SM Energy Company (SM) Earnings Call Transcript & Summary

Thanks, Gregg. Thanks, BofA, for hosting this wonderful conference. I'm Wade Pursell. It's great to be here today. I'm joined by Jennifer Samuels, our VP of IR, and thank you all for joining us today to hear the updated story. I'll try to be really clear and concise on what the big -- kind of the big message about the company is right now. That does remind me of the story, if I can start with a story. I think you guys listen to presentations all day, you deserve a story or a joke occasionally. So mine is about Sherlock Holmes and Watson, do you know? I hope everybody knows who Sherlock Holmes is. Jennifer is looking at me like, what are you doing? So Sherlock Holmes and Watson, it turns out, were out camping one night and had a great meal. They went to sleep, laying on their back. Middle of the night, Holmes elbows Watson and wakes them up. And if you know Watson, he's kind of the sidekick, right? And he's always trying to impress Holmes. Holmes wakes him up and says, "Watson, wake up. What do you see?" And he's laying on his back and he said, "Gorgeous blue sky with stars everywhere." And Holmes, as usual, is, like -- Watson, as usual, he's trying to impress. "What do I say? Well, astrologically, I see millions of galaxies and billions of stars. Meteorologically, I think I see that we're going to have a beautiful day together, or logically, I think I see that it's around 3:00 a.m." Very impressive. So Holmes is like, "Watson, what do you see?" "Well, what would I say, well, theologically, there's a big God up there, and we're really small. Holmes, what do you see?" Holmes says, "Watson, I see that someone has stolen our tent." He missed the big picture, right? He got right into these details, trying to impress and miss the big picture. And I want to make sure that we don't miss the big picture here today. There's so many things that can distract us, right, inflation and are we headed for a huge recession next year, how deep it's going to be, is China ever going to open, what does all this mean for demand, what about OPEC. I can't really answer any of those questions anyway because I'm not a prophet, as this slide says, in 300 words. But I can talk about SM Energy. And if there's one thing I want you to remember today about SM Energy is really just 2 words, sustainable and repeatable. I guess that's 3 words, sustainable and repeatable. So what do I mean by that? The details of that are we're a premier operator of top-tier assets, been saying that a long time, delivering a sustainable return of capital and empowered by our strong balance sheet and world-class technical team. we're poised to repeat this success. So that's kind of the tag line, and that's going to be my outline today. I'll talk first about premier operator of top-tier assets. You can see from the map, there's only 2, and they're both in Texas, our Midland Basin asset and then our South Texas Austin Chalk assets. I'll speak about those. And then I'll kind of impact that word sustainable and a little bit more about that word repeatable and why we're so confident in saying that. So let's get to it, so premier operator of top-tier assets. The first asset again is the very well-known Midland Basin asset. It's 82,000 net acres in Martin, Howard, Midland, Upton Counties. This is just a fantastic asset. It's one of the best returning assets in the country. If you measure it by low oil price breakevens, which most people like to do, I think it's a good way to look at it, it's one of the lowest in the country. There were some statistics earlier in the year that [ Ingress ] put out that had us around $40 on average, so price is well below where we are currently. We have 3 rigs running 1 completion crew. I won't read through all these statistics. They're there for you. Our plan this year is drilling 53 wells and completing 38 wells. Great assets, so premier operator though, makes this asset even better, right? We talk a lot about that. And the team is just always working the lateral length of the wells. We drill the longest laterals in Texas, which I guess has to mean the longest laterals in the world, right, because the biggest is in Texas. Longest laterals, always working the landing zones, completion optimization, every single well, just working it hard, making this top tier asset even better. So it's kind of the gift that keeps on giving. We say that about the Midland Basin and the Permian, but it's true, right? I mean, 8 different prospective intervals mean most of our success so far has been Lower Spraberry, Wolfcamp A and Wolfcamp B, but we're very excited about the potential in the Leonard, the Middle Spraberry, the Jo Mill, the Dean, the Wolfcamp D. We've actually had some pretty recent excitement reasons to be encouraged in the Leonard, Dean and Wolfcamp D. I'll share a couple of those real quick. First of all, the Dean. This is a well that's now over 1 year old, the Sarah Connor well, and it continues to produce very well, 40% better than peer wells in the area. And then more recently, the Blissard well is only 4 months old, and it looked like it may even be better than the Sarah Connor. So very encouraged about the Wolfcamp D. And then the Dean, we recently talked about 3 Dean wells, look how well they're performing versus what we assumed they would do. The dark line there is our AFE. So they're significantly outperforming what we had even hoped. These are some of the best wells we've ever drilled, frankly. Almost 2,400 BOE per day, 88% oil [ pad ]. So very, very economic wells. So we're very encouraged about the Dean as well. So that's the Midland Basin. The other top-tier asset in South Texas, 155,000 net acres in South Texas, that's very south. That blue line is the Rio Grande River, so it's on the border. Very contiguous acres, you can see in the map. Historically, this asset has been in the Eagle Ford. It's been all about the Eagle Ford for us for 15 years. It was a great asset, still is. But the recent news is all about the Austin Chalk. The Austin Chalk lays completely across the whole position on top of the Eagle Ford and very economic, more liquids-rich, and I've got a few slides to share with you on that, but just real quick. Activity-wise, 2 rigs, 1 completion crew, we are -- it's a very similar program. Frankly, it's kind of a split between the Midland and the Austin Chalk this year, drilling 42, completing 43 wells. Very similar story on the premier operator side here as well, working the lateral lengths, working the landing zones, completion optimization, very similar to what we do in the Midland Basin. So on that Austin Chalk asset, we're now 54 wells in. And I'll talk a little bit about -- I'll call it the discovery of the Austin Chalk here in a few minutes. But we're 54 wells in. They're anywhere between 50% and 90% liquids, very consistent performance, though. The economics of these wells are very similar, believe it or not, to the Midland Basin. So we have 2 very top-tier assets. This is some examples, some recent wells. We've announced 5 in the northern area, 2 in the Eastern area. So as you go across this position, it's a big position, remember, 155,000 acres. The commodity mix changes but the economics don't, I guess, is what I would have you remember. The commodity mix changes. If you're up in the northern area, you see these 5 wells, they are less pressure, but more oily. So 1,300 BOE, but look at the oil percentage and just fantastic returns, 8 months payback on average for those. And then you go to the eastern area and they're more gassy, less oily, but more pressured, bigger wells. So here, you can see much larger wells, 2,400 BOE per day on average, very similar returns though. I mean these are paying back, on average, of 14 months. So great wells across the board. There's a good math again. You can see those 54 wells that we've announced. You can see where they're located, so pretty good representation across the position, which is making us more and more confident in our estimate that there are 400 locations. So lots of inventory in the mix here. The theme of this slide together for some of you that -- for some of us that are old enough to remember the legacy Austin Chalk, which was not so good back in the '90s and the early 2000s, the Austin Chalk always let you down. You'd have a great well, then you have a bad well, a great well, bad well, great well, turned bad. So just very variable performance, okay? Well, what this chart shows is it compares our current Austin Chalk to that historical Austin Chalk. And we've done what we'd call the P10:P90, and all that means is how variable are these wells. Taller the bar, the less consistent. So the blue bars on the far right are the historic Austin Chalk results. And like I just said, very inconsistent. You could -- you never knew what you're going to get with the next well. Well, look at the 2 bars in the middle, the yellowish green. Those are our Austin Chalk wells so far and they look nothing like those old Austin Chalk wells, but they look very much like our Permian wells, which are the light blue bars on the far left. So very resource play-like, very predictable, great asset, high returns. ESG. So we've always said that you can't call yourself a premier operator unless you are an ESG top performer. Always been very important to us, and we're very proud to just show the results and disclose a lot more from an ESG standpoint. This is very much part of our DNA, very much in our culture. Jennifer likes to comment that we've operationalized ESG. Everyone speaks ESG in our company, and that includes the field all the way through. And I'd just like to show this slide because it's third party. And Enverus did a ranking, not just the E but also the S and the G of performance, and this is a long list of oil and gas companies, many, many larger than SM Energy, but we ranked #3. And a similar recent survey was done by Rystad and they had SM Energy coming out as #2, so a lot of focus here, a lot of work on technology, innovation tied to compensation across the whole company. The short-term bonus to the long-term bonuses have metrics in them related to ESG. And I think the performance mirrors that out. Okay. So that's the first section. So sustainable. So remember, I said premier operator top tier assets delivering a sustainable return of capital. So just to be clear on that, so for the last few years, if you've been following us, the big message has been, we've kind of optimized a capital program that would deliver the most free cash flow and delever the balance sheet, because that was a big goal of the company to get a very, very strong balance sheet before we would consider returning capital to equity holders, and we consider strong being 1 in 1, 1x debt to EBITDAX, but probably more important, net debt, absolute $1 billion. So as you know, we're there. We got there quicker than we'd hoped we would, which has been great, well below 1x at 0.6x. And then at the end of the third quarter, we were at $1.1 billion net debt. So you can imagine standing here today really, really close, right? So we were able to announce a return of capital program ahead of schedule last September, and it looks like this. It has a fixed dividend component of $0.60 per share paid quarterly, so $0.15 per quarter. That first dividend was paid last month, earlier this month. And then we also announced authorization to acquire up to $500 million stock repurchase program over the next couple of years. And we started immediately. In the third quarter, we were -- we spent $20 million buying back 453,000 shares. So that's the sustainable part. And then we said there's more, empowered by that strong balance sheet and the world-class technical team, we're poised to repeat that success. I think this is really important. It's important to me as a long-term investor in the company, the ability to repeat that success. So that world-class technical team is what I want to just spend a few minutes talking about here at the end. So I want you to imagine because it is a differentiator of SM Energy. The size of our geotechnical team and the work they do, we believe, differentiates the company. So I ask you to use your imagination and go back to 2015, so imagine in '15, you're looking at a map of the Midland Basin. What you would see in the Northeast boundary is Howard County on the outside of that boundary. And our technical team had been studying that for quite a while, and we're concluding that is not the case, and it created opportunity. We made some very large investments in Howard County and it turned out they were right. Now you have significant activity in Howard County, not just us, but others, and it's turned out to be the top tier asset that I took you through earlier. So that's one. And then imagine a few years later, imagine in 2018, I was up here telling you about this great new top-tier asset called the Austin Chalk. Most of you say, no, we've been there, done that. That's not a top-tier asset. But our technical team, which spent years analyzing this, we owned it, right? Remember when the Eagle Ford -- so imagine 600 wells being drilled through the Chalk over the years. So they had a significant amount of data to study and to reach some conclusions and then we got confident enough to start drilling wells and proven right again. So this team is really good. So how do they do that? Just -- I like this quote. It's from one of the folks on the team, data talks, we listen through multi-disciplined integration. So just a ton of data, a ton of data, analytics on all these wells. This chart just kind of shows you the mini wells provide and others in the area. I think there are 2,200 wells that support all of the -- just in the Midland Basin that they have data on. They analyzed something like 640 terabytes of data and growing. So what do they do with all that data? Well, they use it to, first of all, to aggressively core up the acreage, right? I mean we've gone from -- this is kind of under-the-radar stuff that we've gone from 61% to 81% working interest in Howard County over time by getting really confident in analyzing the acreage in our area and around us, developing the model. Optimizing the completion design is a huge part of what they do, and as I've said earlier, the work on the landing zones. This is a cool slide with one of those examples. The completion designs and working every single well, 25,000 unique designs analyzed. And what this chart shows is kind of on the x-axis capital and then a y-axis NPV. And what you see is the little orange blob is the Midland average and the blue blob is our 2022 average, much higher NPV per well and a ton of that is based on the work done on the completion designs. So kind of the last slide on the tangible results, just to show how much that means, this is some work put together in a research report by Capital One, and they looked at 2020 and 2021 and looked at -- this is all of the Permian Basin. All the other peers are the dotted lines and we're the dark lines. So the light blue is 2020, so outperforming the peers that year. And then the dark blue line continuing to outperform, but even improving upon our own results, which is really cool. And then a separate third party, this is a report from Enverus and this is just Howard County, looking in 2021 versus in '22 and the success of our wells are the dark line and the [ cube ] plot dotted line is the average of the peers. And then that was their conclusion, deepest, highest quality well inventory among our coverage. So ringing endorsement, I would say it like this. I would say, sustainable, repeatable. Those are the words I want you to remember about SM Energy. Premier operator, top-tier assets, delivering sustainable return of capital, empowered by the strong balance sheet and the world-class technical team, very much poised to repeat that success. So told you I'd do it in a few minutes.

If there's any questions, please raise your hand. I'll start it off. [indiscernible] You're adding that debt, target about $1 billion. [indiscernible] How do you think about reducing debt over time, taking into account your current -- your $1 billion net debt target and your current $1.6 billion of debt outstanding?

Yes, it's clearly a great-- it's a great question. And I'll kind of repeat what I said earlier, because it hasn't really changed. We are accumulating cash now. We could take out the 25s and make the absolute debt that targeted $1 billion. We're just being a little cautious in this very, very uncertain environment. It feels, like, a decent time to have cash. We've got tons of runway on those maturities. The 25s or what we're talking about, they trade at a very good coupon compared to where the market is today. So that's kind of our approach for now.

Is there -- is -- you talked about uncertain environment. Is -- if I were to look at that and say, well, you're keeping cash potentially to pursue acquisitions. Is that what you think look like the use of that cash is?

I wouldn't call that #1, but there are certainly possibilities out there. I mean from our standpoint, we just talked about the inventory and how good it is and how long it is, so we don't need to do anything. But inventory is not eternal. So when opportunities come up, we'd like to be ready. So there are a lot of those we're looking at. By the same token, it feels like we're kind of still in a higher part of the cycle. So all of that weighs into that. But in the meantime, we don't know what's coming next year from a recession standpoint, a commodity price standpoint. So just being a little more cautious on that really good debt that's out there. It feels like the right thing to do, but we could change that view pretty soon.

Were you able to reinvest the cash out today?

More than we could have a year ago, that's for sure. It's still negative arbitrage, technically.

So then obviously, being -- building cash makes a lot of sense. As you think about your return strategy, how does it evolve [indiscernible]...

The returns strategy?

Yes, returns and then also potentially reinvesting capital and growing. What are the drivers of that?

Yes. Yes. I mean that's a question we're asking ourselves a lot. We feel really good about where we are currently, and that is this activity level that we kind of got on a few years ago that kind of gives us flattish production, low single-digit growth production that generates a lot of free cash flow. That enabled us to lower leverage, and now it enables us to look at other things like return of capital and other potential opportunities. It's a pretty easy decision currently on would -- why not grow. That would be costs are going up, commodity prices uncertain, plus it's just -- it'd just be really different from a services standpoint to grow. So we feel good about our activity level. Going forward, whether you pay down debt, whether you return cash to equity holders or whether you buy something and add to inventory, even though we don't need to, those are difficult decisions. And we do a lot of math. You -- frankly, if we're looking at buying something, whether it's a company or an asset, it's pretty simple, right? You put it in the model, and does it -- do you increase the value of the company or not? Does that compare to the value of buying back the stock. So those are the -- those are kind of -- that's kind of some of the math going around it now. But as we move forward next year and get more visibility on the macro, we'll probably get more certain on allocation of capital.

And right now, what's your expectation for production growth next year based on…

Yes. I -- we haven't given guidance on '23 yet, but we've said, all year, that we like the program we're on, and you should expect something similar.

You touched about M&A. You've been very disciplined there, haven't seen anything, haven't seen significant M&A recently. Is there much to do? Or was it mostly in terms of leasehold? Or is it mostly corporate that you're thinking about?

Well, we look at all of it. I mean there's been a lot of packages that are still out there, that are coming and we look at all of those. We have a dashboard of companies that we think would be reasonable to look at. You would know the names. And we have green, yellow and red lights in probably 15 different criteria. And we said we're not -- we're open to anything that increases in value in [ capital ], okay? And from an M&A standpoint, it would need to be -- we said this very consistently. It would need to be assets. They always start with the asset that makes sense with us, that there are some industrial logic to them, would need to be something that didn't result in us taking a big step back on the leverage side. We don't want to do that. And in this environment, having a strong balance sheet's really important. Need to be free cash flow accretive. So once you go through all of those, it becomes obviously more difficult to transact, but it's something we consider. We see the merits of size from an investability standpoint. I mean, the multiples speak pretty clearly to that point. So it's worth -- it's very much worth looking at, but it's part of the new mixing.

I've asked you this question. I do this to you twice a year, and I ask this question each time. There's definitely been -- there seems to be a larger scale development is the trend for increasing efficiencies.

Say that again.

Larger scale development has been a trend for increasing efficiencies. And I think I've asked you each time, you believe you're at the right threshold in terms of scale.

Right.

I guess what's the updated thought there? Is it status quo? Or do you -- are you seeing that the larger scale development is easier to do with more size? Is it something that you're large enough to do it?

Yes. I mean there are some ebb and flow in that with us depending on your acreage and where you want to be drilling in a given year. We're -- definite merit, large scale. We've seen that. You'll probably see some of that in the '23 program, and we'll talk about it. But it's -- from a general sense, I wouldn't just say, yes, we need go larger development to gain efficiency. I wouldn't say that.

There's been -- when I look at those -- the charts, you -- and some things -- you've had an improvement in your base production this year.

Yes.

There's been a lot of talk about how the results from wells -- this year's vintage of wells have not been as strong. It seems like you've defied that. You've gone against that. What's your observations about what's happening amongst your peers? And then what you do -- and what are you doing differently?

Yes. I think it's a long list, and I think the presentation today brings a lot of that out, and it's all about the technical work, it's all about the technical team and the focus on every well. That includes spacing and includes all the work that goes into the completion optimization. And it starts with the assets. We have great assets, too. But that's not by accident either. So there's just a lot of reasons. But I always go back to that technical team and focus.

You showed some -- when you look at the Austin Chalk, it's not your father's Austin Chalk. It is pretty impressive to see how the variability has changed. Is there -- are you -- is that all technological advancement? And is it -- or is there -- or you're actually in a different part of the map?

Yes. If I were more technical, I could probably explain it. It is the rock also. It is -- this is a different part of the Austin Chalk, that historic Chalk was East Texas and then kind of points in between, but it is a combination, but it is also the rock, very much so.

And just helping the audience here, the -- I know it's a certain part of the Austin Chalk. Do you feel like there are a lot of opportunities outside of your acreage area? I believe a lot of your competitors may have opportunity. Or is it pretty unique?

I would say potentially, and that's all I would be allowed to say.

That was my indirect way of trying to ask about M&A. Do we have any questions from the crowd? I'm just looking around. I have some more here, so we'll go. You have a lot more oil production in the Permian. So bases -- natural gas bases was not as much of an issue for you. But can you talk a little bit about how you're managing the amount you do have? And also just in general, your -- in the South Texas, where there has been some variability in gas price in, how are you managing that?

Yes. So it's the same risk management process that we typically go through. There's 2 elements. There's making sure that you have the ability to have it taken away first, and we have great contracts with great providers that have firm transportation, and they guarantee to us that they'll be able to continue to do that, and they are doing that. And then the price side, on the basis that we try to hedge that to a degree, we -- on our -- I'll back up on our hedging strategy. Overall, we tie that to leverage. And you've heard me say that many times. And for that reason, we hedge less now because the leverage is lower. But when it comes to bases, we look outside of leverage on that and just try to -- when we think there's exposure or asymmetrical risk, which is the case a lot of times, when you have a blow out, we know it goes significant. And on the other side, you typically don't give up too much on the other side. So we try to hedge the bases, at least a decent percentage of it. And we feel pretty good about -- we feel really good about both bases and our ability to take a [ thicker ] gas away.

So you don't -- if you have -- you have sufficient takeaway capacity. So you don't see your operations being impacted at all from...

No, things can happen. I mean there's no 100% guarantee of anything. Things -- but we feel really good. You look into '23 and lot of folks are nervous at the first half and then things get taken care of in the second half and our team that analyzes that really close agree with that [ as we move forward ].

I'll leave you with this last question. So you touched on this. It does seem like the market rewards size. But there is flexibility that you have being smaller, right? So do you -- is it your view that, hey, there is this flexibility, and we can just keep buying back our stock if the market doesn't recognize it? Or do you -- in your mind, do you really think you guys need to be bigger?

It's a great question. All I can really say is we do everything we can at this company to make it attractive to an investor, whether it's a bondholder, it's an equity holder, whether it's an equity holder buying 1 share or wanting to buy 120 million shares. We do everything we can to make it attractive and valuable. Somebody wants to pay 120, it would be at really high price based on the value of the company that we have built. The multiple for size, we see that, but we're not -- that we're -- and that's why we look for opportunities to add to the size, but we're not going to do it just for sizes' sake because we don't -- we believe that would distort value. If there's a way for that to happen otherwise, that's the fact. But if not a -- we don't think it's prudent to just go out and seek size assuming that multiple would cover.

And I'll take 1 more just because I didn't ask the obligatory inflation question, which I'm sure you were ready for.

What was that?

The obligatory inflation question, and you talked about this on your call. Can you just tell us what you're seeing for next year and I know you haven't given guidance yet.

Yes. No, it's -- yes, it's -- inflation is very real. We said that what we've seen is 25% to 30% inflation from the -- from fourth quarter '21, and that's baked into our CapEx guidance, and we're still in line with that. But it's -- as we exit the year, though, it's still -- you're still seeing some signs of movement. So '23 is -- it could be a little higher. We'll see, running a lot of scenarios, monitoring that closely.

Great. Well, this is fantastic. I appreciate you making the time here. Enjoyed the presentation very much.

Thank you.

Have some round of applause. Thank you, Wade.

Thanks, Gregg. Thank you.