SM Energy Company (SM) Earnings Call Transcript & Summary

Welcome to SM Energy's Fourth Quarter and Full Year 2019 Financial and Operating Results Webcast. Our 2019 results demonstrate very solid performance against our 2019 plan as well as versus Street estimates, including for production, earnings, EBITDAX, cash flow and year-end leverage. Before we get started on our prepared remarks, I will direct you to Slide 2 and remind you that we will be making forward-looking statements about our plans, expectations and assumptions regarding future performance. In particular, we will be giving 2020 guidance. These statements involve risks that may cause our actual results to differ materially from the results expressed or implied in our forward-looking statements. Please refer to the cautionary information about forward-looking statements in today's earnings release, the related presentation posted to our website and the risk factors section of our most recently filed Form 10-K. Discussion of 2019 results includes non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliation of those measures to the most directly comparable GAAP measures and other information about these non-GAAP measures are provided in our earnings release and the investor presentation reference for this call. Today's prepared remarks will be given by our President and CEO, Jay Ottoson; and our COO, Herb Vogel. CFO, Wade Pursell, was unexpectedly called out of town for a family matter, but Wade will join us on Thursday for the live Q&A call. I will now turn it over to Jay Ottoson.

Well, good afternoon, and thank you all for joining us. 2019 was an outstanding year of execution for our company, measured by meeting or beating our objectives in every meaningful operating metric, including top quartile industry benchmarks for environmental, health and safety performance. I'm now turning to Slide 3 in the presentation deck. On the left here, we list our 2019 goals as presented to you last February and, on the right side, how we measured up. One year ago, we told you that the key objective of the 2019 plan was to generate free cash flow in the second half of the year and position the company for long-term profitable growth. We've exceeded this key objective, delivering $29 million in free cash flow in the second half of 2019, which is about a 2% yield over 6 months. And we achieved this despite natural gas and NGL prices that did not work in our favor. We beat our projections for oil production growth, and we optimized our development programs in both the Midland Basin and South Texas, increasing returns. We also made good progress in proving up potential in new intervals in both the Midland Basin and South Texas. We reduced net debt to adjusted EBITDAX to 2.8x, beating our expectation of 3x. In summary, our company is well positioned to generate sustainable and profitable growth in cash flow. Turning to Slide 4. The big driver behind our 2019 results was high-margin Midland Basin production growth, which exceeded our expectations for the year, up 25% versus 20% attributable to better-than-expected well performance and the accelerated timing of completions as we drilled and completed faster than we planned a year ago. Next, on Slide 5, we ended the year with improved leverage metrics, $1.1 billion in liquidity and no bond maturities until the end of 2022. I hope you have all had the chance to review our earnings release, where we provide more detail on the highlights and successes of 2019. Let's now turn our attention forward to the 2020 plan. I'm now on Slide 7. Our key priorities for 2020 are to grow cash flow by making high-return investments in new wells while continuing to drive down costs and increase operations efficiency and to generate free cash flow for the full year and apply that free cash flow to absolute debt reduction. Executing on these priorities should strengthen our balance sheet by improving our leverage and produce growth in cash flow on a debt-adjusted per share basis, a metric which has a high historic correlation to shareholder value creation. As shown on Slide 8, our focus in the 2020 plan is driving cash flow growth, not production growth, which we will achieve by allocating capital to high-margin oily development opportunities in both the Midland Basin and South Texas. I should note that we expect margin growth to continue into 2021. On Slide 9, we show the projected financial results of our capital program, which has reduced nearly 20% versus 2019, summarized with key metrics. In 2020, we expect single-digit EBITDAX growth and positive free cash flow at our planning price of $50 oil and $2.20 gas while leverage metrics improve. If commodity prices prove to be better than our planning price deck, free cash flow will be higher and leverage moves down more quickly. I'll now turn the call over to Herb to speak to additional details on our 2020 operating plan and some recent operational results. Herb?

Thank you, Jay. Turning to Slide 10 and building on what Jay just said about our key metrics, we plan to achieve these with a capital budget of $825 million to $850 million this year, which is down nearly 20% from last year. Of note, 2019 was down more than 20% from the prior year as our excellent well results have enabled us to drive growth with less capital. The capital budget allocates around 90% toward drill, complete and equip expenditures. We anticipate drilling approximately 96 net wells with approximately 80 in the Midland Basin and 16 in South Texas. We expect to complete approximately 94 net wells with 85 in the Midland Basin and 9 in South Texas. In our Midland program, we assume continued co-development in core intervals while continuing to test additional intervals over a broader area. All of our South Texas completions this year are planned to target the liquids-rich Austin Chalk. Slide 11 summarizes our 2020 plan guidance. The budgeted capital program results in 5% to 10% growth in oil production. Oil increases as a percent of the total production volume from 45% in 2019 to about 50% this year. Production guidance is 45 million to 48 million barrels equivalent or 123,000 to 131,000 barrels equivalent per day. We expect gas and NGL volumes to decline, offsetting our oil growth, as we focus our South Texas drilling on the oilier Austin Chalk and improve our margins. Total production guidance assumes ethane rejection for the full year under those processing contracts where it is economic for us to do so. This reduces our total volumes by about 700,000 barrels equivalent for the full year relative to full ethane capture. In terms of cadence, we plan for almost 60% of our completions for the year to be brought online in the second and third quarters with South Texas more back-end weighted. Again, our barrel equivalent production will be relatively flat to last year when adjusting for the full year of ethane rejection that I just mentioned. However, our oil percentage will increase as gas and NGL volumes decline until near the end of the year. Slide 12 shows that hedging is an important part of our risk mitigation, and 2020 oil production is well hedged. Oil makes up roughly 80% of revenue, and we have about 80% of oil volumes hedged to WTI with swaps averaging around $58 per barrel and collar floors at $55 per barrel. We also have substantial hedges in place to Midland regional oil and gas differentials. It is our expectation that Waha gas pricing will reflect potential regional takeaway capacity shortfalls, particularly in the second half of the year. Now let's turn to a more detailed discussion by region, starting with a summary of our 2020 plan objectives in the Midland Basin on Slide 14. There are a few key points on this slide. Our development plan this year has an average well cost of $7.6 million with an average lateral length of around 11,750 feet, which is up from around 10,500 feet in 2019. This translates to an average cost per lateral foot of about $650, and this is top tier. We are currently running 5 rigs and 2 completion crews. Slide 15 summarizes key metrics that have driven the capital efficiency gains that we have reported over the past couple of years. The tremendous progress shown by these measures, drilling faster, completing faster, extending lateral lengths and reducing sand costs, underpins the confidence we have in our ability to deliver more in 2020. Fundamentally, the metrics show how our operating teams just keep getting better in terms of execution. We are delivering wells with high productivity at low cost per lateral foot. And our land teams continue to improve the contiguous nature of our acreage, enabling the longer lateral length. All-in, going from an average cost in 2019 of $690 per lateral foot to a planned cost of around $650 per lateral foot this year comes from a combination of factors: first, longer lateral wells; second, faster execution that enables associated cost savings; and third, cost deflation, coupled with excellent partnering with our service industry contractors. Turning to Slide 16, which, once again, this quarter compares our most recent RockStar area wells to reach 30-day peak IP rates to our historical operated average. We have 41 new wells compared to 193 wells previously reported. This slide really speaks for itself. I believe that over the past 3 years, we have fully established the strength of our wells across our acreage position in differing intervals and at prescribed spacing. These newest wells are clearly strong performers. Now before turning to South Texas, I'd like to make one point on inventory value. As most of you know, we do not provide inventory detail or EURs because we find that companies calculate these metrics differently and data may not be comparable across the industry. I'll now point to Slide '17, which shows the results of an analysis completed by RSEG. It's not our work product, but we understand that it is calculated consistently across peers. RSEG categorized or bucketed inventory by breakeven oil price to assess relative inventory quality by company. In this slide, we are looking at Permian peers and the total inventory by company that hurdles a 10% IRR breakeven price at less than $45 per barrel of oil. It is very apparent from this analysis that a lot of inventory count falls off for our peers with this $45 per barrel breakeven cutoff. All of SM's Midland Basin inventory met this criterion in their analysis, reaffirming the high-quality of our inventory. Why? Because we are focused on returns and, therefore, inventory value, not simply sticks on a map. Developing at low breakeven prices means high rates of return, and that translates to faster payouts on wells and to a more rapid increase in free cash flow. Now moving down to South Texas in Slide 18. There are several points to highlight here. We have had excellent Austin Chalk results to date, more on that in a minute, and this year's completions in our current plan will be dedicated to this interval. Our development plan this year has an average well cost of $7.6 million with an average lateral length of around 11,600 feet, which is up from under 11,300 feet in 2019. This translates to an average cost per lateral foot of just about $650. Our plan currently assumes that we do not have a joint venture partner in South Texas in 2020. We recently engaged a bank to help us broaden the pool of potential development partners. Our gross completion count in South Texas could increase from our plan if we execute a joint venture agreement at some point during the year. We're currently operating one rig and are about to pick up one completion crew in the area. Slide 19 summarizes year-end metrics and shows the terrific improvements our South Texas team achieved last year. Here, too, longer laterals and faster drilling and completion times are critical components as we optimize capital efficiency. Slide 20 summarizes our Austin Chalk delineation program and the results of our latest completion of Briscoe 109H, which we brought into production in December. This new well with only a 6,500-foot completed lateral length came in with a higher oil cut and the strongest productivity per lateral foot of any Austin Chalk well in the area. On the left, you can see that cumulative oil production over the initial 75 producing days has reached 100,000 barrels of 52 API gravity oil. That's very impressive. The 5 wells that we have completed to date in the Austin Chalk, together with our geologic interpretations, indicate the potential for significant high-liquid content and economic recoverable resources in the Austin Chalk on the company's acreage. Now here's the real gem in this call. If you like Delaware Basin wells, you should really love the Austin Chalk wells on our acreage and especially this latest completion. They produce at high oil cuts and can be drilled and completed at much lower cost per lateral foot. As a result of the positive results from our delineation program, we accelerated this quarter the drilling and completion of another Austin Chalk well with a longer lateral. Finally, turning to reserves at a company level, our year-end 2019 proved reserves were 462 million barrels equivalent, including additions before revision of 102 million barrels equivalent. The year-end PV-10 was $4.4 billion or about $14 per share after debt. There is detail in the slide deck appendix for your reference. I'll now turn the call back over to Jay. Jay?

Well, thanks, Herb. Our purpose at SM Energy is to make people's lives better by responsibly producing needed energy supplies, contributing to energy security and prosperity and making a positive impact in the communities where we live and work. Our long-term vision is to sustainably grow value for all our stakeholders. And we believe that in order to do that, we must be a premier operator of top-tier assets. Our definition of being a premier operator includes outstanding safety and environmental performance as well as demonstrating appropriate attention to social and governance issues. Our efforts on corporate responsibility are reported on our website, including our performance against key metrics. In closing today, I would note that 2019 was a pivotal year for us in a process of transformation we've undergone over the last 3 years. We have made the turn to generating free cash flow and are still on a trajectory of improving margins that should be differential to our peers and drive highly efficient cash flow growth. We look forward to taking your questions on our live call tomorrow morning, and thank you again for your time and attention.