SM Energy Company (SM) Earnings Call Transcript & Summary

Hi, everybody. Next up, we're lucky to have SM Energy, and we have the CFO, Wade Pursell. And I will pass him the mic and take a seat.

Thank you, Gregg. Well, good morning. It's wonderful to be here with you in person. Good to see you all in person in New York City, good to see New York City, surrounding us and this wonderful view. Thank you. I will take you through the presentation this morning. I'll do kind of a quicker version so that we'll have plenty of time because I know you like to do some Q&A. So I'll just kind of give a quick overview and make sure to try to get some of the big points of the SM story. I'm not a prophet, I say that all the time. So you've been warned. Okay. So we -- for a long time now, we've been calling ourselves a premier operator of top-tier assets, and that is very much the case. And -- and I'll show you a few slides this morning that I think really confirmed that. It's very important for us to be a premier operator. It's very important for us to have top-tier assets. So I'll talk about both of those. And then I'll also talk about how important it is to be a leader in ESG stewardship. Now I've made that a separate category. I'll tell you that we've always believed and said that you can't be a premier operator unless you are a leader in ESG stewardship but it's such a highlighted area these days that I've made it a separate category. And then kind of the big message right now is this fast approaching low leverage -- fast approaching low leverage. It's actually been pretty amazing how fast this has happened, but I'll kind of -- I'll end the talk with some specifics on that. So premier operator. So I like this slide. This is some data from Enverus where they've taken 19, us and 18 other peers, some of these pretty large caps, frankly. And they basically ranked these wells since 2017, I think, so a pretty good sample size of wells and just looked at well cost per lateral foot, well cost per lateral foot. And you can see that we rank very well in that category, top 5%, actually #2 on that scale. And when you just look at how important the long laterals are as an input into that calculation, if you just kind of pull that out separately, we rank #1 as far as the average lateral length of wells being drilled. And again, this is compared to a lot of large caps as well. So some folks like to ask for a good reason, can you be as capital efficient as a small mid-cap? And I think the answer to that is absolutely, yes. This slide, I said I would go fast, I'll just kind of skip through a few of these. I'll jump to top-tier assets. This is a pretty simple calculation. Just go to the 10-K at the end of the year and look at pull out standardized measure of oil and gas property. So the value, the smog, if you will, of the proven reserves and look at that on a per BOE basis, and you can see that this is a reflection of the value of the assets, the top tier assets. When the value per BOE, we ranked #2 in that calculation in this peer group. So more than proven reserves kind of expanding that to look at inventory, a couple of statistics on inventory back to Enverus again. So this is some third-party data. First of all, they look at the highest value basins in the country. And they look at it in terms of, well, what's the lowest breakeven oil price. And you can see the list of basins. And number #1 and #4 happen to be the West Austin Chalk and the Midland Basin -- our basins. So we're in the right areas. And then when you look at -- or when they looked at our actual inventory, stacks out very well. Now obviously, there's larger companies, large caps that have longer inventory. But when you look at a company our size, small and mid-caps in the peer group that they selected, our inventory is very, very high value and long life. So what this shows is inventory that generates returns below $40 a barrel. We have 9 years of inventory below $40 a barrel. So that ranks #1, which is really good. So a couple of comments on each basin. I'll look at the Midland Basin first and then the South Texas, Austin Chalk. I think most of you are familiar with the assets that we have in the Midland Basin, 2,000 net acres, most of that up in Howard and Martin County, we call the RockStar area. I think analysts called it that when we made the acquisitions back in 2016. One was from QStar, 1 was from Rock Oil, put them together, RockStar. Great asset. If you go down to the south, so that's about 5 years. We've had that asset in the more legacy Midland Basin asset is what we call Sweetie Peck, and that's down in Midland and Upton Counties, and we've been there for about 15 years now. I won't talk about the specifics on this slide. We got 3 rigs running, 1 completion crew pretty much on track with the plan -- the activity plan that we laid out early this year in the Midland Basin. I kind of go back to a premier operator status a little bit here and show that the team is just continually making a great asset even greater is the way I'd like to say it. And whether it's more fluids, more sand. I mean, this is just an example of 3 wells, 3 well pack called the Miracle Max, and you can just see the result of the higher sand loading and the more fluids, 50% higher production. So it's just great evidence of some great wells being made even greater. Another example here, these are 3 wells flipping over to the Northwest kind of 3 wells up in Northern Martin County. These wells were actually -- I think it was Enverus someone pointed out that this was kind of a record in the Midland Basin. The productivity of these 3 wells combined 2,500-plus BOE per day, got a lot of that oil percentage to 91% and they continue to perform well. So then flipping over to South Texas, where historically, for us, if you followed us a long time, this was an Eagle Ford play, and it was really the cornerstone of the company for many years, great, great asset, more of a gassy kind of a wet gas asset, that was really good to us for a long time. But recently, it's become the Austin Chalk story and the Austin Chalk interval covers the whole area above the Eagle Ford, and it's been a great asset, and it's proving to be as potentially as great an asset as the Midland Basin asset for us. So -- and I'll show you a few things on the Austin Chalk here in a second, 155,000 net acres. We've got a couple of rigs and 1 completion crew working here on pace to drill and complete around 38 wells, primarily in the Austin Chalk this year. So those wells, you can see -- I like this map because it shows kind of how spread out those wells are and the wells that we drilled and completed last year, and that just gives us more and more confidence in our assertion that we believe there's around 400 total locations. So a lot of inventory very high value, as I mentioned earlier, the returns are very similar to the Midland Basin. So we're very excited about this asset. The team put together this chart, I think it's -- I think it's really compelling for those of you that remember the history of Austin Chalk has kind of a checkered past going back to the '80s and '90s and first decade, it was very different. If we could have renamed it, we should have because this is just -- it's like a totally different play. The historical Austin Chalk was way far to the east, like East Texas, and it had a lot of inconsistent results. you'd have a great well, then you'd have a disappointing well. Great well, disappointing well or the great well, would start declining rapidly very fast. So what this chart shows real quickly is the P10, P90 ratio. So kind of in layman's terms, what this shows you is how consistent the well results have been. So think about the -- it says, calls it your father's Austin Chalk. But the blue bars are looking back at those well results and you see a very wide P10, P90, so very inconsistent versus the 35 wells that we have included so far in the -- more of the yellow bars, you can see that you've got a number of closer to 2, which means very consistent, very resource play like, I'll say. And then over to the left, the light blue bars, are the mini wells that we've drilled and completed in the Permian Basin that have been, as we all know, fantastic results. And these look very similar, which is great. just another slide on the Austin Chalk, 40 wells that have been reported pretty consistent 800 days in now from the first wins. So we're really starting to get excited that they are what we thought they would be frankly, and they're not declining. They are -- they're hanging in there. It's a great, great asset. The average payout on these wells now is 8 months. So really good stuff there. Kind of not to be forgotten the Eagle Ford. We've completed a few wells in the Eagle Ford late last year, and we announced, I think we're completing 3 or have completed 3 in the second quarter, 2 of those are old DUCs that are just being completed. And then 1 of them, I think, is a co-development well with the Austin Chalk. So it made a lot of sense -- but the point is these are great wells also. And with natural gas prices where they are, it's fantastic to have that option as well, less than 6 months payout on these recent Eagle Ford wells. Finally, the last point I said leader in ESG stewardship. I'll say it again, we don't think you can claim to be a premier operator unless you're a leader in ESG stewardship. That's always been part of our culture and it still is, and I can talk a lot about statistics and metrics and we'll answer any questions you have. But I'll just kind of summarize 3 points that stick out to me as far as how we think we are achieving these results kind of, I'd like to try to remember them in 3 T''s, 1 is top quartile metrics compared to peers in the AXPC, we continue to monitor those, whether it's spills, whether it's safety, whether it's emissions, and we hold ourselves to be in the top quartile there. Second T is tied to compensation. These metrics are in our STIP our short-term incentive program for all employees. So very, very visible, the importance of ESG to the company. They're also included in the long-term compensation program as well. And then the final T is technology, continue to experiment and test different technologies to continue to improve, whether it's methane emissions or greenhouse gas emissions, whatever it is. And you see the results. This is a recent slide addition we've made from Rystad. And they scored not just the E, but also the S and the G and they come up with a composite score. You can see we rank -- depending on when you look at this, we've been 1 or 2 every time they've reported. So on this one, we're #2. So we're very serious about ESG and very proud to present those results to you. And then finally, kind of the message right now is this really accelerated pace of delevering that we've been on. And we've made that our objective for the last several years, but it's really accelerated most recently. I won't go through the first quarter results again, but that obviously, the results have had a lot to do with it. I'd like to summarize the first quarter as production coming in kind of at the top end of our guidance and capital coming in at the low end of our guidance. So the result was free cash flow more than we expected, and that resulted in more delevering we're on plan for the year. We've reiterated our guidance on the call. I won't go through that again. And then from a hedging standpoint, we get this question a lot, our strategy with respect to hedging is the same as it's been for the last at least 12 years, I know, and that is tying hedging to our leverage. And we -- the more leverage we've had in the past, the more hedging we've had. And now as we're approaching a period where leverage is coming down fast, you can imagine that we'll continue to hedge, but at much lower levels. This year, as we came into this year, leverage was higher. So our target was 50%, and that's where we are with oil. On the gas side, we have about 40% to 45% hedged, not a lot of hedging on the NGLs. So if you look at our total hedges this year on a BOE basis, it's probably closer to 38%. And then in terms of next year, as we see leverage really falling, I think our target will be more like 25% or 30% as we move into next year. So the balance sheet as we're -- we've said for a while now that we have a target to get to 1 in 1, 1x debt to EBITDAX and probably more importantly, absolute debt of $1 billion. So we've been on that path. And in the first quarter, we paid off the [ 24 ]. As you probably noticed that, and we announced that we would be taking out the second lien notes, and that's scheduled to happen late next week. From a total leverage standpoint 1.05x, so we were almost to our targeted level at the end of the first quarter. So you can imagine standing here today, we're probably there. But as far as the -- getting to absolute debt you can kind of do the math and take the second lien out, you can kind of see what's going to be left. And we said on the call a month ago that we thought we'd get to $1 billion sometime later this year, probably in the fourth quarter. prices have improved since then. So you can imagine, we're definitely on pace to get there later this year. And we said when we get there, the equity holders like to ask this a lot, and this has been a big theme of returning capital to shareholders that, that would be the time that we would consider the appropriate sustainable return of capital to shareholders at that time. Rating agencies have all upgraded this year. I expect further upgrades if things kind of continue the way they are, especially after the second lien notes are taken out of the capital structure. Objectives haven't changed, building NAV through scale the Boston Chalk program. I think the more Austin Chalk results that come out and the continued consistency, I think there's clear evidence in the equity and bond values that, that's starting to get traction and starting to get value like we planned for and hoped for. Again, the growing the free cash flow and getting leverage to 1 in 1 clear objective, maintaining that top-tier inventory is really important, obviously, and then demonstrating the differential ESG performance. So I'll end with the slide I started with. Hopefully, you agree with us that we're a premier operator of top-tier assets and a leader in ESG stewardship, and we're clearly fast approaching low leverage. So with that, I'll open it up for questions, Gregg.

I'm ready. I'm going to start off with a bunch of questions, but at some point, if you do have a question, I'll -- raise your hand. There's someone walking around with the microphone. I'll probably pause when we're ready for that. So you hit a lot of the key points here. Good job. Good job. So one of the things that you've talked about once you get to your target of 1 in 1, you'll think about returning value to shareholders. How do you think about production growth today in that context, potentially growing?

Great question, very popular question. We put forth a long-term plan, I guess, a couple of years ago now that had us at kind of an optimized activity level that would enable us to generate a lot of free cash flow and grow modestly -- grow modestly grow modest being low single-digit production growth and that's been our consistent message in our -- and it's still our plan, and that's what we're -- that's what we're doing. So as we get closer to that returning of capital question, that will be part of it. As far as -- our plan hasn't changed, is the quick answer to that. Do we do we look at what it would take to add a rig, what would that mean for production next year. We always look at those scenarios. As you know, that would be very challenging to do right now anyway. I think it would probably take 8 or 9 months if we decided to do that today to get a rig and probably be more expensive. We have we've kind of stuck with our guns, stuck with our plan, and that's kind of where we're headed for now.

Got it. So it is -- I mean I recognize quarterly prices are strong. So are you are you looking for a market signal that tells you it's okay to grow more? I mean, I know you've got to wait 8 or 9 months to get the rig?

Yes. I mean, right -- I mean, obviously, we watch for market signals. But right now, it just doesn't make sense for us to consider that. It just doesn't. We intentionally we intentionally came up with this program, and then we're getting the results that we hoped we would get from that. So we kind of like that.

So when it does -- when the day comes soon, when you start thinking about returning value to shareholders. It sounds like, obviously, there's stock buybacks and there's dividends, whether it's fixed or variable, how are you thinking about that today? And how are you measuring whether your stock is cheap that you should be buying back stuff?

Yes. We will -- I've used the word sustainable a lot. So you could read into that some form of a fixed dividend that we're very confident in the sustainability of -- and any analysis would be done at prices much lower than the strip. in terms -- we tend to look more at [ 60 and 3 ] in that area when making those kinds of decisions. So beyond that, we'll consider other things. You mentioned buybacks, you mentioned other dividends, nothing really more to say on that at this time, and we'll consider all of that. But if I were just answering the question, dividend versus buyback, I mean, we always have our own view of NAV in our model, so that would obviously be a factor in how the stock is trading versus peers would always be a factor if we were considering more than just a fixed dividend.

And as we move forward, how should we think about your cash taxes over the next several years?

Yes.

What type of guidance can you give us?

Yes. No, it's -- I think I mentioned it on the call a minute ago, and it's still pretty much the same. And that is that we will -- if things stay kind of the way they are with respect to our activity and with respect to commodity price environment, you can assume we'll become a cash taxpayer this year in a small way, probably $15 million or $20 million. And then next year would be more of a run rate going forward for a while if things stay like this again. And that would be in the low hundreds to $150 million of cash taxes, which is obviously more than 0, but it's not when you consider the free cash flow with these prices that will be generated in that assumption, it's not a meaningful number compared to that. And it's a number well south of what you would think of as a rate -- as a corporate rate. So you still have the IDCs, you still have deductibility that's deferring taxes.

That was shifting gears to M&A. You highlighted RockStar. I didn't realize the name was ... the name.

It wasn't my idea.

It was a good one. And then so you've been acquisitive in the past, it's been relatively quiet. What's -- what are you thinking about in terms of pursuing M&A and opportunities to add acreage?

Yes, Yes. Great. Great questions. We do have -- I'll start with the fact that we don't need to do anything, which is really important, right? I mean it's -- that amount of runway, that amount of inventory we have that Enverus said 9 years even at below $40 is really important. And that's important. It doesn't just mean if we have a pullback, the inventory works, that is important, but it also means that we're going to generate a lot of free cash with those assets during this period. We're always looking to add though, it's not -- 9 years is not eternal. So we're always looking to -- for opportunities to add. On the bolt-on side, on the -- I'd call it, the A&D side, there's always things in our areas that we're looking at. It's difficult right now, as you would imagine, at these prices, the bid-ask spread is very real. It would be hard for me to imagine spending a lot of capital on an asset acquisition right now given our priorities. So I'll put that aside. M&A, we understand and agree that there are benefits to scale especially from an investability scale. I think operational scale, there's probably not a huge benefits to us. You saw the numbers. I mean, we get the services we need and have great relationships. And capital efficiency is probably as good as -- better than anyone. So -- but from a -- just from other areas, whether it's G&A, savings, cost of capital, but also getting to the -- rising to that level that is more attention to more investors. We get that. So, we look at M&A and we -- you would imagine the list wouldn't surprise you with the companies we follow. It's -- I'll just repeat what we always say because it's very true that we're not going to do it just to do it. It needs to have some logic to it. The assets need to make sense. The leverage needs to be at a level that wouldn't send us back where we were, needs to be accretive. Things like that. So given all -- given that criteria, obviously, nothing has happened, but we'll continue to look.

You mentioned the bid-spread ask. It seems to me that equity exchanges would be a way to address that. Is it that the sellers aren't necessarily looking to take stock?

It's a great point. I think you're right. I think that's why M&A you don't have the bid out -- I mean M&A has its own issues, but if it's equity for equity, it's a relative thing. So -- and the same case for AD, if you could get a seller to take the equity that's a possibility. I agree. It hasn't -- people are not -- the door hasn't been getting knocked down by people wanting the equity for an asset, but yes, but it's -- it makes it more of a possibility.

So you highlighted a slide earlier, saying how you can -- at your size, you can compete with anybody in terms of your D&C results. So do you -- is there really no advantage to being larger other than cutting G&A?

Well, I can only speak for us. And for me, again, cost of capital advantages, G&A advantages and investability, I think is -- I tend to think that's real as far as attracting a larger investor base to me are the big advantages. I don't -- yes, just operationally, I mean, the results speak for themselves. And it's not an accident. I mean, we've been in the Permian Basin for 15 years, and we're very -- we're very relationship driven with the service providers and very predictable. So laying out plans and not bouncing around has always played very well with us and the vendors. And so yes, it's hard for me to imagine that, that being improved upon.

So you don't share the idea. A lot of consolidation happened in October of '20 based on this investability idea. Now that we're -- somewhere it was said a company like SM would have been in that camp or even too small to matter. Fast forward to today, obviously, there's a lot more interest in the space. But I'm curious if you're seeing in your holder, in the investor base changing where you are attracting capital that's more desirable in the longer term?

Yes. I think Jennifer would tell you that we are starting to see some of that. not in a big way, but definitely, we're seeing it. And I think you've -- it's -- wouldn't surprise you that that's probably a big part of the stock run up recently. So yes, it's -- so I think that's happening.

Are any of those people saying yes, you should get bigger or we like you this way?

We haven't got a lot of comments about you should get bigger.

Like the way I indirectly handled that question?

Yes.

So inflation, obviously a big topic. It's -- what's -- can you tell us how you're managing it. And if you think your it's a little more than you thought it would be.

Yes. No it's a great topic. It's a great topic. And it's still -- it's dynamic and it's evolving, right? I'll remind us all that we came into this year forecasting and planning for 15% inflation this year versus '21, but we also said that, that was an average for the year and that a lot of the first half was kind of already contracted in so that you could assume that there was a trajectory that in the back half obviously be a higher number than 15% to get to that 15%. And you could also assume that, that means that if we're thinking of '23, which we haven't guided on, that we were and are assuming that inflection continues -- and is higher in '23. And we certainly believe that now. It's for us, I think we've said that the areas -- you really have to break it down to the components and the areas that are probably most exposed are things like labor, steel, diesel -- and those 3 components make up about 20% of our capital just to give you materiality on them. And we're obviously -- we do what we can to lock things in on the steel side. We now have steel -- and the main thing is access first, right? I mean, that's #1. And we have all the steel lined up we need for the program this year. And then sand is always a big component and we actually benefit greatly from being an anchor tenant of U.S. Silica in the Permian, long-term arrangement there. But then on the -- because I know a lot of companies are struggling with sand and getting it and how much to pay for it. And then in the South Texas side, we've recently, I think, contracted sand through the end of '23. So at a higher cost because it's not the deal that we have with U.S. Silica.

That's very helpful. And so you mentioned if you decided to add a rig it'd be 8 to 9 months. Besides that, are you concerned at all about the quality of what the incremental rig crew and frac crew is going to be? Is that a consideration?

Yes. I think it is. It's -- I don't know of anything that I can tell you that is a big concern. But just anecdotally, yes. Yes. I mean we've had -- we're reasonably pleased with the labor that we've had on the existing program. But as you start to consider more, I think that's a concern.

And you -- when you -- if you were to contemplate growing more, maybe even not, have you -- are there discussions around down-spacing to capture more resource?

No, that's -- we certainly look at that, and it's a great question when prices run up like this, right? It's really -- we take that decision very seriously though. I'll tell you, when we look at that, we look at prices more our mid-cycle view. I mentioned [ 60 and 3 ] kind of prices in that area because the last thing you want to do is down space at these prices and then -- you don't get to go back if prices drop from here, but it's something we look at.

I mean do you -- if it's [ 60 and 3 ], do you think there's opportunities for down-spacing?

I'd say there's opportunities. I'm not saying we will.

Okay. hit on the Austin Chalk, which sounds like results were great. Just gathering, processing and transport. Anything that you're concerned about? Obviously, mostly oil in the Permian.

Yes. No, I think we're in pretty good shape there. One of the concerns we had a lot of people had was gas in the Permian a potential issue in late '23 or early '24, and some announcements recently from Kinder, I think, have made our marketing group feel much better about that.

Okay. Look, I think I have one last question for you, but I'm going to turn to the crowd and see if there's anyone has one. I got one more -- what are you most -- it's as good as it gets -- so what are you most worried about?

I will -- my worries and they're typically this, nothing internally. I mean it's -- I mean we're really excited about the assets, the team, the culture the direction of the company, it's always macro. I mean it's always macro, soon as you think it's as good as it gets and how could oil ever go down again? I mean you can't assume that. You can't assume that. There's too many things that could happen with the global economy and on the supply side. So it's always macro is my answer to that question.

You and me both -- so this is a great way, asking to see you again, really appreciate you making a trip up here, Let's have a round of applause, it was great. Thank you.

Thank you.