SM Energy Company (SM) Earnings Call Transcript & Summary

Greetings, and welcome to the SM Energy's Second Quarter 2026 Earnings Call. [Operator Instructions] Please note that this conference is being recorded. I would now like to turn the conference over to Megan Hays, SM Energy's Vice President, Investor Relations. Thank you, Megan. You may begin.

Yes, thank you. Good morning. Welcome to SM Energy’s second quarter 2026 earnings call. I’m Megan Hays, Vice President of Investor Relations. It's a busy morning for everyone, so we'll jump right in. Joining me are Beth McDonald, our President and CEO; Wade Pursell, our Executive Vice President and CFO; and Blake Mckenna, our Executive Vice President and COO. Today's discussion will reference forward-looking statements. Please see Slide 2 of our earnings presentation as well as the Risk Factors section of our most recent Form 10-K for risks and uncertainties that could cause actual results to differ materially. We will also reference non-GAAP financial metrics throughout the call. You can find definitions and reconciliations to the closest comparable GAAP metrics in yesterday's earnings release, Form 10-Q and in the slide deck available on our website. When we get to Q&A, please limit your inquiries to one question and one follow-up as this simply allows us to get more of your questions today. With that, I'll turn it over to Beth.

Thanks, Megan. Good morning, everyone. The second quarter was our first full quarter operating as a combined firm. We generated $467 million of adjusted free cash flow, returned $137 million to stockholders and have now actioned approximately 95% of our merger synergy target. Together, those results demonstrate that SM is already stronger, more cash generative and more valuable than either legacy business on its own, and they underscore why this platform is materially undervalued today. Integrate, Execute, Bolster, the framework for 2026 hasn't changed, and this quarter is proof that it's working. I'll take each in turn. On Integrate, we have now actioned approximately $355 million of our $375 million run rate synergy target, which we raised last quarter to nearly double the original. The organizational capability we brought to this merger is real, and it's now showing up directly in our cost structure, including a lower G&A outlook that Wade will cover. Overall, we are ahead of the pace that we laid out when we announced the merger. On Execute, production averaged approximately 440,000 barrels of oil equivalent per day within our guidance range and building into the second half of 2026, pro forma for the divestiture of our Galvan assets in South Texas. On the strength of that trajectory, we are increasing our second half production outlook and reaffirming our full year capital plan. Wade will take you through that detail, but the takeaway is clear. We are executing within a disciplined capital framework and turning the combined platform into a higher free cash flow, higher return business for our stockholders. On Bolster, we closed the Galvan divestiture, substantially achieving our $1 billion divestiture target within a year of the merger and directed the proceeds to debt reduction, putting us on a visible path to low 1x leverage. Alongside that, we also repurchased $84 million of shares this quarter under our capital return framework. In addition, with the cash on hand at quarter end, we provided notice to redeem the remaining 2027 Senior Notes, underscoring the rapid progress we've made in strengthening the balance sheet. That combination, a stronger balance sheet and rising free cash flow with buybacks already underway is a key part of why we believe SM’s equity is so attractive today. In short, this quarter shows we are doing what we said we would do, integrating at pace, executing the plan, strengthening the balance sheet and demonstrating the free cash flow and returns power of SM. I'll now turn the call over to Wade, who will cover the second quarter results and our guidance update.

Thanks, Beth. Good morning, everyone. Our financial results were strong. Adjusted EBITDAX was $1.4 billion. Adjusted net income was $526 million or $2.19 per diluted share, and we generated $467 million of adjusted free cash flow. Capital expenditures for the quarter totaled $717 million, below our guidance midpoint of $835 million, primarily driven by D&C timing. We are reaffirming full year capital guidance of $2.65 billion to $2.85 billion. So again, we generated $467 million of adjusted free cash flow for the quarter. We returned 30% of it or $137 million to shareholders through the dividend and share buybacks, the dividend being $53 million and $84 million used to jump start our buybacks, consistent with our 80/20 framework that we've discussed. Leverage continues to fall. And as it enters the low-1x area calculated with mid-cycle commodity pricing, we anticipate increasing the percentage to buybacks. Speaking of leverage and turning to the balance sheet, we reduced net debt by about $1.1 billion during the quarter, ending with net debt of approximately $6.25 billion. That includes $620 million of cash and an undrawn revolver. We used the Galvan divestiture proceeds to redeem all $819 million of our senior notes due in 2026. And yesterday, we called the remaining 2027 notes for redemption, leaving no senior note maturities until mid-2028. Turning to guidance. We are raising our second half production outlook to a range of 435,000 to 440,000 barrels of oil equivalent per day with oil at approximately 238,000 barrels per day. As we've said, the second half average production rate is the right framing for 2027. We're in the early stages of building the 2027 plan. You should expect a disciplined capital program focused on maximizing free cash flow, and we'll provide more color on the volume and capital cadence as we approach year-end. Full year 2026 ranges are in the release -- but with a partial year of Civitas and the Galvan divestiture, both in this year's numbers, the second half average is the cleaner baseline to model. Additionally, reflecting accelerated integration and full capture of our G&A synergies, we are lowering full year recurring G&A guidance by approximately $50 million at the midpoint. This is a durable run rate reduction with a significant free cash flow benefit. On that note, I'll hand it to Blake for a review of asset performance. Blake?

Thanks, Wade. Our results start at the asset level, so let me walk through the basins briefly. In the Permian, our combined footprint delivers procurement and scheduling efficiencies and gives us more flexibility. We're using our scale and technical team to continue unlocking the value of this high-return inventory. In the DJ Basin, our combined company completion practices, Simul-frac in particular, continue to drive real capital efficiencies. It is a low-cost, high-margin business and the consolidated footprint has made pad design, scheduling and the cost structure much more competitive. In South Texas, the Galvan sale strengthened our balance sheet and high-graded the remaining position toward higher-margin liquids-rich development weighted towards the Austin Chalk. I want to spend a moment on the Uinta and the work our team is doing to drive efficiency and productivity. This year, our team has standardized our Uinta development program to pair completion innovations with faster flowback and longer laterals. Together, these changes are meaningfully improving well economics and cycle times and as a result, pulling cash flow forward. We are developing our position with 4-mile laterals, which our contiguous acreage makes possible. Our blocked-up acreage is a structural advantage few operators can match and long lateral development is a deliberate capital efficiency lever that improves returns across the program. On the completion side, we deployed several innovations, including Simul-frac operations using natural gas frac fleet, remote frac equipment, a sand slurry pipeline and dual-string coil drillouts across our long lateral program. Our completion pace has increased over 2,600 foot per day, which is more than double our early 2026 rate. And these initiatives are delivering more than $1 million per well in drilling, completion and equipment cost savings that we have realized over the past 6 months. We have several compelling levers to pull in the Uinta. And together, they are making this oil basin a more efficient, higher value part of SM's portfolio. And more importantly, the Uinta is one example of a broader advantage at SM, a technical organization that systematically captures shares and scaled innovation across our portfolio, multiplying the impact of every improvement. And with that, I'll turn it back to Beth.

Thanks, Blake. Before we go to Q&A, let me leave you with 4 things that show our value creation flywheel is turning today. First, the merger is delivering with 95% of our synergies actioned at a present value of $1.8 billion. Second, we are generating substantial free cash flow and returning it to stockholders. As leverage moves toward low-1x of mid-cycle pricing, you should expect the mix of that free cash flow to shift progressively to buybacks. At today's valuation, we see repurchasing SM shares as a highly compelling use of our capital, and our 80/20 framework is designed to get us to the right leverage level while taking advantage of that opportunity along the way. Third, we are derisking the balance sheet with no senior note maturities until mid-2028. And fourth, we are constantly high-grading our assets and using our scale to ensure our capital goes to the highest return opportunities. We expect 2027 to showcase the full earnings power of this platform, a full year of the combined company, onetime costs behind us, synergies at run rate and a balance sheet built for returns. I look forward to your questions.

Thank you, Beth. Operator, please open the line for questions.

[Operator Instructions] Our first questions come from the line of Gabe Daoud with Truist.

I was hoping could maybe start off with an ops question, maybe circling back to what I asked last quarter. Just really curious about Howard County and the progress there, particularly with these U-turn wells. So the Zissou wells, it looks like maybe just south of that, you're targeting co-development of the Lower Spraberry, Wolfcamp D and Wolfcamp A. Is that a new development pattern for you guys in that area?

No, I would say -- I'll start off, and then I'll hand it to Blake to add anything that he wants to. That's not a new development for us. As you know, SM has been in Howard County and has really delivered strength in our returns profile there from the Spraberry, the Dean and the Wolfcamp throughout that section. What I would say is we're using the best practices that we've pulled together from a strength in SM after the merger in order to be able to unlock additional acreage in and around Howard County.

And just a follow-up on that. We feel great about our U-turns with the combined team and the work that the DJ team has done on U-turns as well successfully, we have a high degree of confidence in the operational ability of our teams to execute U-turns.

Got it. Got it. Okay. Okay. Sounds good. That's helpful. And then maybe if I can follow up, another ops-related question. Just curious, offsetting the Zissou wells or looks like some 4-mile laterals that have maybe targeted or have gone back to a DSU that hasn't maybe been touched in a few years and looks like these wells are performing pretty well. So curious if you can maybe talk a little bit about that and maybe if some enhanced completion designs have kind of led to some outperformance here.

Yes. I appreciate the question. 4-mile laterals have been a big win for us. And then on the completion design front, we generally like to not comment too much on it, but I think looking at the performance of the wells should give you an indicator of the progress we're making as a team.

Our next questions come from the line of Michael Scialla with Stephens.

It looks like you get pretty close to your leverage target and you've pushed off the nearest maturities. I want to see if we should anticipate any change to the return framework? Are you still planning to direct 80% of the post-dividend free cash flow to the balance sheet?

Yes. Mike, great question. We're obviously very pleased with the pace of the delevering that's been happening. I would -- and we're very pleased with our ability to buy back $84 million of stock during the second quarter, hitting that 20% target with a higher amount. I would say going forward, we've mentioned that kind of the target to get to really what we consider really -- we want a really, really strong balance sheet. And that's that low 1s area at a mid-cycle commodity price. Obviously, right now, the trailing second quarter, I don't think anybody would consider that mid-cycle. So that's our direction. We're getting there, though. I would just say, to answer your question specifically, for now, just anticipating us buying back at the same pace, kind of sitting that 20% as a minimum. And then we'll just be tracking it as we go forward the rest of this year.