Select Water Solutions, Inc. (WTTR) Earnings Call Transcript & Summary

Well, the first answer would be that it's a needed solution, a growing problem. So like we talked about earlier, the ability to take lease operating cost out of the equation throughout the life cycle of the well extends that economic lives of those reserves and brings a better return to the customer but if you're going to do that at the same time that you're lowering the capital cost on the AFE to drill and complete the well and bring the scale and intensity that is needed, like we're describing with Endeavor job that we did, it's really important there. So number one, it fits together really well for a value creation to our customer base and a return to our stockholders. But at the same time, we described that, it also changes the character of the company in a meaningful way. The services side of our business heavily weighted to completion and the AFE dollars and the state of the activity within the commodity base at that given time. So the technicality of being able to produce the well. I mean the services delivered as they develop these wells is different in the full life cycle of the produced water. So one, we're moving to more predictable, stable, understandable, less cyclical application with the infrastructure. It's also contracted in nature because you're really becoming partners with the oil and gas company. It also has a lower capital maintenance intensity than a service provider during the completion cycle like frac companies. And it also brings the ability to really have the optionality of taking that piece of water that's produced and putting it back into the completion when needed. But when not needed it still has to be dealt with. Like we said, you can't flare water, so you have to do something different if you're not going to be using it because completion activity is contracted because of a commodity price, our capital spend amount. And at that point in time, you're going to direct it to disposal, and it's still going to be an income-producing position for our company through the life of the well on it. So it's more repeatable, predictable, it's higher gross margins, it's lower CapEx requirement to maintain. It's less cyclical than just a pure completions company and it really adds value to our ability to return to shareholders, return on investment, stability of the business with less cyclicality. So it's really a great opportunity, but it's a great opportunity because it brings value to our customers and our shareholders.

And Jeff, you've touched on it a little bit as to John, but when you think around the emphasis on infrastructure, both of what we're focused on, but also just generally the secular demand in the industry, I mean a single user system, which is what most of the operator systems are that have been invested in over time, ultimately results in underutilized capacity in an asset it's got to be built for the peak demand of that single user's application of transport. So what Select can do to commercialize and integrate multiple operators into a single piece of infrastructure, whether that's pipe, centralized facility, disposal and really create more of a water balancing application of managing the longs and the shorts of water, both on the demand side as well as the takeaway side, it really drives that optimization and utilization of a piece of infrastructure that results in reducing the overall capital required to build out for peak capacities in multiple ways. And it allows us to most efficiently optimize the use of that barrel based on those longs and those shorts and schedules changing and multiple operators having the different application of timing of both production as well as takeaway for new demand. So it really -- taking a commercial approach towards infrastructure build-out really, I think, creates a better value proposition. It's a more efficient use of the capital dollar and I think ultimately results in decreased costs over time because you can push more volume through a piece of pipe and every incremental barrel through a piece of pipe managing that fixed cost base is a very high-margin incremental barrel for us.

Of course, that business has been growing through both organic greenfield projects and acquisitions. It sounds like it all just dovetails together to try to maximize the efficiency of the system and that once customers get tied into the network. It's very difficult, if not impossible, for those wells to leave the system. So you essentially have them for the life of the well. Is that the right way we should be thinking about this?

I think, yes, Jeff, that's certainly part of it. When we think around adding to the portfolio and building it out strategically, we've done a lot on the acquisition front over the last few years to really add that base infrastructure footprint across every basin we operate in. We've been able to do most of those acquisitions at below replacement costs. And so as we look at building out a project scope to solve the needs of the customer base, if we can find ways to acquire as opposed to build at a more efficient way to deploy capital, that will always be something that we focus on. And once we get those assets into the system, then we can network them efficiently, enhance the utilization of them and really drive value creation out of that acquired asset base. But what we're focused on when we look both at acquisitions as well as organic projects is how can we most efficiently put our capital to work. Can we integrate with existing infrastructure that's out there that the customers themselves own and operate? And how do we optimize the utilization of that asset base. And if we can take an acquired asset, create good value and derisk that through an existing revenue stream but know that we can integrate it into a larger network and drive enhanced utilization over time, reduce costs over time and really organically build around that asset in a brownfield manner. That's always going to be a great return profile for us when we can have that next incremental layer of investment on a brownfield basis around [indiscernible].

Since 2021, the company has closed more than 15 strategic M&A transactions, as you alluded to. Those have added more than $100 million of run rate adjusted EBITDA to Select. Chris, you talked about how the company adds value to acquisitions. And this year, you've closed 5 transactions, I think, so far for about $138 million. How do the assets that have been acquired this year fit into your existing networks? And I think those include 2 that expand your solids business, one in the Williston Basin and one in East Texas.

Yes. So I'll maybe start with just kind of the strategic fit of the deals we've done. So generally speaking, if you look at the acquisitions, we've been active in multiple basins here. So we've added assets in the East Texas, North Louisiana area, in the Haynesville. We've added assets in the DJ Basin in Colorado, up in the Williston Basin, as you mentioned, and then also out in the Permian Basin. We like having that geographic diversity and the ability to look at optionality around deploying our capital efficiently in the most attractive opportunities. But each of these really fit a strategic need as well in East Texas and in particular, we have a market-leading position with a large gathering system transporting produced water from Louisiana all the way down into Texas for disposal. That's really the only one of its kind in the basin. And we have a pretty established strong market-leading position out there. The 2 transactions that we did out there earlier in the year really gave us an efficient application to add disposal capacity to that network so we can take that large pipeline network and really add disposal capacity at the southern end of it to ensure that we can more efficiently add additional pipeline expansion off of that and ensure that we're not going to be disposal constrained. We can integrate those efficiently with brownfield interconnections and really create more of a hub-and-spoke system out of what has historically been a large trunk line delivery mechanism. So I think that you're going to see good opportunity for growth and value creation out of that asset base. And what interestingly, has been a fairly kind of challenged basin from a completion standpoint. So that's taking our revenue base in the Haynesville up to 90% production weighted. So it really takes away the cyclicality of that completions activity in a basin that's been somewhat challenged with gas prices being where they have been. And we continue to see demand for new solutions out there, and we've actually been able to increase our pricing as well as we've been able to create value out of reducing the transportation cost of getting that barrel from Louisiana into Texas. If you think about the application of acquisition in Colorado, we have a -- we were really the only recycling provider, we developed the first commercial recycling solution in Colorado. And the acquisition there really added an existing disposal asset, but also a permit for new disposal and recycling application as well that gives us more ability to network and create an integrated system as opposed to stand-alone assets in that area. So we think there's going to be great opportunity to take those stand-alone assets that we built and we bought and integrate them efficiently via pipe and create more value out of that. In the Permian Basin, we added a significant amount of disposal capacity in both the Midland Basin as well as the Delaware Basin. It really is a focus on adding smaller, diverse shallow capacity, and we don't like to have our -- all of our eggs in one basket as it relates to single kind of large-scale deep injection and where you've been seeing some of the seismic challenges around those types of assets. We like having a large diverse portfolio across the full scope of the basin that allows us more flexibility to integrate and more diversity to move those volumes, as John mentioned, out of basin or further afield from the core areas of activity. And in that acquisition of Trinity in the Midland Basin gives us that. And then in the Delaware Basin, that's where we've got some of our most prolific investments around recycling here recently and the interconnect of continuing to build out that network with multiple recycling facilities now over the course of this year and adding disposal to that footprint, just gives us more flexibility and optionality around managing that barrel coming into the network as activity fluctuates. To your point on solids, that's really been kind of a new area of development for us. We originally acquired some assets out of one of our transactions back in '22 to add both landfill capacity and solids treatment. And when you think about why look at more solids, we added slurry wells in East Texas. We've added additional landfill application in North Dakota and Montana. We've got a solid treatment facility up in the Northeast now. When you think around providing the comprehensive solution to the customer, managing the full waste stream, ultimately managing that fluid waste stream efficiently also integrates and dovetails nicely with managing that solid application of kind of full life cycle management. When you think around the recycling application of what we do, treating that fluid barrel ultimately results in solids on the back side. How can we -- similar to what we've done with recycling, take what has historically been a cost to us and create a revenue opportunity out of it and reduce the cost of our own operations efficiently as well. John, I don't know if you have anything to add on the solid side of things?

I think you just -- I think, Chris, you said it, but the relationship between landfills, disposal and solids management all fit together really well. When you separate solids, you end up with fluids, those fluids have to be disposed of. When you run landfills, you end up with leachate water, and that leachate water has to be disposed off. When you run solids management, you end up with solids that have to be delivered to landfill. So it really fits together very nicely as we thought about it and as we've learned, like Chris says, our first one came with a total company acquisition. So we got put in the business, but we've learned from that. And I would also say that it's waste conversion and management of waste. So what we can do with that waste and what we can get out of it, almost every one of the pieces we're talking about has oil reclamation in it. So skim oil coming out of disposal, landfill, solids management, recycling facilities, it all has oil reclamation or capture of skim as we think about our processes and what we do.

Briefly on the tuck-on M&A with -- among your customer base, you clearly work with some of the biggest companies in the industry. Does M&A among the customer base have much of an impact on Select's business?

It's a great question. Usually -- well, first of all, I would say, scale, demand, scale. So as you see these big transactions come together and add a massive amount of scales to acreage and application and link to horizontals and all the things that come with intensity and size that scale is looking for scale when they look at a provider like Select, they actually need to demand it because we just described it in our Endeavor conversation earlier. So it's positive in that sense. Usually, we're on both sides of the transactions. Select is of size that usually the customer base is on both sides of it. So we have usually a synergy as it relates to the relationship, as it relates to the assets and the contractual nature of those assets. It would be not uncommon for one of those mergers to happen, and we have contractual nature and relationships to our systems and our offerings that are on both sides of that transaction. So I'd say, in general, they have been very good for Select and what we've done and what we're trying to do is in the sense of bringing value to our customer to that acreage as these continuing announcements come across our screens.

Chris, you mentioned that now 90% of your Select Haynesville revenues related to production, which insulates you from some of the drilling and completion, which is impacted by low gas prices. With the focus on infrastructure, how do you see that trend playing out across the company over the next couple of years?

Yes. So I mean when you think around the focus that we've had, Jeff, strategically around building out the infrastructure platform, I mean, it's been kind of multifold. Clearly, there's an important part of what we're doing to add stability and predictability of the business. We've taken what was a 90-plus percent completions weighted business into something closer to 1/3 of the revenue today coming out of the production life of the well, which is -- and that's growing. And we've added a large portfolio of contractual relationships to the business over the last couple of years as well. If you look at our infrastructure business in total, more than half of the revenue and profitability out of that segment now comes from long-term contracts that are range in -- and tenor from 3 to 15 years. So that's been a strong acre of support to continue to grow the business and gives us more flexibility around how we can approach underwriting new capital projects. I think importantly, when we think around getting long-term contracts in the business that underpin the new capital dollars going into building out infrastructure, we're also focused on how we can utilize that contractual relationship with the customer to more efficiently integrate the full scope of what we bring to bear around services and around chemistry. So if we can establish a critical need and solve a real problem for the customer around an integrated infrastructure solution. I think we're also seeing the demand and appetite towards creating that more holistic solution integrated within that contractual relationship that integrates the last mile logistics that we bring to bear in services as well as the chemical application of how we take that barrel, make it usable and redeliver that, that supports our chemistry business. So we're going to continue to see that contractual revenue base grow, Jeff. Generally, all of the new capital projects, the $100 million or so of new organic projects we're investing in this year are going to be underwritten by long-term contracts. And we see a similar pipeline of opportunities looking into in '25 so that's going to translate into continued growth in not only the production related revenues in the business, but the contracted revenues and cash flows in the business. And I think if we look longer term, we've committed to getting 50% of the profitability of the overall company coming out of that infrastructure segment by the end of '25 on a run rate basis. That's a material shift in the business in a very short period of time from what was a legacy completions weighted service application to really a very different dynamic of company with the predictability, stability and repeatability of that revenue stream coming out of infrastructure over the next 24 months.

Well, that shift could have some pretty profound economic implications for Select as well. In the first quarter 2024, the water infrastructure gross profit margin was almost 47% compared to 20.5% in water services and 17.4% in chemical technologies. When we think about the economics and the visibility you touched on, Chris, growing the fee-based business over time, that's the highest margin part of the company. Should have a disproportionate impact on your profitability, your cash flow growth and therefore, how you look at just new growth opportunities [indiscernible], is that right?

Yes, that's exactly right, Jeff. I mean, if you look at 2023, I mean it was a record year for Select in terms of revenue, profitability, cash flow generally across the company. And we've got visibility into continuing to grow the adjusted EBITDA in 2024 as well. And so you take not only a growing business, but a business that's seeing a transition towards a more contracted production weighted high-margin contribution from that infrastructure business. Generally, each of the new projects we're investing in are going to be accretive to that overall infrastructure segment as a whole, which I think gives us visibility into getting that 46%, 47% gross margin, you mentioned up to 50-plus percent over the next year or so. That will continue to be materially accretive to the overall company particularly as we look at some of the opportunities to consolidate and shore up and focus our efforts in the water services side of the business, in particular, to continue to focus on the margin improvement and efficiency initiatives on that segment. But the more weighting we get towards infrastructure over the next 12 to 24 months, the more we should continue to see that consolidated margin profiling freeze and see a 20-plus percent consolidated EBITDA margin profile will be attainable in the relative near term.

I think you said that you expect to convert about 40% of 2024 adjusted EBITDA into free cash flow. Having closed already this year, roughly $138 million worth of acquisitions. Chris or John, can you talk about how you think about the funding mix for acquisitions when you compare it to the greenfield projects you have? And is there a point at which equity is considered as a component?

Yes. I'll maybe start and let John add on. We've obviously been quite active in the first part of the year here from an M&A standpoint with the 5 deals that you mentioned, Jeff. We've been able to largely fund the business out of free cash flow over the last 24 months. We were a debt-free balance sheet at the end of 2023. We utilized liquidity and the revolver capacity we had, fund the latest acquisitions, but do have good visibility to continuing to generate strong free cash flow out of the business based on that capital investment profile. And when we say that, that's inclusive of both the maintenance and the growth capital required to accomplish what we're looking to accomplish here. How we fund that and allocate our capital, we'll continue to look at closely, Jeff. I think we've got a lot of opportunity to continue to drive equity value here. I think we can continue to believe that there is a very good chance to continue to drive sequential growth on a year-over-year basis out of the base business and the more we continue to drive value through that stability, predictability and contracted revenue base. I think we'll, and we'll continue to find opportunities to improve the equity value over time for our stockholders. So I think that we'd be a bit reticent to use the equity in a material way in the relative near term. I think right now, we've accomplished a lot in the first half of the year here from a strategic standpoint and the back half of the year is going to be very focused on investing organically around that asset base. And we've got a strong backlog of opportunities. We've mentioned in recent calls that, that backlog has doubled over the last 6 months. And importantly, it's not only doubled in terms of the size and scope of the overall number of projects we're looking at. But I'd say the confidence weighting of the execution of that project backlog continues to improve as well. So we've got a large opportunity set ahead of us over the next few quarters to really invest organically around that asset base. And I think that will be probably the primary for us, Jeff. And the more we add stable, predictable revenues to the business, the more we add production-related scope, I think the more flexibility that gives us around how we look at the balance sheet and how we might be able to utilize the balance sheet to help fund our growth over time. One of the important parts of Select is the diversity we have with integrated service and chemistry and we generate a lot of strong cash flow out of those 2 segments -- out of the base business within services and chemicals. Chemicals as a manufacturing business, it's a very high return on assets and a very strong cash flow generator for us and services is certainly a relatively light capital intensity relative to some of the other areas of service in the industry. So if we can generate 70%, 80% free cash flow out of those 2 segments, that gives us significant flexibility to help fund our growth strategy and infrastructure, which has obviously been primary for us here recently. John, anything to add to that?

As Chris said, the backlog has doubled in 6 months. We're very -- we also see now that the project size and complexity between the relations of multiple customers and asset base as we figure out how to hook these systems together is becoming reason for that backlog to double. We also see that a lot of the backlog doubling comes from customers actually inbounding calls to us versus us calling on customers really searching for and needing a solution to their intensity or their production life and water production. And all of them have the same kind of investing parameters and gross margins that we push out. I mean we try to buy things on for your cash on cash or less. We try to do projects with those same kind of thought processes on a return basis. All of the stuff that we're doing has an ability to push up to that 50% plus in gross margins. So the profitability is changing to the positive on what was a really completion call-out service business. And then I would also tell you that all the projects are kind of fixed assets and have related surpassed agreements or asset agreements of utilization and they all are projects that just really are less labor-intensive and less capital maintenance intensitive through their life of the contract or the life of the wells production. So it really changes to a very positive of what we can do as we think about dividends or share buybacks or distributions of earnings through dividends and some return of capital to our shareholders as we develop it out.

To that point, John, Select raised its quarterly dividend 20% in the fourth quarter of 2024. It sounds like from your -- the comments that both you and Chris made that really that shift underpins the dividend visibility for the company over the next several years as this business continues to grow and expand.

Yes. We do believe the profile of the company's earnings is changing in the sense of predictability, repeatability and full life wellbore through production. And that's just ability to plan around as it relates to cash flow and dividends and dividend increases as we continue to build this infrastructure business.

Yes. And as we look at kind of overall capital allocation, Jeff, I think last year was a great example of a diversified application of deploying capital. We do think that all capital competes against itself. So when we look at both acquisitions and organic projects, we're obviously going to weigh the competitive application of what might be a deployment of capital towards share repurchases. We were pretty active last year with about $87 million of total shareholder returns through the combination of buybacks and dividends. We do have continued authorization out there about $21 million left on the existing authorization. But I think we're going to be pretty disciplined and tactical in our approach of how we deploy capital, take it quarter-by-quarter and really look at what's the most optimal use of deploying our free cash in any given period of time. And obviously, the first part of the year, we focused on the acquisitions, and we've got a large project backlog here in front of us. We continue to enhance our commitment to shareholders with the increased dividend last year, and we'll continue to look at that as an opportunity, particularly as we add more stability and predictability around that infrastructure part of the business. That gives us more flexibility around that shareholder return profile and also gives us more flexibility around the utilization of the balance sheet to continue to support and grow the business.

You've both been very generous with your time today. John, I'd like to maybe close with -- you've been very -- you've built and managed and sold businesses that have been involved in most areas of the onshore oil and gas industry in the U.S. If we can wrap up, how do you think about Select's role of providing critical solutions to the industry really positions the company for sustainable value creation?

Yes, you've been in the industry a pretty good well, and I think the industry demands value today because it's such an exciting opportunity in what's been now developed in the United States. So Select's value is the value that we can bring through the full life cycle, the drill, the complete, the produce, the intensity, the job itself, the reservoir rock that's getting exposed and what it needs, the automation that we bring to the job side along with the ability to engineer these jobs that are very complicated in nature that we described and the scale that we talked about, they're all really a package of the full life cycle, the needed application of long solution life for management of water throughout the well's life. So I believe Select is really in a unique position as it relates to water and water services or chemistry to bring the value that demands the scale and the intensity across the customer's acreage and the production life of the well. So I think it's in a really good spot to bring that value, and I think all companies need to bring value now.

Yes, [indiscernible]. We've had a comprehensive discussion. We look forward to hosting another fireside chat at some point in the next several months. John, Chris, thank you very much for your time today.

Thank you very much.

Thanks, Jeff. And thanks, everybody, for joining and the interest in Select.

Thank you.