's the potential for an inflection at some point in the future that could more materially impact the free cash flow outlook?

Yes. No, thanks for the question, Doug. And yes, I think in the long term, we really look towards the adjusted free cash flow as being sufficient really to fund the distribution just on its own. So there is a system fee -- reservation fees in there and they do enhance our EBITDA and cash flow, but the accounting would require that, that offsets against the long-term contract nature. And that's really what we're seeing going on against in 2027 as they really do offset each other. But on the long-term basis, we're very comfortable that our adjusted free cash flow is sufficient on its own to fund distributions. And adjusted free cash flow as well going forward, it won't include the net impact of any noncash accounting deferred revenue adjustments that we make. We'll be taking those out. And so on a cash basis, we're in a good position. We expect to have -- in our midpoint of our guidance for 2027, we have about $160 million of adjusted free cash flow after distributions. And so we feel comfortable that, that cash position is really what is going to be able to shore up our distributions going forward.

Doug, this is Jonathan. Just as a [ parley ] because I know this is a question coming up. Just for clarity, the free cash flow after distribution that we have more than exceeds any fixed system reservation fees that are in our model. So on a go-forward basis, with or without those, we're able to fully fund our distribution from free cash flow for the foreseeable future.

Okay. Understood. And maybe a follow-up on leverage, if I just kind of do some math on '27, I'm getting right around 4x, which is maybe the high end of what you talked about. Just curious, kind of how quickly you anticipate being able to get back down to that 3.5x to 3.75x long-term target? And more generally, kind of what's your path to getting there? Is it tied to being able to win some third-party volumes and grow EBITDA? Or is it going to be more tied to paying down debt with some excess free cash flow?

Yes. Thanks, Doug. And the key thing here as well as observe is that the leverage increase is not due to increases in debt. Our debt level is expected to remain relatively flat to 2026. And we're going to be incrementally cash flow positive after distributions, and that will help bring down the debt level that we have going into 2027. I'm sure there is a range around the EBITDA and there is a range around our guidance, and that's why we've gone with a pretty wide guidance range on our leverage from 2027 of 3.75x to 4x. But we expect to try and get down to the 3.5x to 3.75x in the long range, and we'll use the surplus adjusted free cash flow after distributions in order to get there. We do not anticipate leveraging up further. But obviously, all of that is subject to the appropriate and disciplined look at growth. And that may cause us to temporarily change our view on the leverage, but we would aim to nonetheless get down to the 3.5x to 3.7x long-term guidance.