SM Energy Company (SM) Earnings Call Transcript & Summary

Our next speaker will be Wade Pursell, CFO of SM Energy. Pursell will be speaking a lot more about the Uinta integration deal that's been ongoing, and we will have prepared remarks, and then we'll get into some Q&A after that. Thanks.

Thank you, Betty. Good afternoon, everyone. Good to be here. Thanks for inviting us this year. It's always good to be in New York City this time of the year, beautiful place. Thank you for joining me today for the update on SM Energy. I'll just jump to the -- I'll jump past that slide. I'm still not a prophet, if you've heard me speak before, so I'm going to be talking about the future today, but just take that for what it is. So if you've heard us talk before, I know you've heard us describe SM Energy, so who's SM Energy, I know you've heard us describe ourselves this way. Premier operator of top-tier assets, delivering a sustainable return of capital and then empowered by world-class technical team and strong balance sheet, we're poised to repeat that success. That's kind of who we are. I want to focus today on just one of those pieces, and that is the world-class technical team part of that. If you want to think of just 4 words, why is SM Energy different? Why should I invest in SM Energy versus other companies, other E&P companies, think of returns-based technical focus. That's really what differentiates us, we think, especially from companies our size, and that is that focus on technical expertise, and I'll talk about that as we go through the presentation more. So I said top-tier assets, we're in 3 top-tier assets, 2 of them in Texas, 1 in the Midland Basin, 1 in South Texas, and then most recently in the Uinta Basin. And I'll actually tell -- they all tell a really good, unique story on their own about us being technical focused, returns-based technical focus so I'll get into that. And really, that's -- we believe that's the only way you can generate a slide like this. And this slide is a really important one. If you just take 1 home today, take this one home. If you look at the last 5 years, these are simple metrics for an E&P company, very rooted in what we do, and that is production and proved reserves. And what you see from this slide is that over the last 5 years since coming out of COVID, we've grown production well over 60%, oil over 70%, proved reserves well over 60%. And in that period, you would imagine, well, there must have been a lot of capital involved in doing that. And if I go to the capital structure and if I look at total shares outstanding at the beginning of that period and at the end of that period, it's exactly the same, 114 million shares outstanding. So no dilution for that growth. And if you think, well, maybe you levered up to do it. If you look at our leverage at the beginning of that period, it was 2.3x. And standing here today, it's closer to 1x. So we've actually delevered during that period also. So we -- that's who we are and that's the output of what we do. And if you ask me what the next 5 years should look like. We plan on it looking like that, continued growth, capital-efficient without diluting and without levering up the balance sheet to do it. So how do we do that? It's a great question. Technical team. I would say that over the last 17 to 20 years, SM Energy has been very focused on building muscle in all of the areas that we think are really critical to being a successful resource play company and especially in the technical area. That means geosciences, that means engineering. That means data analytics team, means systems, processes, back office everywhere, really building muscle technically and with people that are attracted to that. I think we have a culture that attracts people to that environment and a leadership development culture that attracts people in all areas, frankly, of the company. Our attrition is really low compared to our peers. So I said that the 3 top tier assets really tell unique stories around that technical expertise and they do, starting with the 2 in Texas, the 2 older stories, I'll start in the Midland Basin in Howard County. If you go back to 2016 or 2015 and you looked at a map of the Midland Basin, Howard County would be outside the map, it'd be off the map. And our technical team had done a lot of work and have gotten very excited about that area saying that this is great rock. This is a great, great part of the Midland Basin. Back then, you would have seen maybe 3 intervals in Howard County. This is a good visual. The map on the left is Howard County back then and the level of activity, maybe 3 intervals, not that many wells drilled, a lot of verticals, so a lot of data to study and then fast forward 10 years later and wow, what a different image, right? Over 5,000 wells drilled, 9 intervals now. It's truly been a wonderfully successful acquisition for us and truly a top-tier asset. And the next story is the Austin Chalk. So in West over near the -- actually in South Texas near the border, the Rio Grande, we have what's called here the West Austin Chalk, and that's important because back in 2018, if I said Austin Chalk, when we said Austin Chalk, everyone said, that's -- they almost said it's a 4-letter word. Because the history of the Austin Chalk was not a good history and it was further east. It would have -- a good well would come on but then it would go away too quickly. And then the next one wouldn't work. And the P10/P90 it was just really, really high. Lots of variability. This Austin Chalk was very different. And our technical team said, this is just a completely different play all together. We truly should have renamed it the Wolf Chalk or something like that, but we didn't. Took time to prove again to folks. And if you look at the slide on the left, and the picture on the right, you see that eventually, these -- we're drilling wells that the returns are very similar to the Permian Basin, great asset, lots of inventory. We're now seeing 465 locations, and we're just a little over 100 into that. So another great story, top-tier assets, driven by the technical focus. Just an update on both of these assets, they continue to perform really well, and they both continue to have a lot of inventory in them. These charts we just -- we typically update these. Periodically, it's third-party data. Enverus actually gives us the data for this. And it compares -- the one on the left is Howard County versus our peers. The one on the right is the Austin Chalk versus our peers. And it's just a cumulative production plot showing the average performance of the wells versus the peers in those areas. So this is an enormous amount of data. These are wells going back to 2021 for Howard County and 2018 for the Austin Chalk. So just enormous sample size and just continued outperformance versus the peers in both of these basins. I said premier operator, that's an important part of the mix also that technical DNA is also in the operations of the company. And that's all the data driven before the well has even drilled, making sure we hit the landing zone perfectly. Drilling longer laterals, trying something new on every completion, bigger completions. And what you see is over the last 4 years, our average time to drill a well, our average time to complete a well has just gone down and down and down and down. And the result is 15% lower D&C cost over that period of time, just based on premier operations. Great work there. The insets in the green. I'll let you read those yourselves. Those are some examples of some things that they've been doing this year to improve those results as well. Okay. Let's move on to the third story, the Uinta Basin. So the technical team looks for opportunities to add to our inventory, to add to our top-tier assets not just in the areas that we're in, they certainly do a lot of that, and we're able to organically add inventory. We're able to add an Austin Chalk interval on top of the Eagle Ford, which is what happened in South Texas, but they also look in other basins where there is opportunity to deploy our expertise in a new area if the opportunity presents itself. And that happened a little over a year ago in the Uinta Basin. What we identified in the Uinta was an asset that, again, not well known, not unknown by everyone, but not well known, an area that might look a little smaller to majors, certainly. And to others that might have looked, they might have heard notice things like waxy crude, having to rail out of the area. So things that we think are opportunities that might have looked as deterrence. But what the technical team really loved and loves is the characteristics of the reservoir. So this is 4,000 feet of stacked pay, potentially 17 intervals. So you can imagine the opportunities and the wonderful playground, if you will, to really deploy our expertise into. And then that excitement met opportunity, which it has to when a private called XCL Resources was selling the assets by design, by plan, and we were able to acquire this position 63,000 net acres for a couple of billion dollars a little over a year ago. Very excited about it, all the reasons that I just told you we love about it. We still believe that -- and the integration is complete. We were able to hire essentially everyone that we hoped to. The cultures were very similar. I think the new employees love working for SM. It's just really a match made very well. There's a lot of innovation going on in the area, and I'll talk about that on a later slide, but the performance has been very good so far, and we're very excited about this asset. This is just showing you some production. This is, again, a similar chart to what I showed you earlier on Howard County and Austin Chalk. Third-party data. Again, this is inverse data, cumulative production plot. And what you see is the production out of this basin, the top 2 lines, the dark blue and the not so dark blue line. One is what's called the upper cube, one is called the lower cube, there's also a third cube I'll talk about, which is the deep cube. What you see is the production profile of this asset is very, very similar or better than the Midland Basin. What we've been showing the last few quarters, we've been saying, but we've been actually showing the results. It's really important to remember despite the additional costs involved for transportation out of the basin of the oil, the waxy oil, there's high demand for that oil, by the way. But despite that additional cost, the margin per BOE in the Uinta is almost the same as our Midland Basin margins. And that's because mainly the high oil content. This is 90% oil in the Uinta. Some nice innovation and some opportunities to continue to drive cost, we believe, in the Uinta Basin asset. The folks at XCL, a lot of ex EOG people really innovative, I would say, very well-run operation, things like owning our own sand mine. We're excited about that really, we've seen how that really lowers the cost per well. Some centralized frac operations where you have the completion spread in 1 spot, able to run lines and actually frac other areas without moving, mobbing and demobbing so lots of nice savings there. You can see a picture of ascending the sand versus having to put it on a truck on a little rail that's been built. Just a lot of innovative things that have been done in the basin already that we're continuing to do a lot of simul fracking too, a lot of examples. So premier operator, we -- I think we've been saying this at least since I've been here, you can't call yourself a premier operator if you're not a top steward of a top protector of people and the environment, and that truly is part of our DNA. We're very proud to deliver that result. And if you want to look into that further, there's just a ton of data on our website updated with a lot of those statistics. I said strong balance sheet. That's obviously a very, very important part of being an E&P company and being able to repeat the success that we've been talking about. Our balance sheet is currently very strong. It's -- I like to talk about balance sheets in the terms of liquidity, maturities and total leverage. Starting with liquidity, lots of liquidity, a $2 billion borrowing base, which is undrawn, you see it matures way out in the future. It's that really tall bar. That was recently redetermined at lower prices. The borrowing base is actually $3 billion. The bank commitment is $2 billion undrawn again. We're actually building cash currently, $100 million of cash at the end of last quarter. You can see the maturities of the debt that we do add is staggered out reasonably well. We're in debt reduction mode currently. And obviously, we'll be targeting that next maturity, the volumes that are in 2026 and then the ones in 2027. Both of those are callable at par currently, so we can take those out whenever we wish, kind of philosophically, and we've been very clear about this. Certainly, since 2022, when our leverage is -- it's pretty simple. When our leverage is above 1x, we prioritize free cash flow to reducing debt to getting it back below 1x. When it's below 1x, we prioritize that free cash flow to return of capital and we do that in the form of share buyback. Where we are currently is getting back really close to that 1x area, 1.2x at the end of the second quarter. If you look at that pro forma for the Uinta acquisition it's 1.1x. I think we said on the call that if you just assumed the strip to the end of the year right at 1x at the end of the year. So we're kind of in that zone right now where we would be considering getting back into share buyback. The way we look at return of capital is, and we kind of began this in a big way back in '22 after we got below 1x, we said that's what we're doing first. Once we got below it, we announced a fixed dividend and a share buyback program, we believe that's the right way to return capital, a fixed dividend that you can count on, that hopefully will grow with the growth of the business. When we announced it back in '22. We came out at $0.15 a quarter and we've been able to increase that twice since then, once to $0.18 most recently to $0.20 per quarter. So that's the current fixed dividend. We announced a $500 million share buyback during the last few years from '22 to '24 and we were below 1x. I think we acquired $370 million of that $500 million during that period, pulled in a little over 10 million shares during that period. Get the Uinta acquisition, use all cash for that acquisition. So leverage went back up closer to 1.5x. So since then, we've been working it back down to the 1x, the Board has announced a reloaded $500 million share back, which we were anxious to get back into as we kind of get into this near 1x or below area. So that's our philosophy for return on capital. So with that, I'll close. So again, if you're just going to remember 4 words, it's returns-based technical focus. That's who we are premier operator of top-tier assets, and with that, I'll close it up, Betty and open it up for questions.

We'll open up for Q&A. But I'll kick it off way. When you guys first looked at the Uinta Basin. Was that something that was actively pursued in the Uinta basin, what did you see at the time of the acquisition? What did you underwrite? And how did that -- how the reality compared to what you underwrite and how you think about the potential or undiscovered potential for here?

Yes. No, that's a great question. Thank you for asking. I'll just kind of walk through that again. It's all about the technical team and looking for areas that are very similar characteristics, frankly, to the Permian Basin, the stacked pay very oily areas that we can deploy our technical abilities on and generate a return. It's not just technical focus. It's a returns-based technical focus. It would be very hard to replicate what we're able to acquire in the Uinta in the Permian, for example, so competitive. It would be very hard to replicate those returns. So what did they see? What did the technical teams see? They map everything. I shouldn't say everything. It's not -- we're not looking all around the world. Let's just say North America, not offshore. But areas like the Uinta, they get very excited about when they see these characteristics, and that is primarily, again, the very, very thick stack pay. The 4,000 feet of oil, 90% oil with all the potential of the intervals. Remember when we talked about Howard County, the industry thought maybe 3 intervals. And now we've seen 10 years later, 9 intervals. So things like that, all the upside of the intervals. You got -- so you got -- those 7 intervals are kind of broken up in 3 cubes, we call them, like the upper cube, the lower cube, which is in the middle, sorry, and then the deep cube is the deepest so that lower cube is what was mostly underwritten in the acquisition. That was the most known. That's where there's clear value. And that's where 90% of our capital is going this year. But we're very excited about the potential in the upper cube. And then even the deep cube is just really, really upside, right, to be really explored. So that's kind of the makeup of it. You'll see us testing more the upper cube next year, I'm quite sure. A lot of the things that when you said, what can we do I talk about the technical team, and it's not just the way we drill and complete the wells, but it's kind of our philosophy of co-developing we think will also make the overall asset much more valuable at the end of the day versus just focusing on intervals that we know first, but actually codeveloping intervals together, we think works very well. So that's...

I do think you guys have the credibility in Howard County because as you said, the 3 interval, I didn't even tell we're at 9 now so that's quite impressive. Maybe from an M&A standpoint, do you think you have scale in Uinta now, would you want bigger? And is there other parts of the U.S. that technical team have looked at that looked -- found interesting?

Yes. So obviously, it's always better to have more. Would we like to grow in the Uinta? Sure. We knew going into that acquisition that we really wouldn't have to. It's a really good size position, certainly for a company our size. We will look for opportunities, though, if they can meet the criteria that we have for being returns based, the assets they need to be what we consider top-tier assets, and that means they generate really good returns at commodity prices, oil prices much lower than certainly where we are now. So we'll look -- there's other people around us, and we will look for those opportunities. I think there would have been a lot of concern a few years ago. FTC concerns with respect to getting too large in the area. So that's something to factor in. We think we don't know. We think that's probably a little bit easier than it would have been just given the dynamics of the basin, mainly so much of the crude is now trained out -- railed out of the -- actually out of the state and the administration may be a little friendlier to that. But we don't know and we wouldn't count on it, but it feels intuitively like it probably is. So we would look for that. Do we look at other basins, yes, I mean we -- it's not -- we're very happy in the basins we're in, and the plan would be to be able to grow in those, but we're not against looking in other basins. It just wouldn't be the -- I don't think it would be the near-term plan to do that, but that's possible. And then on M&A, again, we certainly appreciate the benefits of scale from an investability standpoint, from a valuation standpoint. So we look at every possible way that we could take advantage of that. But we don't believe in doing something just to do it. We don't believe in scale just for the sake of scale. It needs to meet criteria of being accretive again, assets that compete, assets that are top-tier assets, certainly not seaming the balance sheet the other direction from a leverage standpoint is not something we're interested in. But yes, that's kind of how we view all of that.