SM Energy Company (SM) Earnings Call Transcript & Summary

Good afternoon, everybody. It is my pleasure to introduce the next -- next speaker. We have Wade Pursell, the CFO of SM Energy. I'm going to turn the mic over to him.

Thank you, Gregg, and good afternoon, everyone. Thanks for your interest today. Yes, I will walk through the presentation pretty swiftly. I'm going to assume most of you are aware of the story. And then I'll take all the questions you have at the end. But -- and I'll try to remember today what I'm slide on. I'm on Slide 2 now, which just reminds you that I'm not a prophet, that's all that says. So you've been warned. Slide 3. So I suspect a lot of you know the history of the company, maybe some of you don't, believe it or not, the company has been around since 1908. I was not around for that first century. So I won't talk much about that. I have been around for the second century. I became the CFO of St. Mary Land at the time in 2008 and which was a great year to start. And I've really enjoyed the ride, frankly, the last 13 years, and it's never boring, right? If it might interest you to know that I enjoy rollercoasters too. So maybe that's part of it -- but it's always exciting, it's always -- and I'm really, really excited to kind of give you an update on the story today. And I'm on Slide 3 now. And actually, the story for SM Energy has become quite simple to be really frank. We are -- we've really focused on 2 basins, and we have 2 really, really good assets, one in the Midland Basin, one in South Texas. And I'm going to give you an update on those and take your questions on those as we go through. I'm now on -- that would be Slide 4. We -- last month, we released our third quarter results, and they were -- frankly, it was a great quarter, and I'm not going to take you through that again. I assume you all followed it. You can go back if you want. My summary of that -- of the quarterly results would be very strong well performance, plus continued capital efficiencies plus strong prices equals stronger cash flow and reduction in debt. That's really the story right now and that was very much the third quarter. So now on Slide 5. I'm going to kind of tell you the story today, which I think is really compelling and there's really a good pieces for investment right now, which I know is what it's all about but for you folks. I'm going to talk about it in the categories of plan, people and portfolio. I really like looking at it that way because I think that's the compelling story for SM Energy. And what I mean our plan will -- we came out with a plan early this year. It seems like a long time ago, last February, it was a long-term plan that really focused on optimizing our activity level that maximizes free cash flow and that maximizes debt reduction from that free cash flow. Everything else is outputs. That was the focusing plan, still is the focus of the plan, while generating kind of a flattish to single-digit production growth. So that's kind of the plan we came out with, and it is a compelling plan. I'll kind of talk about some of the outcomes of that now. I'm on Slide 6 now. We talk about value creation momentum. We've had a lot of that this year. The stock prices performed very well compared to peers. The bonds have performed very well this year. We're very happy about that. I would submit that there's probably 3 general reasons for that and kind of underpinning the value of the company, I would say, not to be forgotten is the Midland Basin asset and the consistency and the recognized value of that asset, frankly, is one of the best assets in the country. And I'm not going to talk about that [indiscernible] . So that's number 1. Number two, though, is the growing recognition of the Austin Chalk asset. And we continue to deliver well results that are starting to -- I'm going to use the word de-risk that asset. And I think that's a big, big part of the value creation story at SM Energy right now. And then third, sticking with the theme of de-risking interestingly is the balance sheet. And the free cash flow, it's being generated and is going to be generated and then using that free cash to de-lever the balance sheet, I think, is a very important -- very important point of the story and the part of the value creation that we're seeing this year and that we think we will continue to see as we move into next year. So now moving to Slide 7. That plan that we just talked about generates a significant amount of free cash flow in 2022. And this is just a research report showing that free cash flow in a model compared to valuation. It shows a very compelling free cash flow yield compared to our peers. So that's obviously a very important point. Slide 8 is also equally or even more important point, and that is the impact to the balance sheet of this plan and the de-levering that I just talked about. This shows the balance sheet at the end of the quarter, and there's always 3 ways to look at the balance sheet in my mind, it's total leverage first, and we're very excited to be below 2x the way out of schedule, what we announced for the third quarter. And we've said that our forecast, our focus is to be below 1.5x about a year from now by the end of next year. We're definitely on pace for that. I'll talk about more of that in a second. Other things as maturities matter a lot with the balance sheet, right? And we've got a lot of runway now with maturities, which is really nice to see a bit from a liquidity standpoint, the revolver essentially 0. And we just -- the banks just redetermined that $1.1 billion borrowing base. So lots of liquidity, lots of runway and leverage moving significantly, pretty quickly in the direction that we've been hoping for and planning for. So I'll now move to Slide 9. We get a lot of questions on hedging. This slide is right here because it really does tie into the balance sheet. That's the way we manage the hedging program, that's the way we've managed it for over a decade now. When we're -- when the leverage is higher for the last few years, our hedging is higher. And if you look back at the last 10 years, that is -- that has been a huge benefit for us during these lower -- lower tranches of the roller coaster in the way the industry works and the high volatility that we've seen in the last 10 years. So when we move to periods like now, where we see leverage much less and going down, our program, our strategy guides us to hedge less but to continue hedging. So what I've said is moving into '22, below 2x, we're targeting more like a 50% level of hedging. I think I mentioned on the third quarter call that just talks about oil and gas, but we also have a lot of NGL volumes and some of those are less hedged levels than this. I think overall, we're probably around 40% of our volumes in '22. So as we move forward, we layer in, and we've been layering in smaller layers of hedges targeting at 50% level. The other thing we do in a period of higher prices, which we announced we use collars almost exclusively versus the swaps we've added [indiscernible] so you'll see part of that. But it's the same program that we've always run and we try to be disciplined about it. And over time, it's really benefiting us, and that's the hedging program. So now moving to Slide 10. That was planned -- There is no plan without people and portfolio. So that's kind of the kind of the roots of the discussion with SM Energy. Another way to say that is we've said this for a long time now, our desires to be a premier operator of top-tier assets, premier operator for top-tier assets. So Slide 11. So I'll talk about the 2 assets and the operations with respect to that, starting with the Midland Basin. Again, no one argues with the fact that this is one of the best assets in the country. 82,000 net acres. You can see the map, if you're not familiar, most of it is in Howard County, that's called the RockStar area, those are the combined names of the 2 acquisitions we made back in 2016 . And in the area that we've been in for over a decade now in Sweetie Peck area in Midland and Upton Counties, fantastic asset, currently have 2 rigs running, 1 completion crew that right in the middle of the slide, if you look into Slide 11, where it says the '21-'22 drilling program expected breakeven flat pricing, right there tells you what a top-tier asset looks like, breakeven prices of $12 to $31 a barrel. These are really, really, really good assets. That's the asset -- when we say premier operator, I'll give you a couple of examples, we talked about these over the quarter. The first is just continuing to drive capital efficiencies in unique ways. This is an example, completion design, driving higher EURs and NPV per well. So this is what we call the miracle max, and you can see on the map in the bottom right where it is up in the Northeast portion of our acreage in Howard County. But you got these 3 wells with nearly -- you can see it in the slide, nearly 3,000 pounds a foot of sand loading and 64 barrels per foot of fluid, and you see the results, 64% improvement on the cumulative oil production flat. So really good results from these new completion designs, and we've been doing this on a lot of wells. I won't read everything you can see on the right, but [indiscernible] it improved the EURs, improved NPVs, just another example of ways that the team is amazingly continuing to improve and be more capital efficient. Slide 13, a couple of other examples, longest laterals in Texas. So on average, we drill the longest laterals in Texas. We've also drilled the longest ever. Everything is bigger in Texas, right though. So to ever say you've done the biggest is a big deal, and we had a nearly 4-mile lateral on the Sterling Sundown well recently. So longer laterals. The other premier operator example, I'll point to here is when we just completed our first Simul-frac. And what does that mean? Well, it means 16 stages per day, which is doubling the pace of the typical zipper frac. That's a big deal, faster, twice as fast. Of course, there's a horsepower cost to that, but it's only, I think, 60% higher. So you can understand how the math of that works very well and just improves again, the capital efficiencies of everything we do. I think that comment at the bottom of the slide is really important. It's not just for the sake of doing things that are high metrics and they look cool. It's always in the pursuit of commercially astute technical advancements. That's what we're always about. So Slide 14, so top-tier asset plus premier operators equals -- here's kind of the output of that, and it's the lowest Permian well cost. This is Enverus Research, and it shows how we're the lowest cost. I mentioned that we're on average, the longest laterals, and we see that here. And the result of that is the lowest price, the lowest breakeven price per barrel. And that's really important, especially in a week where you've seen oil pullbacks on like we have seen this last year. I think it's good to remind us that our assets are very resilient at prices a lot lower than where they are right now. I'll actually show you that on an inventory slide in a second. So moving along to the other asset, the Austin Chalk, which is giving a lot of buzz right now, rightfully so. This asset -- you can see the map for those who are not familiar in South Texas has been a great asset for the company. I mean, well over a decade. It was the cornerstone asset of the company for many years as an Eagle Ford asset, a gassy asset, a wet gas asset and really served the company very well. And you're kind of seeing it hit in version -- what -- version 2 now with the Austin Chalk, if you -- I'll give you just a little background. So this asset, the Eagle Ford, you can imagine, we drilled, I don't know, 500 to 600 wells historically over the last decade, but the Austin Chalk lies above it. So every well had to go through the Austin Chalk [indiscernible]. So over this period, we have tons of data to analyze and look at. Plus, imagine 600 wells that have gone to the Austin Chalk across the whole linage. So the team over the last 2 to 3 years was getting very excited about potentially Austin Chalk. And then we finally were able to start testing that couple -- 1.5 years, 2 years ago. And the results have so far been very confirming of what we hoped. And that is that the Austin Chalk is a tremendous resource for us. And I'll show you a couple of slides on that now. I'm on Slide 16. So the thing about the Eagle Ford was it was a great asset during -- frankly, during periods where gas prices were better, NGL prices were good, made great returns. As I mentioned, it was a great asset. The Austin Chalk is pretty -- much oilier, much oilier. And the returns so far we do not compete with the Midland Basin asset. They compete with the Midland Basin asset. And we keep using the word it's still early, and it is, it's getting later. I mean we have -- last year, we have reported 9 wells that had reached the peak 30-day IP rates. And all of those wells are fantastic. And I can tell you, they're still holding in very well, which I'll show you on the next slide. But before I get to that, just the most recent news on the Austin Chalk is Slide 16, and we reported this before the earnings call that we talked about on the earnings call and this is a big milestone. These are 6 Austin Chalk wells completed at development spacing. So this is a milestone moving along. And even at development spacing, you've seen these -- the results of these wells in the cumulative production plant, all doing very well. I mean we expected returns. I mean it's early, but they're eye-popping, right? They're over 100% these wells pay back in like 5 months, very high oil content. You can see that over 50% of liquids content, 3/4, right? To 75% liquids content. -- really good wells. And I mentioned, really importantly, development spacing from 675 to 1,000 feet. So just the continued consistent results of the wells that we've released and look on Slide 17, I really like this map on the bottom right. What you see here is we're now up to 22 wells total that we've actually reported . We have more of those that we -- these are the ones that would have gotten to the 30-day peak IP rate. You see how this -- you see how they spread out among -- along the acreage geographically they are. So getting a pretty good sample of the acreage, which is very exciting, very encouraging. And it's just moving down the path of getting comfortable at the 400 locations that we've been talking about or this is going to be a really big asset. I think as we moved along this year, I mentioned earlier that this has been a big part of the story. I think if the company that are based in here are watching it closely as they should. And we'll just continue to release these results as we move along. I mean within the -- I mentioned the 9 last year within the program this year, we -- I think we mentioned that we drilled 30 wells and completed 25 wells. So as we move along, we'll announce what the program looks like next year and how much of that's going to be Austin Chalk, but there's going to be just kind of a steady path here of announcing Austin Chalk results. And hopefully, they'll just continue to be this consistent showing the value. The other thing, I think Herb mentioned this on the earnings call that if you look at the wells we're drilling now and next year, well all of us so far, frankly, they have, if you assume a $60 oil and a $3 gas price, you're talking about an NPV10 of around $10 million per well. So I'm not going to make any promises on value, but if you can do the quick math on potential of that kind of number with 400 locations. So obviously, very exciting. And then Slide 18, this is an inventory slide, and I think I mentioned it earlier, I like it. It's independent research, it's Enverus, but it really shows 2 things. It shows -- it confirms what I was talking about earlier about the low breakeven prices of our asset, not just the Midland Basin but also the Austin Chalk, how it competes with the Netherlands? Some of the highest return assets that work at lower prices in the -- and certainly in the basin. And then I'll wrap it up with a couple of comments on ESG. We have for a long time said, you can't call yourself a premier operator unless you're a top ESG performer, and we believed that for a long time. And we're actually kind of excited to get much more formal about reporting in this area, and that's what you've seen from us. I think we've used the word and maybe we made up this word kind of operationalizing ESG. you've really seen that in the culture of SM Energy and forming these teams, making it part of daily operations, you're seeing metrics in our -- both of our short-term incident plan and long-term incident plans surrounding ESG, very serious about it. Using new technology, I don't have any results to report to you that we talked about on earnings also some kind of cool new technology for measuring and monitoring emissions that we're testing now and just tons of disclosures, right? All of the alphabet soup between CDP and SASB and TCFD are out there for you to go measure us, and we'll continue to put that out there to show that we are designing and performing at a top tier level in this very important area. Then Slide 20, this is also very important to us. We take it very seriously and then we provide some metrics for you in this area as well. In Slide 21, just to wrap up the presentation, again, I think it's a very -- there's a lot of positive momentum with the company right now, and I think rightfully so, and we're very excited as we move forward with our plan into '22 and beyond, generating a ton of free cash flow, de-levering with the -- and getting recognition for the top-tier assets, not just in the Midland Basin, but also the Austin Chalk. So I'll wrap it up there and open it up to questions.

Great. Your Jeremy client, your teammates suggest to me that I ask you to turn your camera on, if you can, but I'm not sure if you can. So ...

I tried -- I tried at least 10 times now.

He e-mailed me, so I thought maybe for some reason there was something he was telling you, but I'm fine looking at your picture there. And so -- You've talked about this free cash flow generation story. Clearly, this -- to get to this 1x target ahead of schedule. So how are you thinking about -- what you do with that cash in terms of reducing debt, addressing our near-term maturities, how are you thinking about that in terms of paying out cash to investors and maybe even growing some?

Great question. So I will tell you it's over 2x now. And I mentioned -- I think I mentioned on the earnings call that obviously, we're getting a lot of questions from equity investors about at what point do we consider returning cash to shareholders? And I think we were pretty clear that, a, getting to 1x as you mentioned, but quantum of debt matters, maybe more, I think. So getting to $1 billion of debt, we're over $2 billion still is critical to ask before we start considering that, okay? So in any model and any projection, if you keep commodity prices in this area, we will get there, but we're going to get there first. So first and foremost, it's to reduce debt down to $1 billion into 1x. So if you look at the maturity profile, I mean there's -- I'll just kind of talk about that as we move into next year. We have a lot of -- as I mentioned, we've got a nice runway, but there's always prepayable debt as we move through the year, the '24s are callable right now. We'll take that stuff out as we accumulate cash. And then as we get to the middle of '22, we got the '25s, we have unsecured bonds that when you get to the middle of the year, call it about [ 100 ] of it, but then you also have the second lien notes becoming callable. And it's at a price, but that's also expensive debt. So I think I've mentioned it's not news that when we get to that point, there may be drivers that are not simply the math to attacking those, getting second lien knows out of the capital structure is a desire of mine. And I think you could see us attacking those sooner rather than later. But the short answer is we're going to de-lever and we'll make the choices which tranches we attack as we accumulate the cash in '22 and '23, driving toward that level of getting below 1.5 to 1x and getting right to $1 billion.

And so you -- and is there a possibility that you refinance any of that? Or that's the call of a debt and that's what you likely just paid out?

Yes. I think that's -- it's a good question. The bond market has improved. It's just hard for me to imagine in this -- in our plan, the way it's set up so beautifully to generate all this free cash and using that to de-lever, that a refi would make sense. Never seen ever on that as the markets go forward, but it's -- that would not be -- I would not put that in the probable category.

And then once you -- so where does that leave you in terms of returning value to shareholders? Is that something you can do in '23? Or do you think about starting to do that before that?

Yes. Again, Again, I don't think it would even be considered to we're approaching that 1x, $1 billion area. So whenever that happens, that's when we start considering it. And look, the environment at that time will dictate how we feel about that. With what the needs for capital are? And what is the commodity price? Does it feel sustainable? Where are we? That's -- what I've said is that's going to be [indiscernible] and I stand by that. And then if you start asking me whether it's a dividend or stock buyback, that's -- those are questions that would make no sense to ask it right now, it's a bit more about the environment right now.

What about potentially returning -- just you mentioned you're setting up Austin Chalk. What about -- just how we sharing more capital towards growth?

Yes. No, I -- it's a good question. I -- we put this plan together. I mentioned it in -- the plan is what it is. And it's a plan that generates free cash flow and de-levers and maintains that level of production that's kind of flattish to single-digit growth and that just feels really good to us. And it's not just a 1-year plan. As we're putting it together, you put it together and what's the impact in the next 2 years to 3 years and 4 years, and you try to -- I mean it doesn't -- just to bounce around with activity based on price and all those things, we don't believe it's the right way to run that -- to run this business. So we're very happy with the program as we're layering it out right now.

And then the other question, other than return of value to shareholders, that you barely talked about this quarter that is top of mind for people's -- just inflation. Can you talk about how much you're expecting next year? And what you -- how do you -- how -- what are some of the ways you can mitigate it?

Sure, sure. That's a great question. We're analyzing that very close right now as we're going through the budgeting process, I mentioned on the call that we're starting to hear some things and seeing some things, labor, steel, trucking, fuel, some pockets, hearing some noise in the drilling and completion area. But we're assessing that right now. And when we give guidance for next year, we'll bake that in. And present it at that time, but nothing really quantifiable to report yet as far as a prediction on that.

And just remind us what you -- to grow your -- the double single-digit growth rate that you've talked about, what type of capital will you -- have you been talking about it to investors? Just us, how to think about that, maintaining that type of activity.

Yes. We haven't talked about that in a while. It's interesting when you're at a level now which we are, which is kind of flattish and single-digit growth where maintenance CapEx question becomes much easier to answer, right? Because you're almost maintaining and growing side. So if you could look at our program this year is across the -- we're growing set this year, but if you're just looking at current cost number -- I think the last time we talked about it was probably in the mid-5 to 6-ish area, but it's not hard to dial in that number given the kind of the flattish trajectory on right now.

So yes, there's been -- you were very well hedged this year. You've come with less hedging for next year. I'm curious how you're approaching that? Obviously, this big move in crude oil. I'm sure folks probably wish they may be putting a little bit more protection, but I'm curious how you're thinking about it?

Yes. No. I mean it's -- we try to be consistent. And because of that, we've layered some in over the last several months. And I mentioned in the prepared remarks, we use a lot more collars. But it's just -- we have just concluded over the years that a consistent approach and just doing it consistently is just the right way to do it and tying it to leverage in those factors. Look, I mentioned earlier, I'm not prophet, if I was, then we would load up hedges when it's at the high and we wouldn't when it's low, that's not possible. We use hedging as just a protection of the cash flow. And that means leverage drives how much of it we do. And we're just trying to stay consistent and staying consistent, I think, is the right way to do it versus making price calls.

And the other last question was out to half an hour. So like you've been a leader like your peers in ESG. Can you talk about how the process works for you? there's additional initiatives for next year? And just do you -- and this is a question I have. A lot of these ESG metrics are reported. I'm curious how good the monetary mechanisms are? And have you made choices to make sure you have a better reporting than your peers or whatever the industry standard? Just maybe you can talk a little bit about that.

Yes, it's a great question, and that's an early -- as you kind of alluded to, it's kind of an early developing story, right? Getting standards and then getting numbers that you can rely on, I think, it's going to be really important in the next few years. And we're very much focused on that. And whether it's putting in processes within our company that make us feel really good about the reliability, whether it's eventually having some kind of audit aspect to them. I think you'll see a lot more of that. But we're just doing everything we can to continue to improve, to continue to feel really good about the metrics that we're reporting. And I think that's the best we can do.

Okay. And then in terms of additional initiatives you're taking on right now, what's the next level of things we'll see? In this types of things?

Yes, it's hard to -- on ESG?

Yes.

Yes. It's hard to know that there will be some initiatives and we'll try to continue to talk about them. I think the one that we mentioned at the last quarter is very interesting in the reporting area using laser technology and some of these other technologies to measure, you're going to hear a lot more from us on that kind of stuff. And Yes. I don't have any others to preview at this point, but we will have. There's no doubt in my mind.

Well, I appreciate you sharing your insights here. And just telling us what's on the cutting edge. So well, thank you again, Wade and I really appreciate you participating in this conference. And next year, our plan is to have it at [indiscernible] . Hopefully, I'm sitting next to you on the stage.

Sure, hope that's a good...

And we should know what people -- people are intense anyway. Look, it's great catching up. And operator, we can end this call.

Thank you, Gregg. Thanks all.