SM Energy Company (SM) Earnings Call Transcript & Summary

Good afternoon, everybody. Next up, we're lucky to have SM Energy presenting, and we have the CFO, Wade Pursell. I'll turn it over here to him to run through some slides, and then we'll have Q&A. Wade, you're up.

Okay. Thanks, Gregg, and good morning or good afternoon, everyone. Thanks for joining us today in this very, very unique format. Gregg and I were just talking about how different it is in this conference versus last year. I trust you all had a great Thanksgiving. A very different Thanksgiving, I would imagine. And it's interesting, I was just thinking this morning about this conference and kind of getting ready for the meetings and thinking, wow, a year ago, how different, right? I mean, would have flown to Florida, might have got out this morning and maybe even walked on the beach, would be in the room with you guys right now, probably with a suit and tie on, instead of in my home office in very cold Denver, Colorado, wearing not exactly a suit and tie, but I'll just leave it at that. So I'm going to be going through the slide deck. Hopefully, you have it in front of me. I'm going to go pretty fast. But we'll be happy to take any questions when we're finished. I'm on Slide 2 now. And I'll remind you that I'm still not a prophet. If I were, I would have said something a year ago about a global pandemic, wouldn't I? So be forewarned there. I'm on Slide 3 now. So for those of you that may not know us really well, our mission at SM Energy for a long time has been to be a premier operator of top-tier assets. I think most people that know us would agree we've been a premier operator for a long time, and there's a lot of evidence of that. Regarding top-tier assets, we had some that were top tier, maybe some that weren't. And I'll go back to 2016 when we really went on a strategic mission to divest of those that didn't qualify and to really core up in those areas that did qualify as top-tier assets. And really important to have top-tier assets, that -- that's assets that generate healthy returns even at low commodity prices. And we're definitely seeing why that's so important right now in 2020. Made a large investment in some -- in the Midland Basin, adding to what we had there. Frankly, the plan has worked very well in this transformation. We came with a large investment, so it came with some, obviously, some capital requirements that the balance sheet had to fund. And really, just this last year, we were getting to the inflection point of being able to start generating free cash flow, reducing leverage, et cetera, and then the world kind of changed, but we're still very much on that track. I'll turn to Slide 4. It's interesting given all the dramatic changes this year. I looked back before all this happened. Our targets and our objectives are actually almost exactly the same. And that is to grow free cash flow, generate free cash flow and use that free cash flow to reduce leverage. Our targeted leverage is to get to where we're under 2x. We're at 2.4x in the latest quarter we reported. The plan shows us getting there over time. It's a grind, but I'm proud to report that we have a plan that does that in a reasonable period of time. And then finally, from a targeting standpoint, we believe you can't say you're a premier operator. We've always believed this, unless you are a premier ESG performer and that is one of our targets as well. And I'll speak to all of this as we go through the slides. I'll shift to Slide 5 now. Like others, in our industry, we responded early this year with a slowdown in activity, with the pausing of activity and really started focusing on costs and get cost reductions across the board. We've seen really, really good results there. Costs have fallen actually more than we could have expected, which has really enhanced our free cash flow generation this year, to be honest. The third quarter was really, really strong. We generated $64 million, which brought our year-to-date total to $172 million of free cash flow generation. As I mentioned earlier, the goal is to use that to reduce debt, and that's what we've been doing. Just in the third quarter, we were able to reduce debt by $106 million. Next slide is just some data on the third quarter results. I'm not going to read through this. It's really just there for your reference. So flipping to Slide 7 in the balance sheet. Most of you know this really well. As I mentioned earlier, we reported that we're at 2.4x debt to trailing 12-month EBITDAX at the end of the third quarter. You can see how all of that debt schedules out from a maturity standpoint in the chart on the bottom right. We keep chipping away at those earliest maturities. If you look at this chart, the last several quarters, you just see them continually going down and down, and we have those numbers down to where they are currently. We just announced the fall redetermination of the revolver of the borrowing base on the maturity schedule that fits in 2023. That's that large tower, and the lighter color is the reflex of liquidity in that borrowing base. I'm happy to report that the banks reaffirmed the $1.1 billion, which is the number that it was before. And that's not a small thing. I think we probably didn't say enough about it. When you consider the slowdown in activity, when you consider that the $1.1 billion ties back to the spring, and then you consider that we had some really, really good hedges that we were fortunate to have entered into for 2020, this more recent affirmation of the $1.1 billion doesn't have a lot of those hedges in it now. So this is a real testament to the assets and their value even at these lower commodity prices that the banks are using in their borrowing base determination. The other thing that came out of that was kind of an extension, if you will, of the remaining second-lien debt capacity of $380 million. You remember there was a large amount approved in the first quarter. This was the amount that was not used. You should not read into it. That means we want -- that we have anything planned, but it's just additional flexibility. So it was nice to get that extended. Those notes in 2025 are trading quite well. I think they're about par currently. So that's a good thing. It's good to have that flexibility. But again, no plans to do anything with it currently. And then finally, from a debt-to-EBITDAX standpoint, the chart at the bottom left kind of shows you projecting out a little bit in a very directional manner. Granted, I think it's important to note that in 2021 our plan and our forecast, even at current strip, at current cost, has us staying below 3x. And that's important because when you, again, imagine our hedges rolling off and getting into a more current pricing environment next year supported to us that we can generate free cash, keep leverage below 3x. And then as you go into '22, you see it really going down and toward our target of 2x, hopefully by the end of '22. So next slide, Slide 8. Speaking of hedging, we're very, I would call it, consistent, methodical hedgers. And that's really served us well through the years, especially served us well this year. So we've been continuing to hedge. We've got a lot of hedges the rest of this year, which is almost behind us. If you look at 2021, with our leverage level, which is what, frankly, we use to determine how much we hedge, you can imagine that as we approach a year, as we're approaching 2021, our target would be somewhere around 3/4 of our forecasted production hedged as we enter into the year. So I'm not going to give specific percentages, but you can imagine oil is trending that direction. We've been doing some more hedging recently with the improvement in prices. And on the gas side as well, you can imagine us being about 3/4 hedged there, as we approach the end of the year. All the details are included in recent slide. I think the appendix probably of the third quarter results is pretty close, but we've added some since then. So I'll take you to Slide 9 now and a quick look at the assets. Again, we've really cored up into really 2 assets, the Midland Basin and South Texas. I'll say a few about Midland Basin first and then a few words about South Texas. 82,000 net acres, truly a top-tier asset, truly a top-tier asset. If you're in Howard and Martin Counties and then down in -- our more legacy positions down in Midland and Upton Counties, what we call Sweetie Peck, we currently have 3 rigs running, 2 completion crews running. I mentioned that we slowed down earlier. That resulted in us now forecasting about 70 net completions planned for 2020. The other items on this slide, I'll talk about in more detail on the upcoming slides, which moves me to Slide 10. So top-tier assets, but also premium operator as well. And you really -- you can really see it on this slide, the improvement in drilling efficiencies, the improvement in completion efficiencies over the last 3 years are quite significant actually. 51% more feet per day drilled over the last 3 years. And not just point A to point B but a steady improvement, you can see on this chart. And even more so on the completion side, 165% more feet completed per day. Quite amazing, to be honest. Continue to drill longer laterals. You can assume around an average of 11 or 11.5 right now, but some longer than that. And then costs have continued to go down. I think one of the best examples is probably looking at how much sand costs have gone down. So Slide 11. You can see a definite kind of affirmation of us calling this a top-tier asset or the best asset in the basin, you might say, per a recent report from RSEG, what they've done has shown you, our asset versus the other assets in the area and ranked them by the lowest breakeven price. That matters a lot, doesn't it? So you can see that our asset actually makes #1 when you look at it that way. So turning to the South Texas asset real quick. This has been a core asset for the company for a very long time, over a decade. Very large contiguous position, 159,000 net acres. We've drilled over 500 wells here through the years. It's been a great asset for us. Historically, it's been a wet gas asset, but that's changing. And I'll talk about that in a minute. Just some recent developments that are improving here from a cost standpoint, some really good news there. With some improvements in our transportation contracts, we're going to be gaining $0.25 per Mcf in the middle of '21 and then another $0.35 in the middle of 2023. And that really matters. And there's $5 that we've already realized a barrel on condensate is a big deal as well. A quick comment. We recently announced a pretty small JV for 6 DUCs to complete those. That's ongoing this quarter right now. That was an opportunistic case for us to just preserve some capital, get someone else to pay for the completions on 6 DUCs. So I think the big news in South Texas, though, relates to the Auction Chalk and some success we've had there. There's real opportunities there. I'll turn to that on the next slide, Slide 13. The Austin Chalk is a -- it's a zone that lies across our entire position. So you can imagine the potential and the reason for excitement there when you consider how large that position is for us. It's oilier. I mentioned earlier that Eagle Ford, historically wet gas. The Austin Chalk is oilier, which obviously translates to better returns. And so far, early days. But 9 wells in, we're starting to conclude that the returns here are going to be competitive. They appear to be competitive with those in the Midland Basin. So that's very exciting for us. What you see on this slide is the last 3 Austin Chalk wells. And they have -- just to give you an idea of how nice the potential returns here are, they have breakeven oil prices. And that -- by the way, that assumes a $2 gas price with, I think, longer term, $2.40 in that calculation. So there could be some upside there. But some of that -- these wells have breakevens ranging from all the way down to $17 per barrel of oil up to $31 a barrel oil, so really nice low breakeven prices. We can see where these wells are on the map, that these last 3 are nicely spread out, which I like. And then you can see in the cum plot, on the bottom left, they're all performing very well, but very oily, right? I mean if you look at the IP30 oil rates on these wells, they're really nice, and that really does create opportunity for having a high-return asset. We've said if you think about how much potential economic inventory that compete could be here, it's very early days to be making any calculations or assumptions in that regard. But from a potential standpoint, I think our CEO, Herbert, said that it's hard to imagine this being less than 100 locations, which would be great, and could easily see it being up to like 400 locations. So that's meaningful, very meaningful inventory. As a real direct impact on our margins, if you just think about where our margin in South Texas currently are, looking at the chart on the left, and then you kind of bake in some of the positive things on the cost side that are happening, that I just mentioned earlier, with respect to decreases in our transportation costs coming in the next few years and then the high-return potential, high oily nature of the Austin Chalk, you see a dramatic increase in the dollars per barrel margins in South Texas versus what we can be looking at in the coming years from Austin Chalk well. So very exciting. And last but certainly not least, I mentioned one of our top 3 areas of focus being EFC, and this is not new for us. Again, I can't state it enough. We've always believed that you can't call yourself a premier operator in our business if you're not a premier ESG performer. And that's -- it's always about protecting your employees, protecting people and protecting the environment. And you're going to see a lot more from us on quantifying that, showing metrics that actually demonstrate that through emissions on the environment side and through safety performance as well. If you want to look at a lot more detail than I'm showing you here on this slide, and I'm on Slide 15, you can go to our website. We've recently updated our corporate responsibility report that gives you a lot more there. And a couple of other points, I would say, is a lot of oversight from the Board on this, always has been. But just to highlight that, I think we recently renamed one of the committees, the ESG Committee, to show that focus on ESG. And you can also know that a lot of these metrics are included in our compensation. They always have been in the short-term plan, and that will continue, but I think it's safe to assume that going forward, you're going to see some of this show up in our long-term compensation program as well. So finally on Slide 16, I'll finish the way I started. Just reiterating that we are -- I think we're fulfilling our mission to be a premier operator of top-tier assets. We're very focused right now on generating free cash flow and reducing our leverage, getting down to that targeted level of 2x and always only doing it while being a premier ESG operator. So with that, I think that ends my prepared remarks, if you will. I'll turn it back to Gregg for any questions you might have.

Thanks, Wade. So I'll -- something you said. You announced -- I think you announced the JV here today with the Eagle Ford that you mentioned on...

No. That you -- actually you heard it from -- actually it was a few weeks ago, Gregg.

What's that?

Yes. It was actually a few weeks ago.

Few weeks ago? I guess I missed it in the announcement.

So it was a small announcement with the borrowing base redetermination.

Borrowing based -- yes. So that's helpful. So I have 2 questions here from somebody who wants to know how many wells will this be for? Will this extend into 2021? And can you provide more color on the economic splits for the JV? The question goes on, say, for DUCs, does the JV partner economics make allowance for the drilling costs? And then can you just repeat, I believe you said there's $100 million to $400 million of inventory. Could you just repeat that?

Yes, sure. Yes, the announcement that we made, again, this was a -- I would characterize this as an opportunistic agreement. You'll remember that we opened the year up in a different world, looking at opportunities to do things with our South Texas asset. We kind of put that on hold when the world changed for obvious reasons. But I think people kept watching it. And in this environment where gas prices, frankly, and NGL prices improved so much, we were approached by one of the parties to do something, and we were able to negotiate something for really just 6 of our DUCs, and 3 of them being Eagle Ford. And the arrangement, it's for those that are -- they're happening right now, to answer part of that question, here at the end of the year. And they'll kind of be completed and online in the first quarter of next year. So it doesn't really impact the future, but it preserves some capital for us right now. I think we said the number was somewhere around $15 million. It's just the completion costs, and going forward, a 50% interest in those wells. So that's the general part of that deal, not a big deal. But in a period where we're trying to preserve cash and pay down debt, it was something that we were happy to do. And would we do stuff like that in the future, someone has asked, I would say, we always look for opportunities to do things like that. And if the economics justify it, then we'll be keen to look at that. Then your other question was just to say, again, my comments about inventory, and I want to stress, this is very early days and very high level. But just to show the potential, we're pretty confident looking at our position, but it's hard to imagine we're not being at least 100 wells of economic locations here. And you could easily do upside math to get to a number around 400. But very early days, and we'll say more about that early next year when we talk about inventory, but get more specific and quantify it better, as we move forward and drill our wells, obviously.

That's helpful. And just taking a step back. So obviously, you have a clear plan here to deleverage. That's been the mantra for the last several years. I imagine it's even more enforced after this year. But I'm just curious with everything that's going on in the world, how are you thinking about your longer term growth story and shareholder returns story? Has that changed significantly over the last year? And how should we be thinking about it?

That's a great question. I think what I would say is that the plans are not unrelated. What we had been shooting for, as you just said, is very similar to where we are. And that's -- we've always been -- had an eye toward getting to a point where we can generate free cash flow. And the best thing we can do for every investor right now, we know, is to reduce leverage. That's probably changed a little bit, to highlight on that, and the capital markets, what's happened there. So we're probably even, I would say, more committed to that for a period of time than we might have been before. But directionally, it's the same thing. What's comforting to me right now is that we can do that. And I've got to -- we've looked at -- we've done a lot of work, obviously, recently on 5-year plans, 10-year plans and the amount of inventory, economic inventory we have allows us to do this over a long period of time without needing to add big amounts of inventory, especially if the Austin Chalk crew is successful. So the idea of reducing leverage and that being the best way that we can increase value for bondholders and value for equity holders is pretty clear right now. And I don't think it could be any clearer. As far as growing beyond that, I think we'll continue to look for opportunities, but not needing to do anything for a period of time here. I'll also remind folks that, look, the Austin Chalk came up and we owned it already, that opportunity exists in the Midland Basin as well with other zones. We haven't talked about that next this year because that clearly has not been the focus of discussions. It's more about returns, free cash flow, delevering. But those upside intervals still exist. And we do test those, as we go through our co-development plans. You're not going to see us declare any victory until it's time. But I want to remind folks that, that's still there, and that's still upside. But that's kind of the way we're thinking of things right now.

So when you achieve your leverage target, do you think about growing from there for return on capital? Do you think about returning value to shareholders through a dividend or share buyback? How are you thinking about it?

Yes. Great question. And I would say it's -- the things will change. What I will say right now is, again, in the foreseeable future, and when I say foreseeable future, I mean 2 or 3 years, we all know, I think everyone would agree, that the best thing for every investor is to use free cash to reduce debt. So other things at some point will be on the table, but it's going to be a while.

Do you think your 2x leverage target is something you can maybe more aggressive? Is there possibility that coming down more? And just remind us what types of -- what oil price are you assuming when we think about 2x leverage target?

Yes. I mean -- yes. So -- okay. So I'll say it 2 ways. First, just from a theoretical standpoint, the 2x target, we think, is just a good place to be to run an oil and gas company, below 2x, I should say, right, perhaps between 1.5 and 2. So that's our target. Our plan gets us there, as we approach the end of '22, just generating free cash. And that's at a recent strip and a view of the cost environment, maybe with some slight inflation. So that's recent prices is what I would say to answer your question.