Permian Resources Corporation (PR) Earnings Call Transcript & Summary

Hello, this is Scott Hanold from RBC Capital Markets, and thank you, everybody, for attending the 2021 Global -- RBC Global Energy and Power Conference. This session is with Centennial Resources. And presenting we have Sean Smith, the CEO. Sean, thank you for attending and certainly glad to have you here.

I appreciate it. Thanks for the invitation, Scott and look forward to a productive chat, what's in a much more exciting market than we've had in the last over 6 months or so. So look forward to chatting with you.

Yes. And maybe that's a great place to start, because look, Sean, as you said, things are definitely different than they were a year ago. And how do you think about the business differently last year to this year? And it's not only from obviously -- we know thing -- you act and react differently when oil is sub-40 versus teetering to $70. But look like strategically going forward, has there been a change of perception of like what Centennial's core strategy is?

Sure. Yes. I think 2020 was a year of all companies kind of doing some self-reflection on what it takes to survive in a world where commodity prices are sub-40 as you put it. And I think we did -- Centennial did the same and the fact that we pulled back our capital spend and really did a lot of working on efficiencies and things like that, whether it's operations or capital spend or things like that. I think we did an outstanding job focusing on cost efficiencies across the board. As we exited 2020 and got into 2021 and we started to see a little bit of improvement in commodity prices, we started to pivot back towards a little bit of activity, because it could support it. The efficiencies that our team has really put forth in both on the -- again, the OpEx side and the capital side have allowed us to be cash flow positive in a much lower commodity price than we are today. I think what we've talked about in our previous earnings call was that even sub-$45, we're generating free cash flow with 2 rigs. And so I think that's a great place to be. Obviously, we're a long way from that today. And now we're generating meaningful cash flow. Where at the beginning of the year, we thought we'd be positive free cash flow for the year. That was our goal. Now we're talking in excess of well over $100 million of free cash flow for the year, which is -- I see quite a bit of a change from where we were early on. User proceeds is to delever the company that has always been our goal is to delever the business starting last year and into this year and into next as well. I think early in the year, we talked about being sub 2.5x as a goal. I look at our business now, we're going to be much closer to 2x year-end than 2.5 that we announced earlier. So very pleased with, again, both on the cost side as well as, of course, commodity prices being supported as well.

So as you think about that leverage target, obviously, you want to be around 2x and now it's -- your clear path to getting below that. Is there a -- as you step back and you have a conversation with your team, is there a goal to maybe even be even lower? Is 2x, yes, it's great, but 1.5 or 1x is maybe even a bit better. Is there sustainably a different leverage target you all have now or you still think 2 is sort of that right long-term target for you all?

Yes. To be clear, I do not think the 2 is the right leverage for any company out there, honestly, in the world we live in today. That's just for our year-end 2021. Our goal is sub 1x. I think that's the right place for our company to be and, honestly, for a lot of the industry to be. And I think we've got line of sight on that in 2023. I think we'll be sub 1.5x in 2022. And with line of sight on being 1x or below in 2023, so that's where we're headed. That's where I feel comfortable for the company. I think that's how we generate the most value for our shareholders is getting to those levels.

And then the part of the process, obviously, to get there is commodity prices. The other part of it is going to be what your relative activity levels are. And as you stated, you got back to work this year with a lower cost structure, better commodity prices. Like again, oil is teetering at $70, like what is -- where is your mindset right now? What's the appropriate rig count over the balance of this year? And honestly, looking into next year if these prices kind of hold?

Right. Yes. So I think it's pretty clear for us that we're going to keep our 2 rigs steady for this year. That being said, there have been times where it's been at 3 and then we've been at 1. But 2 for the balance of the year is appropriate that keeps us in that maintenance kind of mode, maintenance being from Q4 levels of production. I think that's kind of how everybody is talking about maintenance levels. So I think that puts us kind of near the midpoint-ish of our released guidance from a production point of view. That's appropriate for us that allows us to get to the leverage targets that I mentioned before. As you look into 2022, we haven't given any forward-looking guidance, but I think that the increase in commodity prices does not overly motivate me to increase rig count to try to grow production. The world is still not currently needing excess barrels, and we plan to take advantage, if you will, of the higher commodity prices to increase our free cash flow and use of proceeds to pay down debt. So don't look to put additional dollars into the ground, utilize those excess dollars to pay down our debt.

What is that signal, in your opinion, that the world needs more activity and growth, right? And I think that's the key question, right? You've got the commodity price signal, like that's clear right now. But what's the market signal? Because at some point, it may make sense to add a third rig. What are you specifically looking for?

Right. I agree with you that in some way that you are going to need it, the world will need it, and it's going to hit different companies at different times, I think. But the way I think about it is the excess barrels that OPEC has still off the market. We're somewhere around 5 million barrels, plus or minus, depending on how you think about Iran and how many of those barrels are probably on the market or not in today's world. But let's just say 5 million barrels is being held off the market to help control prices a bit. And so until all those barrels are back -- or nearly all those barrels are back in the market, I think E&P producers in general, ought to be conservative with how they think about growth. As those barrels get put back on the market, which my guess is over the next 6 to 9 months, if those are all properly absorbed by the demand side of the equation, I think at that point in time, the E&P sector in general, and certainly we'll be one of those, we'll look to see how we can impact the needed supply side of things and put additional barrels on the market.

Understood. And as you think about different types of strategy, I mean, the other thing is to think about consolidation. And there's certainly been a lot of consolidation in the industry over the last 12 to 18 months. Last year, it felt more of large corporate consolidation. This year, it feels like it's morphed into more asset-based deals, private companies. When you step back, what -- when we think about like Centennial, where do you all fit into that consolidation conversation? And part of the discussion is what's the right scale for Centennial? How do you get there inorganically and organically?

Yes. So that's a deep question, I would say, Scott. We -- I have said over the previous 2 quarters, I am a believer in size and scale overall. I don't think it's right to grow just to grow. It's got to be accretive to any particular company, and that's certainly how we look at it. So I am -- we are, as a company, looking for opportunities, and we'll continue to do so and attempt to increase the size and scale of the company. I think it's a good way to take out costs and to lower our overall -- eventually your cost of capital is better as a larger entity and your corporate costs can be lower as well. So I think there's some real opportunities there for larger companies that smaller companies struggle to realize. And so we're looking to do that. That being said, it has to be accretive to what we have. And it's interesting as you go through the opportunities that are out there, both public, private or even at just acquiring assets, and we're very particular about what we want to add because of the rock quality that we have is pretty outstanding. And the inventory that we have in high-quality rock is, again, we've talked about 15-plus years of quality inventory at much lower commodity prices than what we're seeing today. So we've got high-quality inventory that we don't want to dilute with just bringing on somebody else to gain size and scale. I don't think that's proper. I don't think that's value add for our shareholders. So we're very selective about those opportunities. And then once we identify the proper opportunities, the price has to be right. So you've got to make sure that it's accretive to all your financial metrics as well as all your inventory says that it can beat for capital. So we are looking for opportunities right now. We'll be active in anything that hits the market that we think could be accretive to our shareholders. But I'm not going to be so aggressive that we're going to give the company away just to double our size. So we'll be very prudent on how we do that. On the flip side of that coin, the next question is, okay, well, that's you as a consolidator or what about a consolidatee. That's the follow-up question that is often asked. And again, I think that we're an interesting company that provides a lot of things to some select firms out there that would be interesting. I am not out there raising the flag saying, hey, we're for sale, come buy us. That's not a motivator to me. I think we have a lot of opportunity to generate value for our shareholders organically. If we were to get a phone call one day and it seems like it makes sense, ultimately, it's not up to me, it's up to the Board and the shareholders, but we will take those things seriously. And if we think that there is an opportunity for our shareholders to gain value through a large organization, we would consider.

Yes. And in the whole discussion about scale and consolidation, is there at all any kind of concern that if you are too stringent and look, let's be honest, there's been a lot of transactions, a lot of small companies getting a lot larger. A lot of big companies getting a lot bigger. Is there ever any concern that it's the fear of being left out? You're a little bit too stringent. You don't get any deals across place and you lose market and just as important, investor relevance as a public company.

Sure. And that's discussed from time to time, and we want to make sure that we are at least looking at that as a potential issue. I think the flip side of that is there's scarcity value around opportunities like ours that do provide a company that is generating meaningful free cash flow with more than a decade of high-quality inventory. So I think that, that remains with us regardless of the timing of things. And so I don't think there's too much of a fear of missing out factor for us. I think that, as I said, we can be a very interesting opportunity, both from just investing in the company as is. Also from a combination point of view, I think we provide a couple of different avenues there. And I think we're going to be selective and prudent. And I do think it is the right thing to do for the shareholders to be patient with things, because we don't -- honestly don't -- we don't need that, right? We have, again, enough inventory there that's going to generate significant returns, significant cash flow for our shareholders that I think there's an opportunity for us to gain value as is. And so I think we're going to be patient. And when the right opportunity is there, you've got a willing team that is open to those discussions.

Got it. And Sean, when you step back and think about the investment proposition then of Centennial to investors. And certainly, at these commodity prices, and the fact that the market doesn't need barrels today, it seems like the priorities is you've got a lot of free cash flow, and it's paying down debt, deleveraging the company, putting yourself in a better shape. At what point in time and maybe the answer is, that it's a thought but way too early to have that discussion. But like how do you think about like in the future, different avenues of showing value to shareholders such as cash returns? Are we just -- for a company like Centennial, is that just not a relevant discussion really to have at this point?

I think it's a little premature. I think our highest value return to the shareholders is by delevering the company. I think that generates the highest return of the free cash flow. So that's where we're going to focus. I think as we get to the 1.5x world from a leverage perspective, that's when we will start discussing it, because then we'll have even clearer line of sight on being sub-1x. So I think that's when the internal discussions will take place. And depending on where the market is at that point in time, whether that's through a fixed dividend, variable dividend, shareholder share buyback program or other, we will look at all of those opportunities and decide what we think is in the shareholders' best interest or growth through the drill bit at that point, right? We may be in a world where we are better off growing through the drill bit, because the world needs it at that point in time. And so I hate to be very specific on exactly how we're going to do that, but we are very focused on generating material returns for our shareholders. And I think we've got a pretty good line of sight on doing that over the next several years, honestly.

Got it. Turning a little bit to operations right now. And you all have 2 distinct, I guess, positions in the Delaware Basin, 1 in New Mexico, 1 in the southern part of the Delaware Basin. And can you -- you talk about like as you look at your activity and how you allocate that activity, what is the plan going forward at this point? And what are the advantages of that strategy?

First of all, I feel very fortunate that we do have kind of 2 areas of operation in the Delaware. We love the Delaware Basin. I think it's probably the #1 basin in the United States from a returns point of view or at least certainly high up there. And within that, I think we've got some outstanding properties like I mentioned earlier in the call. Our inventory and our rock quality is top tier, in my opinion, both in New Mexico and in the Southern Delaware as well. When we talk about inventory, I mentioned 15-plus years of inventory. That's split relatively evenly between the 2 properties. We have a bit more acres in Texas than we do in New Mexico. It's kind of the 2/3, 1/3 situation, so 1/3 being New Mexico and 2/3 in Texas and kind of an even split on inventory. And the reason being is that New Mexico is a bit less mature for us as an operator. We started out in the Southern Delaware and grew that position from 30,000 up to 60,000 acres. And then we entered New Mexico through a series of opportunities and have started to grow that position as well. And then we have put the time and effort into putting in infrastructure, oil, gas, water takeaway. And now that New Mexico has had that level of capital investment, it's ready for a more development period in its life. And that's why this year, we announced 70% of our capital is going to be allocated to New Mexico versus Texas. So kind of, again, 1/3, 2/3, but flip side of the acreage position. So 2/3 of our capital kind of in New Mexico, 1/3 in Texas. And again, that's part of just the seasoning of the assets as New Mexico is more -- less mature, it's time to start to go into development mode there where you have 2 rigs developing multi-well pad developments at the same time and bring that kind of to a level of where we are in Texas, at which point in time, over the next several years, we'll start to equilibrate how the capital is spent between the northern and southern Delaware.

So if I'm hearing you right, I just want to make sure I'm understanding it is obviously, the focus right now is New Mexico. You got the infrastructure in place it's less developed. And obviously, I think some of the returns in the -- some of those areas can be pretty -- quite juicy. But as you look into the balance of 2022, without obviously giving guidance specifically, but it sounds like there's more of a bias to stay up in New Mexico than to return to Texas. Is that correct?

I think near term, you will find more of our capital is spent in New Mexico over the next 12, probably plus months from today. We'll probably have a bit more focus on New Mexico. As we get beyond kind of the '22 time frame, without giving too much forward-looking guidance, again, we've got an equal amount of inventory to drill in both areas, and we want to make sure that we're capturing that resource.

Got it. Got it. And then in the past and not that long ago, you all were looking at potentially monetizing your water infrastructure and, obviously, that ultimately didn't happen. Has that environment changed? Is there an opportunity to meet your leverage goals? And as the asset market or things like water assets improved where that could be a consideration again?

I think it has improved. I think that option is out there. I think we're pleased right now that we own and operate what is a significant asset and that it really helps from a cost control perspective, we're able to move and dispose of water on our own volition, which is great. I think as activity continues to increase in the basin over time, that asset only gains in value. So I think right now, we are not looking to monetize that at some point down the road, maybe it makes some sense again to do so. If you recall, we were -- we and the industry in general had significantly more rigs running in the basin, which definitely impacts water usage and infrastructure usage so while I think that, that time happens again over time, right now, it doesn't appear like it makes sense for us to try to monetize that. I think we're getting a lot more bang for the buck, if you will, from an LOE savings by hanging onto that asset right now.

Got it. And as you start thinking about cost and obviously, you got the operating cost side, you also got the well cost. And can you talk a little bit about your -- the trends that you're seeing on your assets in terms of like well cost reductions is some of the stuff that we've seen over the last year are too sustainable? And do you feel that both operational and even just from high-level service costs, there's any kind of pressures that are out there?

Sure. Yes, a couple of things there. I do think there are some efficiencies and some even just design changes that we have uncovered and several others in the industry as well and that we changed a bit how we're drilling these wells. There's obviously an increased level of understanding of mud systems and things like that, which adds to efficiencies you're seeing in the field. So we're drilling things a lot faster than we did before. Even quarter-over-quarter improvements, it's really amazing that we're still finding opportunities to get better as an industry and certainly as a company as well. So some of those things are very sustainable and more sticky in nature that they'll go through regardless of any service cost pressure. That being said, the second part of your question was about inflationary and service costs and whatnot, and we are definitely starting to have those discussions with service providers. They haven't hit our bottom line yet. I think -- but at a -- as you mentioned earlier in the call, we're touching on 7. In fact, we closed over $70 yesterday, WTI. So there will be cost increase that are going to come across from the service side. And we won't be immune to those. No company will be immune to those. We baked in a fair amount of inflation into our budget for this year. I think it's appropriate for this year. If oil prices remain where they are, I think you'll see additional pressures in 2022. And honestly, I think that's healthy for the industry. I don't think that's a bad thing. I think that's good for everybody. We need to -- a lot of the service companies went through some very difficult times and had to lay off a significant amount of people. We need to increase some of those costs, honestly, to support those businesses to allow them to bring good people back into the industry on the service side of things. So I don't mind paying a slightly higher service cost to get good people back in the field as we increase activity.

That's good to hear. And what about the -- from an operational side, you obviously talked about improvements in the efficiency. What about the improvements in just the performance of the wells as the technological advancements? Are we done there? Or are there things that you're seeing out there right now that's improving? And then is it more of extending laterals now versus in the appropriate spacing versus frac stages and spacing? Like can you tell us the evolution of that and where you think this goes from here?

Yes. I think you've nailed it, Scott. And that I think at least the way I see the world right now, it's more about cost control than it is improvement in recoveries, except for from an extended lateral point of view. Specifically, ourselves, we averaged around 7,500-foot laterals last year, so 1.5 miles laterals. This year, we're closer to 8,800 feet as our average for the year. So materially more footage per well, which helps with an efficiency point of view. So you're getting more barrels per dollar that you're putting in the ground, but it's not a material increase in, let's just say, more sand or proppant or fluid that you're putting in the ground. So I feel like we're in a good place from a completion design. Now it's more about more efficiently spending your dollars to get the same barrels out of the ground. Plus, as you mentioned, the industry has done a better job of spacing properly. I think Centennial was pretty conservative in how we have talked about our inventory and whatnot. And we've tiptoed into denser spacing in previous years, but certainly not to the degree that some others have. So we haven't had to back off our spacing very much. I'd say we've been fairly conservative in that nature. So I feel good about how we continue to talk about our inventory and haven't had radical changes there. But that being said, one of the things that the key technologies I see out there are really from -- if you want to talk about the ESG side of things, it's dual-fuel operations. It's electrifying areas that weren't previously electrified. It's those types of things that allow you to accomplish 2 things at the same time. One is continue to reduce emissions, which I think the industry is doing a good job focusing on that and I think that helps investors come back in this sector. And the other thing it helps from a cost perspective. So it's kind of a 2-fer by looking at these opportunities, things like dual fuel, which I'm very pleased that both of our rigs are dual fuel as well as our completion crew is all dual fuel. So that's a nice, again, dual win from a cost savings and emissions point of view.

And you obviously touched on ESG a little bit there, and it's interesting and as mid-cap E&P, what do you all see as your role in sort of the ESG conversation? I personally think it's distinctly different if you're a major integrated or an international European company, what -- where the bar is versus U.S. E&P. And I think you just demand and ask are a little bit different. But like when you start thinking about like Centennial, like what ultimately are your goals? And I know you all did put out a sustainability report earlier this year. And if you can just kind of give us a sense of Like where you guys fit in the conversation? And how you think about your targets?

Sure. Yes. Thank you for mentioning sustainability report. I think, personally, I'm very proud of our team. We put together an internal ESG team. We actually have it also at the Board level now. So integration of that throughout the organization, I think, is very important. We do take it very seriously. We talked about in our previous 2 quarters being a 99% plus of gas capture. So flaring very little gas is important to us, a, from an environmental point of view, but also from a revenue point of view, so making sure we're getting those things to sales is good for everybody. So that's certainly a focus for us. There's also the SMG side of things, and I don't want to lose focus of those. So we do a fair amount of volunteer work and making sure we are spending time donating to causes, charitable giving and things like that. I mentioned on the G side of things, we do a pretty extensive shareholder outreach program. So I think our role in that is -- yes, while it is less than, call it, the super majors or the national oil companies, I think it's important for all companies within the industry to put some scrutiny on themselves and do their part to behave responsibly across the whole ES&G sector, and that's where Centennial is going to fall. I'm proud of where we're at as a team. There's been some recent reports that have come out, independent reports by third parties that have put Centennial in the kind of the top quartile, depending on how you measure your metrics, and I'm proud of that. I put that up on a bulletin board here locally in town for people, because it should be something that we brag about. We are doing our part as an oil-producing company to gather investor interest in our sector. I think until the entire industry continue -- or it has embraced it, but continues to embrace further standards on ESG that's going to allow the generalist sector to look at our sector and be -- and see an opportunity there, both from an environmentally safe way of operating but also from just a cash flow generating machine. It's really interesting to see the whole industry pivot. So I think if we can do both of those things, Centennial included, the generalists come back into the sector over the next call it -- maybe they've already started now, but over the next 6 to 18 months.

That's good to hear. And we've only got a minute or 2. And just really quickly, obviously, the winter storm Yuri was obviously a big impact to yourselves and the industry. And what did you learn from that? And can you talk about like your downtime relative to your peers? And are there ways to kind of get better into if an event like that ever happens again?

Sure. I think that was definitely a shock to the system, and it's -- everyone was, it's good to have one of those, because it allows you to test your systems. I think we did an outstanding job as you're seeing this storm coming, preparing for it the best that we can in an area that's not used to seeing those kinds of temperatures. And then certainly from an electricity point of view, the whole state of Texas had issues there, and we run off electricity for a fair amount of our operations. So I would say, in general, we were probably slightly better than the average producer out there from a downtime perspective. We were down about a week for a chunk of our production. But then as we brought things back on, what we had forecasted might take several days, took a day or less to get wells back up and operating. And then on top of that, they came back online right where they left off. So I would say our team did a very good job of anticipating what troublesome areas there might be and getting in front of those such that when the opportunity was to put those barrels on the market, we were ready to put them back on. And so proud of how we handled that. I think we talked about it last quarter and how it affected our numbers, but got right back to where we want to be, and it didn't influence our full year annual guidance on any metric.

All right. And Sean, we've reached the end of our 30-minute session. But we appreciate your comments and hope you have a good rest of your day.

Yes. I appreciate it, Scott. Look forward to chatting in. Thank you.

All right. Thanks.