SM Energy Company (SM) Earnings Call Transcript & Summary

All right. We'll go ahead and get started with our next company presentation. We're happy to have SM Energy with us this afternoon, President and CEO, Herb Vogel, here to tell us a little bit more about the company, and then we'll do some Q&A. Okay. All right.

Great. Thank you, Bill, and thanks to CS for inviting SM. Afternoon, everybody. Really glad you're able to be here and listen to the SM Energy story. It's been an exciting run. We've had a great transformation over 7 years, and we're at the cusp of great things here. We had a great 2021. And I'm going to be having some fun going through the SM story with you. So first, I will be making some forward-looking statements, and I'll just point you to the cautionary statements about that. And then really, what I'm going to do is look back briefly at 2021. I'm going to do kind of an accelerated version through our slide deck to leave some time for Bill to ask questions. And I'm going to look ahead at 2022 and then look underneath the hood a little bit and take a look at the assets that underpin our performance that we've had and that we see looking forward. First of all, I'm going to start with 2021, and I'm really going to go over contrasting where we were on our goals for 2021 versus where we actually -- what we actually delivered. And the first thing was to generate free cash flow in 2021. And we were targeting at the then strip pricing in early 2021, around $100 million in free cash flow. And with a commodity price tailwind plus the performance of our assets, we actually generated almost $400 million in free cash flow. So a great year there. Target was to reduce leverage. It's been a priority of ours for several years now. We were targeting getting it 2x by the end of 2022. We actually got in under 1.5 by year-end, and that's versus year-end '20 when we were 2.3x. The other goal is maintaining our top-tier inventory. Those of you who have been following us closely know the quality of our assets. We've got some great acreage. We basically replaced any inventory we consumed during the year. And we see potential to add from there. So we're at 13-plus years of inventory, and that's really high-quality inventory. And then finally, on the ESG side, we want to be at the top quartile of our peers. And we definitely exceeded all our internal targets for methane intensity, greenhouse gas intensity and our produced fluid spill rate. So just a great 2021. I'm going to skip over this next slide. I'm going to get into some of the details a little bit later and go straight to our balance sheet. As I mentioned, 100 -- 1.47x, we eliminated about $450-some million in debt last year, which is phenomenal. And you can see in February, Valentine's Day, we retired another $105 million in term debt 2024 maturities. So this is the debt stack. You can see we've got the second liens and some term debt in 2025, and we're really working on generating the free cash flow to retire more of our debt there. And that's a major priority. Proved reserves, great year. Commodity prices were up, but they're really at $66 oil, so considerably below where strip is today. Our pretax PV-10 is $8.2 billion now, SMOG, the SMOG calculation would be just over $7 billion. Reserves Life Index of 10 years. And you can see the components were really, out of the about, 143 million barrels, about 80-some million of that was in the Austin Chalk and about 40% were in Midland Basin. So phenomenal there. Total reserve adds of 143 million barrels. So that's 2.8x production replacement, which is phenomenal for the type of capital the year we had last year. You can see the numbers there, 61% proved developed and 41% oil, 42% gas and 17% NGLs. Talking about inventory. Our total company expected inventories for 13 years. We like to show Enverus' number because it's really talks to the quality of the assets. And there, they see 9 years of inventory at a sub-$50 barrel oil with good returns at -- and we see our Midland Basin inventory is 12 years, and the return on that inventory, average return is over 55%. So that's the fundamental -- you got to have a runway on inventory, and we're well positioned on inventory end of things. We're not running out of inventory. That gives us a lot of flexibility on what we do year in, year out on our use of our free cash flow. So looking ahead real quickly. The strategic objectives are really clear to us. We believe we're really undervalued from our Austin Chalk perspective. So it's really, we want to build our NAV through scaling up our Austin Chalk number of wells so that people can see the type of performance we are getting continuing with our Austin Chalk. So we're going to complete about 32 wells in 2022 on top of the 40 -- well, 30 for the rest of the year, we got 40 today because we turned on 5 wells this year. And then we're going to grow our free cash flow and reduce our leverage. And these are the targets 1 and 1. So just remember that for us, 1x levered and $1 billion in absolute debt. We anticipate getting there by midyear for the leverage and by end of the year or early next year for the $1 billion in absolute debt. At that time, we'll talk about what types of options we have for returning cash flow to -- return capital to shareholders. And then we're going to continue to grow our top tier inventory. We've got active programs, really checking out additional intervals in the Permian Basin and obviously doing what we can on the Austin Chalk with where we are. And then on the ESG front, we're continuing to be top tier in terms of overall emissions in particular Scope 1, Scope 2. We show this little house here. Basically, the premier operator is all about operating extremely well. We've got one of the finest technical teams in the industry. We've got great assets. And then if you walk your way through the house, how do you get to the equity value, it's really growing the reserves and inventory and really using our capital wisely. So our guidance overall, $750 million capital budget, production of 51 million to 54 million barrels equivalent. And we're going to be allocating a bit more capital than last year to the Austin Chalk than last year. The Permian Basin will be 55%, and the Chalk will be about 45%. You can see the first quarter guidance there. But let me just jump ahead to hedging. We were hedged at 75% in 2021. With our leverage dropping as far as it has, we chose to go to around a 50% target. That's where we are in oil. Gas were a bit less. And then NGLs were considerably less. As our leverage continues to decline, we see hedging forward at more the 30% to 40% level for 2023, and that's really just tied to our leverage. Looking underneath real quickly. I get quite excited about looking at Midland Basin. We're going to have 40 net completions, but it's our new completion design, which is exciting. We'll be running 3 rigs and 1 frac spread there during the year. First is 3 wells with a new completion design, where we've shown a 50% improvement over 9 months. There's a much bigger story here. We looked at a lot of data, really over 1,400 wells optimizing and we use machine learning to assess the optimal completion design. And what we found is in the first 50 completions we ran in the first half of 2021, on average, the improvement in performance over the old completion design is 15%. And the incremental capital for that enhanced completion is not that much, about $0.25 million per well. So that's the Miracle Max. There's -- the other was on the northeast part of our acreage here. In the Northwest, we just hit 3 of our highest IP90 productivities in the northwest portion of our acreage. And here, you can see 91% oil, 2,500-plus BOE per day. And those are the 3 wells listed. So that's just what's underpinning the real outperformance in our oil production in the third quarter and the fourth quarter last year. Switching over to South Texas. Here, we'll drill about 37 wells and complete about 38. 85% of those will be in the Austin Chalk. The remainder will be in the Eagle Ford, 4 that are DUCs currently and 2 that will be codeveloped with the Austin Chalk. And we'll be running 2 rigs and 1 completion crew there. I'll just talk about why allocate more capital to the Austin Chalk. This slide is probably the best indicator of it, independent third-party, Enverus, looked at the breakeven oil price for a lot of our Permian peers. So all those gray bars and the yellow average. And then on the -- in the box is really showing our Austin Chalk in blue and our Permian in gray. So you can see we've got 2 basins, top tier, both of them, and we have the optionality of switching back and forth. We're choosing to go more to Austin Chalk simply because we haven't been recognized -- the value hasn't been recognized in our share price yet. And we get great results, and we really are driving for maximizing free cash flow over a 3-year period. We're able to do that with the Austin Chalk as well as the Permian. This is a little bit more on the Austin Chalk. This shows the average production of our wells in the Austin Chalk and you can see going through over 2 years. This includes 35 of our new wells last year. We see over 400 expected locations. We've put that number out there more than a year ago, and we're still on track for that type of inventory count. So this is no incremental capital for land, simply organically derived directly above our existing 600-well Eagle Ford position. So that's why it's been super capital-efficient. The map on the bottom right shows in black the wells that we -- our PDP wells. The blue wells that were in 2021 and the green is our program in 2022. So you can see we're pretty well delineated. We've got a lot of development, pilots of development spacing throughout the acreage. And 2022 is all about coming up with an optimal completion design. So far, we've done is run an old Eagle Ford completion design. And now we're going to be spending about an extra $18 million this year on doing science to really optimize that completion design. And we hope that, that will achieve the same sort of results we've seen in the Permian every time we've improved the completion design there. Average payout of our 2021 SM wells was 9 months. So basically, we put capital into an Austin Chalk well. And on average, 9 months later, we've paid it back. So those are -- in my 38-year career, there's very few instances where I can say we've got that type of well. And it's true for the Permian as well as the Austin Chalk. So just to look forward again. Again, it's about building NAV through the Austin Chalk, growing free cash flow in the 1 and 1. Just going to remind you that. Top-tier inventory, look to us and then differential ESG. So really, that was my quick -- as fast as I can do it through that slide deck.

Maybe we could start -- those are some great slides on the Austin Chalk. And I think you had mentioned at year-end '21, you had 35 wells producing. Sort of maybe a little bit more detail on what gives you confidence from those 35 that -- in that inventory, whether there's upside to that 400 location number, sort of what you're looking for in '22?

It's a great question, Bill. There's a lot of old history with the Austin Chalk from the 1980s on a vertical fracture play in East Texas and wide results from dry hole to great well. And you just couldn't rely on it. Our rock is quite different. It's quite porous, it's permeable and it's really amenable to the horizontal wells with multistage fracture treatments. We have a lot of data from the Austin Chalk. As I mentioned, the Eagle Ford is beneath. So we've drilled 600 penetrations through the Austin Chalk. A lot of those we have logs on and so we can map it extremely well. Then we've taken core and we've done a considerable amount of microseismic fiber optics to really assess the Austin Chalk. So the 400 is a reasonable estimate of the count, and obviously, it depends on lateral lengths. We're, right now, the '22 program will be about 11,000-foot laterals. So we -- based on our track record, we know we can optimize from here. We're just started on this. 35 wells may seem like a lot, but it's really not that many for when you see how much opportunity there is to grow. So I'm really excited about that.

That's good context. Maybe we could talk about cash returns. Not explicitly on these slides, but you've demonstrated free cash flow last year. You're growing it this year. And you've got, I think, pretty good visibility on that leverage target. So maybe you've had the benefit of watching some of your peers put out these cash return programs and seeing what people are receptive to. Obviously, that's driving a lot of stock performance. Just help us think about -- I know these discussions are ongoing, but how you and the Board are thinking about the right mix potentially of base dividend, variable dividend, buyback, continued debt reduction, that sort of framework.

Yes, Bill, that is definitely the question of the day. We've heard that a couple of times today, maybe.

You have to repeat it.

So the way we're looking at it is that we've had this priority of getting our debt down because that, we view it as an impediment toward our share price being what it could be, is that overhang of debt. So we're focused on that. We've set targets there. And then we said we will look at what the best means of returning capital to shareholders is, at -- once we get to those targets. Now we got asked Friday and we said, well, if today, as today, we'd say we're undervalued and buybacks would be option. But we don't know where we'll be 6 months from now, and it could be a different environment. We know the world changes fast. There's been plenty of examples in 2020, 2021, and again this year. So we're going to come up with a program that really makes sense for our shareholders once we achieve those targets.

Maybe a natural next question from that is sort of the view on or outlook for M&A. SM built a pretty significant Midland position through M&A a few years back. And now that you've got visibility on those debt targets and you've got the free cash flow, how does -- what does the outlook for M&A look like for you over the next 1 to 2 years?

Right. We get asked that quite a bit. And we think, from the M&A standpoint, we have a lot of experience with A&D transactions to acquire acreage where we've basically applied our technical skills to identify value accretion that we could do. So we look at it from a big M&A, from a merger of equal standpoint. We're open. It just needs to -- from being on the acquired side, we believe we need to achieve value for the assets, the NAV we have. From the other perspective, if we were looking to acquire, we need to make sure the quality assets is equivalent to ours. We need to make sure, at least from a debt standpoint, it doesn't hurt us. It needs to be comparable, and then it should be free cash flow accretive. It should be industrious logic, so it needs to make sense from -- and preferably where you could get synergies. But there's no doubt, economies of scale are beneficial.

Okay. And then maybe on ESG, I know you've mentioned that you beat your 2021 goals, right? Does that -- I think the focus should be more on sort of these near-term goals because they're more actionable, you're more accountable. Is there a scope to set more aggressive targets, and then you can correct me if you've already done so, for '22 or sort of the next 3 to 4 years?

Yes. We do -- we used to always say the [ natural ] was top quartile amongst our peers, which is automatically getting better and better over time. We've been a little bit more aggressive in December. We put out a position to target zero net [ basically ] flaring and routine flaring in 2023 and also not more than 1% flaring at all. So we're setting a tougher hurdle than many of our peers are. And it's because we really -- when we say we're a premier operator, we really have people really focused on reducing those emissions, and that's key to the whole ethos of the company, basically. And we also have it as part of our both short-term bonus and long-term incentive programs to do both.

And how about where do you guys stand on the net zero target? Obviously, much more long term. It seems like companies are sort of mixed on whether or not those are very feasible, but there's a lot of pressure, obviously, to implement them. So any thoughts there?

We're constantly looking at it and figuring out what's the glide path to whatever year that and how our emissions are doing and what it would take. So whenever we put something out there, we will have a specific plan on how we get there rather than just stating a target out there that there's no way to get to. So we understand our assets well, and we're really figuring out where we can really reduce emissions, whether it's combustion, flaring or other emissions for us.

Just as important as having the goal, I think, is having a way to get there. So that's the right way to think about it. So, I'm happy to open up for any audience Q&A if there are any questions out there? Yes.

Yes.

I think there's a mic right behind you. Or you can just yell it out.

So you've come a long way, obviously, on the balance sheet. So on an absolute level of debt, not necessarily just a leverage on what is a pretty good year or should be a pretty good year, what's the absolute level of debt you'd like to get to? Or said another way, how much more reduction do you want to do?

Okay. So when we say 1 and 1, we're saying 1x lever then $1 billion in absolute debt. We felt we're quite comfortable with that. And the way we look at it, you can't just look at leverage because there's that denominator of EBITDAX, and that can be profoundly impacted by a dip in commodity prices. So that's why when we look forward. And $1 billion absolute debt level, plus or minus, that's a reasonable level for -- with our current assets, a company our size to be at. So that's how we look at it. Any others?

I do have one more for you. I forgot to ask. If you look at your '22 guidance, I think it's low to mid-single-digit growth. Is that the -- does that change with -- when does that change in terms of an oil price, if we stay above 100 for much longer?

Right. I mean that's the -- another one that's a challenging one to answer. The way we look at it is we're focused on debt first. And the growth number that we have, that 3% we got year-over-year, '21 to '22 is really driven by a planning process of where we look 3 years, how do we generate maximum free cash flow. And it just so happens that's in that low to single-digit -- flattish to single-digit growth sort of level. So it's an output of that plan, not something where we're driving for a certain growth target. So we don't have a plan to go, add a bunch of rigs to increase the production in response to short-term commodity prices.

And is that mid-single-digit number of the right number longer term if we're in a sort of mid-cycle oil price environment for SM?

So with where we are today, where we're at the -- needing to eliminate the debt as fast as we can to get down to the 1 and 1. That's the focus. So we're not trying to answer that out there. And once we get to return of capital to shareholders, that's what will kind of fall out of the mix.

Okay. Great. Any other questions? All right. If not, please join me in thanking, Herb.

Okay. Thank you. Thanks for your interest in SM Energy, too.

Thank you.