Permian Resources Corporation (PR) Earnings Call Transcript & Summary

Good morning. Welcome to the -- to Day 1 of our 7th Annual Energy Conference at J.P. Morgan. I'm Zach Parham from the E&P research team. Joining us next is Centennial Development, a Pure-Play Delaware Basin E&P that recently announced a merger of equals with private operator, Colgate Energy. Today, we have representatives from both CDEV and from Colgate with us, including Sean Smith, CEO of CDEV and James Walter and Will Hickey, Co-CEOs of Colgate, who will be leading the combined company upon the deal close, which is expected in 3Q.

I guess, first off, a question from both teams. Maybe Sean, you can answer it first. Could you give us some color on why you believe this transaction is the best path forward for both of the companies?

Yes, sure. I'll certainly speak on my behalf and you guys can chime in as well. But I said repeatedly that Centennial, which is a Delaware Basin Pure-Play already, is constantly looking for the right size and scale to be meaningful to an investor base. And so we are always looking for opportunities to grow the business. We already were at a place where we -- our leverage was less than 1x. We're generating meaningful free cash flow. We announced a shareholder return program. And so the borrower is really high for opportunities that we thought would be interesting to us. As the Colgate opportunity presented itself, we looked across the aisle and really across the lease line because the acreage footprints are so great. And so a real opportunity to generate something meaningful better than what we had as a stand-alone basis. The combined company will be the largest Delaware Basin Pure-Play out there. They want it only out there of that size and scale. We'll have over 180,000 net acres combined. We'll have over 140,000 barrels of oil equivalent combined, we'll generate over $1 billion of free cash flow next year, assuming strip prices. And so it's just really a much stronger company combined and we were stand-alone. All of that will allow for a much more meaningful and accelerated shareholder return program than a stand-alone basis. And so for all those reasons, it made a lot of sense. On top of that, our current shareholders, it's accretive to them, both from a cash flow and free cash flow per share basis. So it really checked all of the boxes that we were looking for, including the inventory depth and quality that these guys have. Both James and Will have built a very, very company alongside Centennial, as I said, really along the lease lines next to Centennial. And I think that the business combination just makes a ton of industrial as well as shareholder sense. I think there's a lot of opportunity to drive increased value out of the pro forma business. And we look forward to truly integrating the teams over the next couple of months and just really driving that value. So I couldn't be more excited about the business combination and look forward to getting it closed here in the next couple of months.

Yes, I'd say from our perspective, so we've been a private business the last 6.5 years and always focused on how do we make the business better to drive incremental value for our shareholders in kind of back half of last year, I think we had probably had conversations with some people in this room. We started to explore the process of a stand-alone IPO. When we hired a bank, we did multiple filings of our S-1. And I'd say as part of that, we explored other strategic alternatives as well. And as we looked at the totality of our options, like they were all really good. The stand-alone case was good, the stand-alone IPO could be cool. And there were other strategic options that could have made a lot of sense, but -- the more time we spend with Sean and his team getting to know those assets, getting to know what the pro forma business could look like. I'd say it was really clear that, that was the best kind of next step to build the best -- really the best independent company in the Delaware Basin. So I'd say it made a ton of sense. Sean's hit a lot of the points that we're excited about. But I think this business is stronger than we could have been alone and it should allow us to provide tons of strategic flexibility, a really attractive return to capital program and hope to continue to drive outside shareholder returns.

Great answers. James, Will, maybe you could talk about your capital allocation strategy and how you think about that post the Colgate close? How do you balance production growth with free cash flow generation and shareholder returns.

Yes. So we've announced that we expect to grow 10% quarter-over-quarter from Q4 this year to Q4 next year. And it's really not a growth-driven strategy. That's not how we approach the business. That's not how we think about capital allocation. It's how do we maximize free cash flow over the near term and kind of near term for us. Somewhere in that kind of 12 to 18 month range and the incremental activity that leads to 10% growth as compared to a maintenance CapEx program actually increases our free cash flow over that period. So it will be free cash flow accretive to have that incremental activity. And I'd point out that's not incremental activity in the sense of adding rigs, adding completion crews like the 5 rigs that we're running today is Colgate with 2 completion crews, and the 2 rigs that Centennial is running with 1 completion crew, that's enough to drive that kind of growth on its own. So we're not adding -- we're not looking to pick up crews in what is a pretty tight market. But as we think about what to do with free cash flow and kind of capital allocation going forward, I'd say our return of capital program, we haven't officially unveiled it in the details of what that looks like that the exact formula, but our plan is to communicate something new investors that's really clear and specific. And look, we want to return a lot of capital to our investors in a way that looks like the large caps and should hopefully differentiate us from our current peer group is that 40%, 50%, 60%, 70%, I'd say, we're probably not in a position that we can unveil that, but expect to have that alongside detailed guidance at close.

Got it. And you kind of talked about this there. But how do you think about that cash return program? How do you view buybacks versus variable dividends, common dividends. We've seen a variety of programs across the E&P space.

Yes. And we'll ultimately have to get approval from the new combined Board on what that program looks like but it is the way we're collectively thinking about it is a mix of all of those. I think today, Colgate has $100 million a year base dividend as part of our return of capital program and Centennials got the $350 million share buyback that was authorized last quarter. I think both of those concepts definitely play a role in the combined business. I think we like having the base dividend, just to provide consistent returns regardless of the market. I think there's an investor base and frankly us that like that consistency of knowing what's going to be coming back regardless of the macro environment. I think we like share buybacks as a way to be opportunistic to the degree there's dislocations in the market, to the degree there's unique buying opportunities as a result of the macro. I think that's attractive as well. And then that probably doesn't get you to where we want to be in terms of total capital going back to shareholders. So I think some sort of well-defined variable dividend strategy kind of bridges the gap to get where we want to be on a yield basis.

Got it. I guess just moving over to the operational side. Cost inflation has been a big topic within the industry. What are you seeing on service cost inflation currently? And kind of what are your expectations for cost inflation in the back half of the year?

Yes, I'll take that one. So I'd say kind of to date in 2022, obviously, we've seen quite a bit of inflation. I think round numbers, we've probably seen from the back half of '21 and Q1 to today, probably 10% inflation across the board. And kind of what does that mean going into '23, I think that's kind of the biggest question. You tell me the oil price and I'll have a much better idea of what inflation would be. But I'd say that this business we've built is extremely robust from a return perspective. Like these are -- we're drilling some of the most capital-efficient locations in the Delaware Basin, which is the most capital efficient basin kind of in the onshore U.S. And so I'd say it will be resilient from that standpoint. In addition to that, there's a lot of synergies in this deal. This is a -- we are combining 2 asset bases that are on top of each other. We share 20 miles of lease line, I'd say, both Centennial and Colgate on a stand-alone basis, we're very good capital-efficient operators. But as we started to kind of lay the team's best operational practices next to each other, there are a lot of places for improvement. I mean there's a lot of things the Centennial team has done that we never adopted at Colgate. There are clear, low-hanging fruit, easy wins, and there's a lot of things we've done on the Colgate side that they haven't done. So hopefully, you'll see kind of the increase in efficiencies will offset a lot of that as we head into '23. And we're going to -- as James mentioned, we're going to come out with guidance at the close of this deal. So I think that we will be one of the first to take a view on '23 and hopefully we'll see kind of the embedded efficiencies of this new business help offset some of that inflation.

Got it. And maybe following up on that, Will. You mentioned a couple of operational synergies that the 2 team -- between the 2 operating teams. Could you detail some of those and what they might look?

Yes, I'd love to. I'd say kind of first and foremost, I think one of the more obvious ones that have been pointed out is Centennial's drilling at their current pace about 50 wells a year with 2 rigs, which is very, very efficient. I'd say that's kind of some of the fastest cycle times in the industry, especially in the Delaware Basin. And if you're saving 3, 4, 5 days on any given well at an $80,000 per day spread rate, that's a meaningful reduction in per foot cost on the drilling side. And I'd say that's something that we plan on and adopting a lot of those best practices across the entire fleet. Things like offline cementing -- things they do on the bit side that is, I think, unique to them and something we plan on adopting. Other things I'd say, Colgate on the facility side, we've been using tankless facilities for quite some time now and have seen a material savings as steel prices have come up less tanks overall is a great way to save dollars. And if you have good midstream partners and good downstream takeaway, it doesn't cost you much to do it. And then I'd say just generally speaking, I mentioned we shared 20 miles of lease line like in the Texas side of our assets. There's a lot of benefits for that much shared lease line. Centennial has got a great water recycling infrastructure that will be easy to leverage across both companies, I think less people because the routes are right next to each other. So I think things like that. And then I think the last thing to call is, across the Board, Colgate's operating structures. I mean we are a lean team. I think from a G&A perspective where kind of the Centennial team has historically been right at or right above $2 per Boe from a G&A perspective. Colgate's been right around one. So this combined business will be significantly lower on a kind of dollar per Boe from the G&A perspective than Centennial was on a stand-alone basis. I think closer to where Colgate was than where Centennial was historically and driving that down over time. So hopefully, everyone will see the per unit metrics, the capital efficiency on the D&C per foot side, et cetera, will really show up in our '23 numbers.

Sure. Maybe another on operations. Can you just talk about the future operational split between the legacy CDEV assets and the Colgate assets? How do you think about the pro forma program going forward?

Yes, absolutely. So for '23 and really kind of as we -- this is stuff we're working through in real time, but the expected case is it's probably going to be 2/3 on the Colgate legacy, 1/3 on Centennial. Obviously, our goal is to drill the most capital-efficient locations in the pro forma inventory. And so we're working through that in real time what exactly that looks like. But I think a good safe assumption is 2/3 on the Colgate side and 1/3 on the Centennial side. And then kind of what does that actually look like? I'd say it's probably close to 50-50 between New Mexico, Northern Delaware and Texas, Southern Delaware. I will call out that the Southern Delaware assets that we have been drilling at Colgate today are equally as capital efficient as the Northern Delaware. I think kind of historically, people have thought the Northern Delaware is better than the Southern Delaware. And I think in some cases, it is. But the Southern Delaware assets that Colgate's bring into this deal, which is where the majority of the Texas activity will be are still very wide, large undeveloped fairways where we have remaining Third Bone Spring, Wolfcamp A, Wolfcamp B inventory that is very, very competitive from a capital efficiency perspective with our Northern Delaware. It's -- these are high oil cuts, it's 50% oil type inventory. So this is not a -- this should not be any bit of a degradation, in fact, should be kind of accretive to the overall capital efficiency that Centennial had on a stand-alone basis premerger. And so I think that's a lot of what Sean hit on in the kind of as they approach the NAV accretion of the overall deal that should again show up in our '23 guidance.

And maybe jumping back over to the financials. You've talked about being [indiscernible] of leverage by year-end '22 once the deal is closed. Can you just talk about your balance sheet targets? What level of leverage or total debt do you think is appropriate to put on this business?

Yes. So I mean I'd say for -- just for some history, I think Colgate has always taken a very conservative approach to balance sheet and how we manage the business. So I'd say, since we started our development program 5 or so years ago, we've never had leverage above 1.5x on a debt-to-EBITDA basis, and it's typically been kind of a target around 1. And a lot of that was in the context of when a lot of the E&P peer group was at 2, 3, 4x leverage. So I'd say kind of low leverage is in our DNA and something that's been critical to kind of foundation and success of our business over time. I think at close, we expect to be right at or just below 1x leverage. I think we'll probably pay down a little bit of additional debt from there. I think terms of long-term targets, I think we believe that this business benefits and equity returns benefit from some amount of leverage in the system, but kind of call that -- call it half a turn to a turn. I think -- we think that kind of is the sweet spot where you get a little bit of that equity juice. But even in kind of really bearish downsides like we saw in 2020, the business is really safe and protected and can ultimately thrive. I'd say back to that experience we were less than 1x levered throughout the COVID pandemic, and that really positioned the business to do some things on the strategic side that allowed us to drive outsized equity returns, and I think that's important going forward.

Got it. Maybe another one kind of connected to the balance sheet. Can you talk about your hedging philosophy? You're going to be [indiscernible] leverage going into '23. As you reduce leverage, do you think about hedging less? Maybe just detail how are you thinking about hedging going forward?

So I'd say, in the private context, Colgate hedged quite a bit more. I'm not sure if that's kind of where the question is stemming from. But in the public business with the balance sheet where it is today, we think hedges are important, having some amount of base hedges to protect the near-term development plan, especially the contracted development plan, the base dividend and some additional capital returns beyond that. I think that's critical. But what does that look like? It's probably 20% or 30% of production hedged for the current year and the following and maybe something de minimis beyond that. I think that should allow us to maintain a reasonable leverage position in times of lower commodity prices. I'd say the way we approach it philosophically is we really pressure test the business, and we've got thankfully, really high-margin asset that can generate free cash flow at lower commodity prices on its own. And you combine that with a modest hedge book. And I think we want to be able to be a strong business that can be dynamic and take advantage of those dislocations if oil is at $20 or $30 like we saw in 2020. So I think you'll hear us hedging to protect the business at all cost, but I think at the same time, finding ways to make sure that our equity investors who are often buying the stock for the commodity price exposure, have plenty of that. And as we think about it, if we're 20% or 30% hedged in the next 1.5 years, like that's maybe 1% hedge into kind of PV barrels over the next decade. So plenty of exposure, but also plenty of downside protection.

Got it. Maybe just jumping back to the operational side. Can you talk about what the pro forma inventory depth looks like. How long the inventory runway is in Reeves versus in the Northern Delaware and New Mexico?

Yes. I mean I think inventory was probably the biggest reason this deal was able to get done. I think from Centennial's perspective and Sean hit on it in his opening remarks that -- they were very confident with their long runway of 15 years of inventory and did not want to do a deal that was inventory dilutive. And I'd say similarly, as we've built Colgate, I could contrast it to some of the other privates out there. We've been very thoughtful in maintaining a business that has ample running room, ample inventory relative to our current production levels. Think as opposed to having 2 or 3 years of inventory and trying to blow it down, which I think is a business model that a lot of other privates have adopted. We thought we want to have 10, 15, 20 years of inventory and make sure we have a good sustainable business that's going to be here to stay. And so yes, I think if you think of what Colgate brings to the table at our current pace, it's 15 years of inventory, and at Centennial it's about the same. So this combined business at the kind of what we're putting out 140 wells per year drilling pace has about 15 years of inventory. And I think what really makes it unique is it is very, very high quality. This is an inventory that you're going to see a degradation in capital efficiency in year 2, 3 or 4. We probably have 10 years of this type of capital efficiency that you'll see in '23, and this is a very, very high-quality, 15-year inventory business, which really allows us the flexibility to do a lot of great things, whether we're -- how we think about the M&A markets, obviously we're going to be very, very picky, how we think about just whatever we want to take the business next, the long runway of inventory is very key to this combined business story.

And maybe just one on M&A. Clearly, you haven't even closed this deal yet. But how do you view M&A in general in the Delaware Basin going forward? Maybe just start there.

Yes. So I'd say. So Colgate's been very active on the M&A side the last 2 years. I think we've done a handful of transactions that were publicly announced, and we've done quite a few more that were not. But I'd say from a starting point, like the combined business that we have at close is so attractive and has such a high-quality asset base that I'd say the bar is really high kind of as we look out and think we have amongst the highest quality and longest inventory in the Delaware Basin. Like if we're going to do deals, it needs to make the business better and drive enhanced equity returns. And I'd say the higher quality of your asset base is, the harder it is to do that. So we'll certainly be looking. I think M&A has been an important part of our equity value creation story. It's something that we're really good at, I think, identifying deals that are undervalued, integrating them quickly and ultimately developing them has been a great part of our value creation story. So to the degree we can find opportunities that enhance the business, enhance equity returns, we'd be excited to do them. But I think it's just getting harder as our business gets better. And frankly, the quality of assets that are out there is probably not getting better. But I think I'd say from an M&A perspective for the investor group here, I'd say you should rest assured, we have perfect alignment. I think we're amongst the largest shareholders of the combined business. We are going to be the last people who want to do a deal that's dilutive to the ultimate return story. So I think we'll be out there, but I think we're be very picky and only do deals that we have a high degree of confidence that are going to further enhance returns.

Got it. Maybe one just bit of a different question, but you'll have a different management structure at Colgate, the co-CEO structure that you've had in place since the company was founded. Maybe can you talk about that, how you'll split up responsibilities and how you see working together going forward?

Yes. We've got this question a lot. And my first answer is normally, this is not new. We've been doing this for 7 years, but you kind of took away mine -- took my line with your question. But yes, I mean, we've been co-CEOs since we founded the company in the fall of 2015, and it's worked remarkably well. I think that's one of the secrets to our success at driving value for our investors is we've got 2 of us. And I think that allows us to divide responsibilities in a way that fits our skill set. I've got a financial transactional background. So I oversee the land department, the legal department, the accounting department, the kind of M&A machine and Will's got a technical background. He spent the majority of his career before this at Pioneer and so he's an engineer as well. So it naturally oversees operations, geology, engineering in a way that was truly well, but I'd say we see the business the same way. We have the same vision, the same goals, the same philosophy, but with different skill sets. So it's really complementary, and it's ultimately allowed us to do more because we can actually be in 2 different places at the same time when we need to and making 2 different sets of decisions. So I think it's been awesome. I think to the degree that wasn't the case, I don't think we would have had the success that we've had kind of building the business today.

Got it. And then maybe another specific to the transaction. Can you talk about the lockup on the shares that are being issued to the Colgate holders? And do you have a sense for if the private equity sponsors are looking to exit? Or how you think about that over time?

Yes. So all of our shares on our side of the transaction are locked up for 180 days post close. But I'd say that's not an important date that I think as our sponsors are focused on at all. I'd say if you go through the proxy and think back to how this transaction came together, you can see that the negotiation and really the [indiscernible] of the back and forth once this became a real deal was who got to own more of the equity. The original Centennial proposal included $1 billion of cash. And our response to that was we don't want the cash, we want the equity like we believe in this business. Like we think that both the value today, but also the potential value creation going forward is awesome, and the cash isn't going to appreciate. And I think you can see that. And I think that's not a perfect answer, but I think it speaks to the way our investors have approached the business. And going forward, like they didn't want cash, they didn't want an exit. They wanted more exposure to the story. So I think you'll see that philosophy as more of a longer-term mindset than maybe some other sponsor-backed deals.

Got it. Maybe going back to the operational side. At current strip prices, we've got oil above $100, gas near $6. How do you think about the '23 program? I know you've got the 10% exit-to-exit growth out there. But would you consider increasing activity beyond what you've currently got planned.

Yes. I think the way that we think about it, first and foremost, I think James said on it earlier, the growth that we're targeting in '23 is really an output of a free cash flow generation machine that we've built, and we are focused on maximizing free cash flow over the next 12 to 18 months. And with payback with $100 crude and paybacks as fast as they are, the incremental rig or incremental well you drill pays for itself within that 12- to 18-month time frame. So it's 10% growth is, in fact, free cash flow accretive in that time frame, which is, I think that's a unique part of where we are today from a commodity price perspective. And I think it goes out saying, but if that was not the case, we would not be growing 10%. The 10% is -- really is an output of that growth. As far as growing past that, I'd say, James said on earlier, we are big shareholders of this business, and I think dividends are extremely important to us as big shareholders of this business. And it also fits the 10% kind of works with the equipment we have today, the 7 rigs, the 3 frac fleets that is the -- those are the rigs and frac fleets we're running this very day. So I think it would be really hard for us to find a situation where we want to grow past that. You may see that as we build efficiencies in the business, that we're able to turn out a few more incremental wells and maybe it goes from 10% to 11% to 12%. But frankly, I don't see this as a 20% year-over-year growth business or anything like that. Just that would really eat into term dividend, which is something that's really important to us.

Got it. And maybe asking that question in a slightly different way. You said you don't want to grow more than that. But if you did decide to, what's the time line? If you called rig company called to get additional frac crews, how quickly could you get those up and running? And when would those add production.

It's a hard question to answer because we're not doing that. But if I was to speculate and make a guess at it, I'd say, given -- and this is one of the beauties of this business, we have a business that is flexible enough that just 1 incremental rig has a material impact on our growth rate. Yet we have enough scale that we can pay a meaningful cash return program, and I think that's really is one of the biggest differentiators of this business. So given it's only one rig, I think we could do it. I just think it would be a more expensive rig kind of across the Board, like the -- where you'd sit on the cost curve for all the wells drilled by that 8th rig would be higher across the Board. I think the sand we'd have to procure would be in the spot market, thus more expensive. The steel we have to procure would be kind of at the mercy of the mills, thus more expensive. The rig rate would be -- we'd be signing a contract in peak market. And so the give and take there is you're effectively working your way up the cost curve that is -- I think that you've heard a lot of people say that that's just not something they're willing to do. And frankly, that's not something we're willing to do nor do we need to do. We are in a fortunate position that Both Colgate and Centennial on a stand-alone basis had procured all the necessary equipment materials to execute on the plan, and it works really well that this plan generates kind of a growth profile that we've laid out for '23 and that, that growth profile helps free cash hasn't hurt it.

Got it. And earlier, you mentioned some operational synergies from both companies kind of best practices. How quickly do you think you can realize those? When could those be implemented across the program?

Yes. I mean I think as soon as we possibly can is the answer. Some things are low-hanging fruit, like I mentioned, that probably show up as early as Q1 next year. But I think the lion's share of them we'd hope to implement by midyear. So as I think about kind of '23, what we're trying to accomplish, you probably start to see a lot of the capital efficiency show up in the back half of '23 is probably the realistic case. And that's -- but obviously, we're doing everything we can to make it happen sooner.

Got it. And maybe one last one. Just on how you see the scale of the business at this point. Do you think you can compete with the larger scale operators who've kind of led the charge on cash return and on returns to shareholders going forward?

Yes, I'd probably a pretty quick answer, but I'd say it's absolutely. I think we have a high degree of confidence that we can have a shareholder return program that's both similar to those guys in every bit if not more sustainable. I think there's nothing that prevents our business on a relative basis from returning capital with the same yield and the same structure and the same emphasis that the bigger guys do. And that's the plan.

Got it. Well, guys, we're running short on our time here. Thanks so much. James. Will, Sean. I appreciate you all being with us today, and I hope you all have a great meeting for the rest of the day.

Awesome. Thank you.

Thank you.

Thanks, everybody.