SM Energy Company (SM) Earnings Call Transcript & Summary

Hi. Good morning, everyone, and thanks for joining us today on Day 1 of the Natural Resources Conference. I'm [indiscernible] from the E&P research team here at JPMorgan. Up next, we have SM Energy and E&P focused on developing assets across 4 U.S. [indiscernible] basins, the Permian, DJ, South Texas and Uinta. We're very excited to be hosting SM's President and CEO Beth McDonald. Beth joined SM as Executive Vice President and COO in September 2024, was named President in September 2025 and appointed CEO in January 2026. Beth, thank you so much for joining today.

Thank you so much for having me.

Yes. So maybe to start off for those in the room who don't know you. Can you tell us a little bit about your background? You started as a field engineer, how does that shape the way you lead today and what drew you to SM?

Yes. Thank you for that, and thank you all for joining us today. I started as a field engineer with my love for geoscience and engineering and problem-solving and started as an ops engineer, did time in drilling and completions and then really found myself in reservoir really more on the strategic perspective. I joined Pioneer in 2005, working exploration projects in deepwater at the time, Gulf of Mexico and Northern Africa, which is kind of crazy when you think about a company like Pioneer Natural Resources, you think Midland Basin. And so I like to say that I had a tremendous opportunity at Pioneer, 20 years with the company, worked several different basins, primarily South Texas. I led our South Texas asset team. I ran the Pioneer Water management team and then stayed until Exxon when Exxon took over. And I was leading multiple teams at Pioneer really primarily focused on the pure play Permian that we ended up being. And so I think that the thing that attracted me to SM was it's technical focus. And if you look at the track record of SM, for much of the last 10 to 15 years, SM has really been pushing the limits. And so they did that in Howard County in the Midland Basin, made tremendous wells in the Wolfcamp A and in the Dean, some of the best wells in the basin came from SM Energy. And then in South Texas, the Austin Chalk was really a differentiator. And then in 2024, we stepped into the Uinta Basin and made a difference in an underappreciated base and continue to see the high margins that came from that. And then finally, I'll just say a little bit more about SM is that the people are really part of the difference, and that's what attracted me there. So the technical focus and you have heard in the past when [ Herb ] would talk about returns-based technical focus, but we really punch above our weight. We tremendously desire being curious and asking what if and making a difference in the industry even at our size.

Yes. And you've stepped into the COC at a pretty notable moment. The largest merger in SM's history, volatile price environment and the new board. What's been the mandate on day one? And what surprised you the most since?

I would say you'll continue to hear me talk about integrate, execute and bolster. Those are our 3 strategic priorities going into the year. And so integration is going really well. We have had tremendous velocity going into the year. We have increased our target from $200 million to $300 million to $375 million on our synergies and we continue to deliver across the board. You see many of that coming across our cost of capital, which is really, I would say, probably our most I wouldn't call it a surprise. I think it's a lot of hard work from our dedicated team to make these things happen. But what I would say is the sheer amount that we're seeing come to fruition in just the first 100 days of this transaction, I think, is really more of the surprise. The fact that our team accelerated many of our goals throughout the year to the first half of the year and have been able to deliver on that. That's really the surprise point when it comes to the overall transaction. But we're really excited about the value that we're creating through the merger.

Yes. And speaking of value, in the E&P sector is crowded with a lot of companies who make similar claims. And maybe can you make the case why SM specifically deserves a place in an institutional portfolio? And what is generally differentiated with SM Energy?

Yes. I think several things. So after the [ Civitas ] merger, it brought us into 4 premier basins, and the rock quality is very similar. We were just talking about this in one of my last meetings. And actually, if you look across the board and you take into time depositional history, you know that from South Texas, Permian Basin out through the DJ even into Canada, that was a primary depositional environment called the Inter Cretaceous Seaway. And at the time, it really created these premier basins in which SM is part of. So we're -- not only do we have the differential technical team, we now have a portfolio of 4 basins with differential rock. And so we have the ability to have the scale now to create the synergies from a procurement perspective. We have the technical team to do it. And now with the tailwind of commodity prices that we've seen versus where we came into the year, we've been able to meet those strategic priorities even faster. So we talk about a lot our flywheel. And what that is, is we've doubled the size of the company. We have line of sight to a low 1x leverage position. We have a new return of capital framework where we're focused 80% on the balance sheet, 20% on share buybacks as that leverage goes down, more goes to share buybacks. We throw off more free cash flow next year as our onetime costs roll off, and we continue to see value creation from the merger.

And you just talked about being a multi-basin operator. We've heard some investors argue that maybe 4 basins is too many basins just given it can create complexity, dilutes focus and makes it a little bit harder to model. You've seen large single basin operators up close. How do you respond to this view?

Yes. I think I love this question because basin diversification is actually a strength. Coming from Pioneer, you're very efficient when you're in one basin, but you're actually pretty limited too, so there's concentration risk. If you can think about capital allocation is always kind of similar. So where am I putting my money when I look at the capital program from a drilling and completion perspective, it's in the best-return wells, right? Well, if you're in one basin, you might not be able to do that because you have multiple rigs on top of frac fleets you have supply constraints from a water perspective and you have water takeaway constraints if they're all on top of each other. When you have a diversified portfolio, you don't have that concentration risk. Your capital allocation is still the same. You're going to put it on the highest return projects that you can, the most capitally efficient incremental dollar. But now you have the diversification. You also don't have large basis blowouts that impact your entire financial position and one winter storm will take out a lot of your production. And so we see the diversification as a strength. The other thing that I think is important to keep in mind, just like I talked about the rock quality of being very similar across multiple basins that we see as a strength. And they're not very far from each other. So if you think about it, SM's position now in the Southern Midland Basin is only a couple of hours away from our South Texas position. So utilizing efficiency in our vendors and our equipment and how we operate is easy to do across multiple basins. And so we see that as a strength in having come from a pure play. I think that we'll start to see more and more companies start to diversify over time as we move through the industry.

Got it. And you became a 4-basin operator with [indiscernible]. Maybe just kind of looking back, can you walk us through the strategic rationale behind that deal? What did SM buy that it couldn't have built organically and where does integration stand today?

Yes, I think a couple of things. When we went into this merger, we saw double-digit free cash flow accretion at $60. And now we are in a fundamentally different commodity price environment. So the accretive metrics that we're going to see are going to be better. The other thing it gave us was the scale in the premier basins that I've already talked about, but the scale really drives us to see those synergies that we're delivering today. And finally, just the synergies, right? So that's a tremendous opportunity. When you look across the board at all of the categories in which we're meeting and ultimately will exceed the goal there, we will create about $2 billion in NPV that neither company could do on its own. So just from the synergies alone, we're creating that valuation. Additionally, I think it's important that we keep in mind, not only were the accretion metrics there when we did the deal, but also our ability to double the size of the portfolio at the same M&A metrics is just not out there. And so doing it with this opportunity, SM really saw that a strength for us. Our ability to take double the portfolio with our talented technical team, both on the operations side as well as the subsurface side and deliver value from that. We saw as a tremendous opportunity. Now you're seeing it roll through Q1, and you'll continue to see it through the remainder of the year as we execute.

Yes. And SM's technical team has a track record of being ahead of the market. I think some examples of this are being a first mover in Howard County and then drilling the first 4-mile laterals in the Uinta and Midland. And I believe SBI was similar in that case. And so what's the team working on today that maybe the market fully hasn't appreciated yet? And where do you see are the biggest needle movers in terms of the technical team?

Yes. I think all those things are spot on. I love -- we did a lot of kind of digging in that and I asked the DJ team, which I was -- we knew that the DJ team from Civitas was a strength. We knew that their execution team had done things that were differential. U turn, J wells, can-to-can wells, whatever you want to call them, they were doing differential things in the DJ as well as lowering our costs there. And what we saw was that, yes, they did the first 4 miler in Colorado. We did the first 4 miler in Utah, and we did the first 4 miler in the Midland Basin. We actually did the first 4 miler in the Austin Chalk in South Texas. So add them to all 4 of our basins, we have the records there. And so I think what that says to our team is it shows the mentality of what if or why not, right? And so we have this curiosity component to continue to push the limits of what we're doing. And we, as a leadership team, allow our team to do that because we've seen differential movement in our capital efficiency numbers because of that. So that's on the execution side. On the subsurface side, SM continues to provide additional incremental inventory opportunities organically. And we've done that, and we've proven that over time. So start back to Howard County. Just like you mentioned, some of the best wells. And then in South Texas, our Austin Chalk position, it was actually bought and purchased for the Eagle Ford position. The Eagle Ford is still there. It is still attractive to us, but the Austin Chalk creates better returns right now. And so that's what's getting our capital. If we shift to the Midland Basin, you'll hear us, and we have talked about for a while, the Woodford-Barnett. I think the industry is catching up to the narrative that we had 2 years ago on our slides as it relates to the Woodford-Barnett. And now you're seeing the ability to execute that more efficiently through managed pressure drilling and landing zone optimization. And so now it's carrying a weightier narrative as it relates to the Permian Basin. And then finally, if you look at the Uinta and DJ, our Rockies position, we continue to optimize there. We have more locations in the upper cube as well as the deep cube, which we're not counting as part of our inventory. I think it's something that you will see us continue to add over time as we further delineate that part of our portfolio. We have additional acreage to the north in Uinta that we have no locations on. We own it right now. It has vertical production on it. We're drilling a pilot hole to understand that, and you'll see more inventory being added to that. And so there's tremendous opportunity both from a subsurface perspective on the acreage we already own to add organically to our inventory number. So not only is there value creative from the actual accretion numbers, the free cash flow, the synergies and everything that we're doing. But technically, we're adding additional value to our portfolio through what we do every day.

Yes. And I think the Permian Basin obviously gets a lot of focus from investors. But I think you guys have done a really good job also strengthening how the Uinta and the DJ portfolio. Maybe starting with the Uinta, that's an asset that actually generated the highest cash margin in the portfolio, but I believe I think around $40 per BOE in the first quarter and you drilled your first 4-mile lateral on the basin. Maybe just walk us through that basin, how does it fit within your portfolio? And how does the extended lateral program, what does that mean for economics and inventory [indiscernible]?

Yes, it means it's more capitally efficient. And so when you look at the 4-mile laterals that we've recently drilled there, the first ones, we actually have the measured depth and the TBD records in Utah. We're getting more capital efficient. And I like to speak to the uniqueness of Uinta and that it's hard-pressed to find the same thing that we're doing there in other places other than the Permian Basin. And so for the Uinta, we have a same frac fleet that is run on our own residue gas and it's an e-fleet run on our own residue gas using our sand from our sand mine, and it's a remote frac situation, which means we only move the frac fleet 2 times a year. We remote frac 2 to 3 miles away so that we can see that efficiency and that uptime and what we're doing. And so that's actually not done very often in very many parts of the United States. It's done in a few parts in the Permian Basin. And so when you think about our ability to do that, really driving down costs, increasing our capital efficiency in Uinta is just one another reason why we love that basin so much.

And then maybe just quickly on the DJ, it's a newer basin for you. How does that fit into the portfolio? And what are some key learnings that you've had or surprises that you didn't know maybe before you got your hands on the asset?

Yes, a few things. So in the DJ Basin, let's just start with the fundamentals of the basin. Again, it's a great rock and it's produced in many, many basins in the same depositional environment. It is a high-margin play. It has low cost. People equate to drilling in the DJ Basin to cutting powder. And so as a Denver company, we love that. We now have the DJ Basin. The other thing I would say is that we slowed the DJ Basin down in order to be able to operate it more capitally efficient, and you saw that on our first quarter call. And the other thing I would tell you is that the DJ Basin is an environmental leader. And we have tankless facilities, right? So what does that mean? Less facility cost, right? And so we're looking at those tankless facilities that use 3-phase flow meters and asking ourselves, how do we apply these same learnings here with less facility costs less environmental impact from a pad design and how do we save costs in other basins. And so I think that's one thing that we've learned from the DJ Basin along with the drilling and completion learnings and best practices that I mentioned before as far as the U turns and J's that they have done.

Got it. And I think if you -- following SM, it's pretty clear what your framework is for this year. It's integrate, execute, bolster. Can you maybe just quickly just touch upon those 3 frameworks and just how you're tracking along the 3 and maybe where you see the greatest value coming through the end of the year?

Yes. So integrate, execute, bolster, I talked a little bit about each one. I'll go into a little more detail. So from an integration perspective, let's talk about people because one of my focal points this year is to create a united culture that brings people and data together and enables our team to execute on the value mission. And so we've been able to do that. So within 90 days, all of our teams are together in the same buildings by function and all of our data is coming through the same platform. That's something that couldn't be done previously, and we saw that as an opportunity bringing the Civitas assets in to a 100-year-old company that had already established itself from an infrastructure perspective. And so that's -- from an integration perspective, as the people and the culture and the data, those really drive the rest of the synergies, right? So if you look at the cost of capital piece and our velocity to that. We sold our South Texas gassier assets that were not strategic for us for $950 million. We were able to pay down debt, $700 million of absolute debt. And basically, through that as well as our refinance of some of the high-yield notes that we inherited from Civitas. We've been able to just really knock it out of the park for our cost of capital. And we believe that, that as well as focusing on our balance sheet, we'll continue to rerate the stock. And then if you look at execute, Q1 was just one data point. The proof that we have is to show the Street that we can continue to execute at scale and doing that at double the size. And so we believe that's one data point of many to come that we'll have throughout the year. And like I said, so bolster was the strengthening of the balance sheet. So all of those pieces, I think, are important parts that you'll continue to hear us update as we continue this flywheel of free cash flow generation back into our return on capital profile and especially as we pivot into 2027 when those onetime costs come and they roll off. And then we look to that 1x low leverage area and our return on capital is starting to shift more into share buybacks.

Yes. And you just talked about 1Q being one data point, but it was a pretty positive data point. I believe 1Q oil was 5% ahead of guidance and total production was 6% ahead of what you guided. Maybe just talking briefly about what were some of the main drivers of that outperformance kind of the operational momentum you see with the [indiscernible], you also increased your second half run rate, which you guys have really pegged as what the company should look like on a go-forward basis to I think around 430,000 [indiscernible] equivalent. So just thoughts on the execute and what's been driving that outperformance?

Yes. So Q1 was really an outperformance on production, our base production as well as some of our new wells that we turned in line across all 4 basins. And so our base production outperformed in all 4 basins. We had an outperformance in a couple of different basins on our new wells. And so we were very encouraged by that. We increased the overall production for the year as Q1 kind of just flows through the calculations for the year. and that ends up bringing up the back end second half run rate to the 430,000 BOE per day. And that's really where we start to see the most capitally efficient program going forward. That's why we started the year with the value versus volume really focused on that free cash flow profile, strengthening our balance sheet by paying down debt, leaning into share buybacks.

And maybe with execution, you've talked about the flywheel and the momentum that you have going to next year. Another thing you've talked about is buying back your own stock is really one of the best uses of capital that SM can make right now. With leverage declining, you have a buyback authorization in place and free cash flow accelerating, maybe paint the picture of what your return of capital looks like now versus what it could look like as you approach low 1x leverage? And maybe when that shift is going to start to happen?

Yes. I think that's a perfect segue to how we're going to continue to create value through the merger. And so we started this year going into the year thinking that we could see commodity prices in the low 5s maybe even a 4 handle, right? So it was pretty bearish going into the year. We created a plan that would focus on strengthening our balance sheet as well as returning capital through share buybacks. So first thing that we did was we increased the base dividend. You saw us do that. That was confidence that the Board and our management team had in our ability to create value from this merger. And then beyond that, we started the year in the high one times area. And then with the tailwind of the wrong [indiscernible] in the commodity price environment, we have line of sight to the low 1x area. What does that look like? So we had the 80-20 as we started the year. As we continue to drive down to the low 1x area, that percentage changes. Obviously, we're still going to focus on debt because it's important. We have too much absolute debt. We want to get that down over time. but we see where we are trading, and we see that as a tremendous opportunity and return on our capital. And so we'll continue to lean in more. So as we get down to that low 1x area, you'll see that percentage increase. Is it going to be a shift right off the bat? No, I think it's going to be a gradual increase into the share buybacks over time as we see our leverage come down.

And obviously, the Civitas merger was a big catalyst in terms of this rate of change story. And maybe just a brief touch on your industry views on just consolidation in general and how Civi is going to play in this picture -- sorry, how SM is going to play in this picture kind of going forward?

Yes. I think in general, overall public M&A has slowed down. We've seen some -- you've seen us, you've seen [ Devon Cotera]. But in general, what we're seeing hit the market or asset sales, including our South Texas gas asset, right? So I think what you'll continue to see is those asset sales happen, what the commodity price environment has given us maybe now over the last week, is maybe the bid-ask spread is coming together and some of these deals actually move forward. What does this mean for SM? We're not going to be in the acquiring mode. We just doubled the size of the company. We have asked our technical team to go back to the acreage position that we have and really build that organic inventory from the acreage that we have. And so that's what we're focused on. what does the market and asset do for SM, it allows us to look at the rest of our portfolio and understand where the market is as far as valuation for what those assets might go for. And then as we roll into our evaluation of here's where the synergies are coming out, here's how it rolls into our economics, here are where the different pieces of our portfolio land out. Now let's understand where those asset sales are in the market. And if there's an arb between those 2, then there's more value for selling that piece than SM keeping it, and that's something that we'll continue to look at as we optimize our portfolio over the time.

Yes. And SM with the deal, it's already pretty much shown a strong track record in terms of that integration, you've increased your synergy capture to $375 million from the prior $200 million to $300 million range. And with 300 [indiscernible] today and 100% by the year-end '26, I just, I think, showed some strong proof in what you guys are able to do on that integration front. Maybe update on how you've been able to increase the [indiscernible] target so far? And what buckets have you seen the greatest upside?

Yes. I think just straight out the gate we made a lot of very quick decisions to strengthen our balance sheet. When you look at our South Texas divestiture, that was an SM legacy strategic part of our portfolio to divest. And we knew that right out of the gate. We knew what we were getting with the Civitas transaction and we said, let's go see what we can get on the market during time when there were very strong gas prices, and we were able to do that. So our cost of capital decreased by eliminating $700 million in absolute debt. The other thing that we did on March 3 was we refinanced our 8 3/8 and pushed those out into 6 5/8 notes. And so we've been able to strengthen it there. So we exceeded that target right out of the gate within the first, call it, 60 days of the -- basically the close of the transaction. And so beyond that, if you look at our G&A, we got most of that done in the beginning. We have some that is still to come as far as vendor duplicity and we have also firms that were over time, we don't need 2 of the same firms. So those kind of public company transactions and synergies that you see over time, those will come at time. And then finally, on the D&C and probably, most importantly, D&C and ops, we're seeing completion optimization from the standpoint of now we have 2 data sets in a much larger Permian position. Our teams got together right away. They started to talk about how do we optimize this how do we save cost but increase or keep production flat at the same well performance, and it was really more of a value-driven decision. And if you guys kind of note on completion optimization, you can make a change today in a valuation or a data set and tomorrow, you can implement it in the field. And so those are some of the quick wins that we did that we saw on the synergy side right away. Another part of the quick wins that we had was the procurement leverage. So right after the deal, we met with several of our vendor partners. We saw -- here's our plan. We were looking at 2026 and understanding what our activity levels would be. We sat down with them and made strategic decisions to lock in great pricing at scale in multiple basins with several vendor partners. And so we were a little fortuitous on that, and it's great that we've been able to keep our costs low and our synergies high there. Additionally, I think there are more things to come. And so that's why we increased that target. It takes a little bit of time to implement a new facility design. What does that look like? It looks like a streamlined facility in the Permian Basin where you can harvest equipment from one location and use it in the next one, so you don't have to continue to buy new tanks, right? So that's just one example. If you look at the water disposal and water supply infrastructure that we now have by having a larger footprint in the Permian Basin, we're able to get some of our costs down there from the supply side that goes into your completion costs and from the disposal side that runs through your OpEx. And so I think those kind of combinations, we continue to see opportunities that will start to get us closer and closer to that ultimate goal.

Great. And I think we have just a little over one minute left here. So maybe just for one last question. What do you want investors who are meeting with SM for the first time at the conference to walk away with? What's, I guess, the key headline messaging that people should leave here with?

I think we have now a premier portfolio and 4 basins, 4 of the best basins in the United States. SM has doubled the size of its scale. It's given us the ability to deliver on synergies that is creating tremendous value up to $2 billion that we couldn't do without this merger. And additionally, what we have is a pivotal moment for investors to look at our stock and see the valuation that's going to come through this merger. So we're coming into the year. We have the tailwind of commodity price. We just doubled our size. We have line of sight to low 1x leverage, and we continue to -- basically, we're lowering our leverage there. We're generating more free cash flow. We're going to lean more into the share of buybacks, and this is a time for people to really be part of that valuation and that story that's going to continue to generate more returns into the future. So now is the time.

It sounds like a great update and a lot to look forward to as kind of head through the rest of the year. Well, thank you so much for your time.

Thank you.

And thank you for joining.