SM Energy Company (SM) Earnings Call Transcript & Summary

Welcome to SM Energy's Third Quarter 2020 Financial and Operating Results Webcast. 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 providing guidance for 2020 and beyond as well as commentary on strategic objectives beyond 2020. 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 forms 10-K and 10-Q. Discussion of third quarter 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 referenced during this call. Today's prepared remarks will be given by our CEO, Jay Ottoson; CFO, Wade Pursell; and President and COO, Herb Vogel. I will now turn the call over to Jay Ottoson. Jay?

Good afternoon, everyone, and thank you for joining us. I will start with my comments on Slide 3. Our message today is very simple, our quarterly results indicate again that we are on track in accomplishing our strategic priorities. Those priorities are to generate growth in cash flow through making high-return investments, while spending within our internally generated cash flow and using our free cash flow to reduce absolute debt and leverage. As a premier operator of top-tier assets with ample liquidity, we are well positioned to continue making progress in the same positive direction. Third-party analysis of our Midland Basin results indicates that our wells there have among the lowest breakeven oil prices of those of our peers. And we continue to see excellent results from testing of the Austin Chalk on our large acreage position in South Texas. Our third quarter results were exceptional, exceeding our own expectations and those of the investment community. We generated $64 million in free cash flow in the third quarter, contributing to our total $172 million in free cash flow year-to-date. That is remarkable for a company with a current market capitalization of around $180 million. The free cash flow we generated was applied to debt reduction. Long-term debt was reduced more than $100 million during the quarter and is down about $350 million year-to-date. Our forward business plans are being optimized to maximize the amount of free cash flow we generate over the coming 3 years, allowing us to reduce absolute debt and leverage while expanding project inventory on our existing asset base. Before I turn the call over to Wade, I would like to shout out a big congratulations and thanks to our SM team members who have delivered these great results despite the challenging times for our industry and of course, the pandemic. I'm particularly proud of our outstanding safety performance and with the success of our team in managing consistently within our stringent COVID-19 protective protocols. With that, I will turn the call over to Wade for his analysis of the quarter. Wade?

Thanks, Jay, and good afternoon. So turning to Slide 4. Our third quarter results were very straightforward. So I'll use our time to highlight some key points. On the topic of generating free cash flow, I'm happy to report that we've been quite successful. This stems from a combination of things. Capital expenditures have been reduced 27% at the midpoint from our original February plan, which is a combination of deflation, timing and efficiencies, while production guidance remains within our original range. Lease operating costs have been reduced by 25% from our original budget, which is a result of aggressive cost management and efficiencies in the field such as faster connections to the electrical grid, which sizably reduced the cost associated with running generators and more efficient use of compressors. So as a result, better operating margins and lower capital, combined with our strong commodity hedge positions, led to substantial free cash flows, which we've been using to reduce debt, which leads me to Slide 6. During the quarter, we applied free cash flow to the repurchase of outstanding 2022 and 2024 bonds at market rates, buying back $91 million of principal value of debt for $66 million of cash. Including the credit facility, total debt reduction in the quarter was $106.5 million. We ended the quarter with net debt-to-adjusted EBITDAX of 2.4x and that's down slightly from last quarter. We are on track to keep net debt-to-adjusted EBITDAX south of the 3x level through 2021 and approaching our 2x target at year-end 2022. And that's based on our plan running at strip pricing. And we substantially reduced our near-term maturities. Debt due through the end of 2022 now totals $297 million and that's down from $649 million at the beginning of this year. We retained significant liquidity, which was $880 million at the end of the third quarter. Regarding the revolving credit facility, we had our fall bank meeting a few days ago and expect to complete the redetermination process in the next couple of weeks. There's not much I can comment on here, but I don't foresee any surprises at this point. And now turning to Slide 8. Our updated guidance highlights our focus on capital discipline and cost management, while well performance from both Midland and Austin Chalk continues to be strong. Specifically, the reduction in capital expenditures includes further realization of capital efficiencies, such as faster drill and complete time and some additional cost deflation, but it also includes testing a higher cost completion design and costs associated with a number of wells scheduled to turn in line in the first quarter of 2021. Our 3-year plan is structured to meet our objectives of generating free cash flow and reducing leverage over the course of the plan, and thoughtfully incorporates timing to take advantage of the current lower cost environment while growing higher-margin oil production in 2021. So to wrap it up for me, I would just like to emphasize we're currently on track, actually slightly ahead of plan, to generate free cash flow in 2021 and substantially grow free cash flow in 2022 based on strip pricing. So with that, I'll now turn the call over to Herb to discuss operations. Herb?

Thank you, Wade. The third quarter was also very straightforward from an operations perspective. The team really did an outstanding job while, as Jay mentioned, also adhering to stringent COVID protocols, which are completely aligned with our long-standing focus on employee and contractor safety. Before I review the quarter, I'd like to point out 2 accomplishments that don't show up in the numbers you routinely see. First, our team in Sweetie Peck just logged 3 full years without a single recordable incident. Safety is our top priority, and this exemplifies the efforts of our field employees and contractors. Congratulations to all of you. Second, we successfully reduced flaring in the Midland Basin, resulting in flaring less than 1% of our produced gas company-wide during the quarter. This required a conscientious effort across SM as well as our midstream gas processors. Compensation at SM is tied in part to ESG and specifically greenhouse gas emissions metrics. Reducing flaring is one of the most effective ways for us to cut our greenhouse gas emissions as part of our contribution to our Paris aligned greenhouse gas emission reduction goals. Turning now to Slide 9. In the third quarter, we picked up the pace of completions in Midland, and as a result of the continued efficiencies, we accelerated several completions in the late 3Q from 4Q. In October, we dropped one rig and added one completion crew, which will enable us to complete our planned activity for 2020 and set us up for a strong first quarter of 2021. From a combined ESG and cost perspective, during the fourth quarter and first half of 2021, we will be evaluating dual fuel technology on the drilling rig and on a completion spread. Turning to Slide 10. Here, we show our efficiency gains each quarter. It is truly astonishing and gratifying to see how we continue to get better and better. We now see a 20% improvement in drilling efficiencies and a 35% improvement in completion efficiencies year-to-date, both measured in feet per day. This is what keeps our well cost top tier. I will note that we continue to show average well costs at $560 per lateral foot in our slides, but we are seeing better costs, and we'll bake in the improvements to our 2021 plan as appropriate. Turning now to Slide 12 and South Texas. We have picked up a rig and completion crew in South Texas as planned, and these will set us up return in lines during the first quarter of 2021. During previous calls, we talked about pending contractual improvements in South Texas. I'd like to point out that we are now recognizing the $5 uplift on condensate and oil as one of our older contracts rolled off. In fact, market rates are now providing us with better than a $5 uplift compared with prior terms. I'll add here that we have interest from third parties to initiate a small-scale JV in our dryer gas area, which I believe underscores the fact the potential returns of this area have been recognized externally, especially at recent strip prices. No assumption of a JV has been included in our forecast. Turning to the Austin Chalk on Slide 13. Last quarter, we spoke in depth about our Austin Chalk results, and this slide updates the performance of those recent wells. These wells continue to track a flat oil price breakeven 10% return that is below $20 per barrel for the 109 and 1009-H and around $31 per barrel for the 910H. This assumes gas pricing at $2 per million BTU for the first half of 2021 and then $2.40 per million BTU gas after that, so well below current strip prices. These breakeven prices look even better, lower by $5 to $9 per barrel, when we run the calculations, assuming gas at $2.50 and NGLs at 40% of oil price. I will reiterate that these wells are competitive with any basin in North America. On this slide, I'll draw your attention to the top left, where we have added recent commentary from JPMorgan and Enverus that support our excitement for Austin Chalk performance and returns. This underscores the potential value creation from our existing asset base. We have 2 more delineation wells that have been flowing back for around 3 months now but did appear to have a mechanical issue in one of these wells after completing the well and initiating production. Lastly, I'd like to echo Wade's comments regarding our 3-year plan. Staying with our priorities of generating free cash flow and reducing leverage, our 2020 through 2022 plan is well designed to meet those objectives in the current strip environment. We are taking advantage of the current low-cost environment to generate strong double-digit oil growth in 2021, which in turn sets up for projected lower capital and greater free cash flow in 2022. If natural gas or oil prices exceed strip, it is our intention to use additional free cash flow to reduce leverage. As always, the slide deck appendix provides extensive detail on the quarter for your reference. This completes our prepared remarks, and we look forward to our live Q&A call and webcast tomorrow morning.