National Fuel Gas Company (NFG) Earnings Call Transcript & Summary

Hello, everyone. Welcome to the National Fuel Gas Company's conference call to discuss the planned separation of its integrated Upstream and Gathering business. My name is Samantha, and I'll be coordinating the call today. [Operator Instructions] I will now hand the call over to Ryan Vossler, Director of Investor Relations, to begin. Please go ahead.

Thank you, and good morning. We appreciate you joining us on today's conference call for a discussion of National Fuel's announcement of its plan to separate the company's integrated Upstream and Gathering business. With us on the call from National Fuel Gas Company are Dave Bauer, President and Chief Executive Officer; Tim Silverstein, Treasurer and Chief Financial Officer; and Justin Loweth, President of Seneca Resources and National Fuel Gas Midstream. At the end of today's prepared remarks, we'll open the discussion to questions. We have also posted a presentation to the Investor Relations section of our website to accompany today's discussion, which we may refer to during today's call. Before we begin, we would like to remind you that today's teleconference will contain forward-looking statements. While National Fuel's expectations, beliefs and projections are made in good faith and are believed to have a reasonable basis, actual results may differ materially. These statements speak only as of the date on which they are made, and you may refer to this morning's press release for a listing of certain specific risk factors. With that, I'll turn it over to Dave Bauer.

Thank you, Ryan, and good morning, everyone. Today is an important milestone in National Fuel's history. Earlier this morning, we announced our Board of Directors' approval of a plan to separate the company's integrated Upstream and Gathering business, or IUG, into a stand-alone public company through a tax-free spin-off to National Fuel shareholders. This transaction will create 2 high-quality, scaled, financially strong companies that each have a clear pathway to long-term value creation. We expect to complete the separation in the second half of calendar '27. Following the separation, National Fuel will be a 100% rate-regulated enterprise with approximately $5 billion of rate base. Our utility operations will serve approximately 1.1 million customers across Ohio, New York and Pennsylvania, all of which have constructive regulatory frameworks that support ongoing investments. Our FERC-regulated pipeline and storage business will provide nearly 5 Bcf per day of natural gas transmission services and 77 Bcf of fully contracted storage capacity. Moving to IUG. This new public company will be a premier Appalachian natural gas business with integrated upstream and gathering assets focused primarily in the highly productive Northeast Pennsylvania region. IUG currently has 1.1 Bcf per day of net natural gas production and 5 Tcf of proved reserves across its 1.2 million total net acres in Pennsylvania. With more than 25 years of prospective, Marcellus and Utica development inventory at very low breakeven prices, IUG will be well positioned to grow production, grow its capital efficiency improvement trend and generate long-term value through disciplined capital allocation. In addition, the vast majority of IUG production will flow through its wholly owned gathering assets, which will remain a key driver in maintaining IUG's low-cost structure and attractive cash margins. As Tim will discuss later, we expect both companies to be positioned from day 1 with strong balance sheets and no incremental equity financing needs over the next 5 years, which is unique among National Fuel's regulated peers. More importantly, both companies will have the financial flexibility to deliver continued growth and return capital to shareholders. For many years, our integrated model provided us with a significant with significant financial and operating synergies, along with an element of scale on a consolidated basis. These financial synergies, especially our low cost of capital, were particularly beneficial as Seneca was growing its business. As we sit here today, however, with Seneca's success in Tioga County, IUG now has the scale and free cash flow generation to stand on its own, making the financial synergies of our current business model less relevant than they once were. Combined with the recent closing of our Ohio gas utility acquisition, both National Fuel and IUG now have significant scale and financial strength such that each will be better positioned to capitalize on their long-term growth opportunities as independent companies. Importantly, each company will remain the key -- retain the key operational benefits of our integrated business models. The synergies we've created through the years are almost exclusively between the utility and pipeline businesses and separately between Seneca and NFG Midstream. There's very little operational overlap between the regulated and nonregulated sides of the company. Post separation, the significant operating synergies across our regulated companies as well as the cost structure benefits of an integrated upstream and gathering platform will continue. Further, the backdrop for the natural gas industry is as strong as it's ever been. Natural gas demand is expected to increase from LNG exports, power generation growth and data center demand, with National Fuels and IUG's assets well positioned to support growth in our region. For all these reasons, I believe now is the right time to pursue a separation. Looking ahead, each company will be well positioned to deliver long-term success. National Fuel expects long-term rate base growth of 5% to 7% based on our current capital spending plans, which are underpinned by our contracted for expansion projects and the long-standing system modernization programs across our jurisdictions. In addition, future FERC pipeline expansion opportunities driven by rising regional demand should create incremental pathways to growth. I'll emphasize, thanks to the strong cash flows of the pipeline and storage business, we can achieve this growth without the need to issue equity. IUG's premier acreage position in Tioga County offers a compelling value proposition, its inventory life in the basin, which is more than 25 years at NYMEX prices of $2.25 or less and its low operating cost structure supports substantial, consistent free cash flow generation. Capital efficiency has improved by more than 25% since 2023, a trend we expect will continue in the coming years. While a diverse and growing portfolio of firm transportation capacity provides access to premium markets. Together, these strengths position IUG for long-term success as a stand-alone company. IUG will be led by its current management team, including Justin Loweth who will become Chief Executive Officer of the new company. The combination of a more focused business model and experienced management team and a high-quality resource base positions IUG to succeed from day 1 as a stand-alone company. Bringing it all together, we believe now is the right time to separate IUG from National Fuel and better position both stand-alone companies to unlock their long-term value creation potential. The benefits of diversification served us well for many years. But as we look forward, we think the best path to generating value for shareholders is as 2 independent companies. This will allow each business to focus on their distinct strategic priorities, optimize their capital allocation and better attract investors. With that, I'll turn the call over to Justin to walk through the integrated upstream and gathering business.

Thanks, Dave, and good morning, everyone. This is an exciting time for Seneca Resources and NFG Midstream which comprise our integrated upstream and gathering business. Over the past 20 years, National Fuel has built IUG into a premier Appalachian natural gas company with the collection of high-quality integrated assets across Pennsylvania. Within IUG's footprint, we have more than 300,000 acres across our Eastern Development Area or EDA, concentrated in Tioga and Lycoming Counties, an area that we believe represents one of the best remaining development opportunities in the Appalachian Basin. It has become a key driver of IUG's improving capital efficiency, inventory depth and long-term free cash flow generation. Additionally, we have over 900,000 acres in our Western development area or WDA. This is mostly owned in fee, meaning we don't pay a royalty and have no requirements to drill to hold this acreage. Furthermore, across our operating footprint, IUG owns and operates significant natural gas gathering infrastructure, which transports the vast majority of our production. This allows IUG to develop our deep inventory as an integrated enterprise and supports our highly competitive operating cost structure and continued capital efficiency improvements, both of which we expect to sustain over the long term. These attributes, combined with the strong expected financial profile position IUG to deliver growth [indiscernible] a long-term value creation for shareholders. Diving deeper into our assets, IUG has early inventory depth, with decades of remaining undeveloped well locations. At our current drilling base, we have more than 25 years of inventory at breakeven prices below 2.25 NYMEX. In a basin where high-quality inventory is becoming increasingly scarce, IUG's inventory depth represents a strategic advantage that provides long-term development flexibility to support sustainable free cash flow generation and allows us to pace development to changing market conditions. In addition, IUG's integrated approach to developing our assets and relentless focus on operational excellence has translated into our top-tier capital efficiency trends and operating cost structure. Ultimately, these 2 factors are IUG's North Star. How can we deploy the least amount of capital to grow production to the greatest extent? And how can we develop our resource base with the lowest cost structure in the basin. As we look ahead, our focus and execution in both of these areas positions IUG to deliver long-term success, growing free cash flow and sustained shareholder value creation. Shifting gears to IUG's marketing portfolio, we are well positioned to maximize the value of our production through our significant firm transportation agreements. At present, IUG has approximately 1 Bcf per day of capacity to diverse high-value markets. We've also contracted for approximately 0.5 Bcf per day of additional firm transport capacity that is expected to come in service over the next several years and will support ongoing production growth. The first tranche of this new capacity the Tioga Pathway Project is expected to be available to us next month. This advantaged portfolio will provide access to premium markets across the Northeast, Southeast and Gulf Coast and positions IUG to capitalize on what we believe will be a durable multiyear increase in natural gas demand driven by LNG exports, power generation growth and emerging data center load. As we look ahead, IUG is well positioned for long-term success. We have a deep inventory of core acreage, a highly competitive cost structure and a long-term development plan that we expect will deliver continued improvements in capital efficiency, all of which is supported by an exceptionally talented and dedicated workforce. Together, these attributes create a differentiated investment opportunity, a scaled, integrated Appalachian natural gas company with a deep inventory of high-return development opportunities, growing free cash flow generation and strong positioning to an increasingly constructive long-term natural gas demand outlook. With that, I'll turn the call over to Tim.

Thanks, Justin, and good morning, everyone. As Dave discussed, post separation, National Fuel will become a 100% regulated natural gas company. With the addition of our new Ohio utility, we now have approximately $5 billion in rate base across our regulated companies. Collectively, these assets provide significant scale and given their geographic overlap, support key operating and commercial efficiencies that drive our ability to deliver on our long-standing track record of customer affordability. Our utility business operates within constructive regulatory jurisdictions that supports steady, predictable rate base growth. In addition, each of our state regulators have approved mechanisms that support real-time recovery of a significant portion of our annual capital spending. We've been able to leverage these mechanisms to increase the scale of our modernization program, further enhancing the safety and reliability of our pipeline systems. National Fuel currently spends approximately $200 million per year across our New York and Pennsylvania utilities. And with the addition of our new Ohio business, we anticipate nearly doubling those annual investments. We also have an established modernization program in our FERC regulated business. Here, we operate under a straight fixed variable cost of service ratemaking model, which significantly reduces revenue volatility that results from changing throughput. In this business, we also have a long history of successfully expanding our pipeline infrastructure. And given that our assets traverse a large portion of the prolific Appalachian Basin, we expect this trend to continue well into the future. Since the onset of shale development in the region, we've added nearly 3 Bcf per day of new pipeline capacity. This growth was driven by a significant number of expansion projects across our operating footprint. Early on, they were largely constructed to support third-party producers. But more recently, they become more demand pull projects, driven by utilities, data center developers and power generation facilities looking for reliable, low-cost gas supply. Currently, we have an additional 700,000 dekatherms per day of new capacity under contract, with strong prospects for further growth on the horizon. Nearly 400,000 dekatherms per day of that capacity is slated to come online next month. Our infrastructure sits on top of the most prolific source of natural gas supply in the country. We also have strategic interconnections with every long-haul pipeline in the area. Combining those attributes with a proven track record of execution positions us to continue to be a critical transporter of natural gas and support the growing demand across the eastern half of the United States. Most notably, we are seeing continued interest in additional capacity around the Pittsburgh area, where we have a highly valuable pipeline that we call our line in system. We currently have 2 contracted expansion projects here, 1 of which is set to go in service next month. As we look forward, we expect to see the opportunity to further expand this system. Against the backdrop of growing natural gas demand, we have not lost sight of the importance of customer affordability, an area where we are very proud of our long-standing track record. We have always been a believer that maintaining affordable rates is a win-win, one where we can continue to deliver value to shareholders while also cost effectively providing reliable service to our customers. In our New York and Pennsylvania utility service territories, we've had a long history of having the lowest delivery rates in each state, which remains the case today. We expect to extend the same affordability focus to our Ohio business. Overall, with assets in one of the best regions for natural gas in the U.S., a highly executable plan for growth and further upside from our strategically located interstate pipeline assets across the Appalachian Basin, National Fuel has a clear path to delivering growth that is as good as, if not better, than our high-valued, regulated natural gas peers. Next, I'll switch to the strong expected financial profiles of each company post separation. We've historically maintained a conservative leverage position, which supports setting up both companies favorably of separation. In addition, National Fuel intends to retain an interest of up to 19.9% in IUG. Subsequent to completing the separation, we expect to tax efficiently monetize the retained stake to raise additional proceeds which we plan to use to further strengthen National Fuel's balance sheet. From a credit perspective, we spent substantial time with the agencies discussing this transaction and feel confident in our ability to achieve strong relative ratings at both companies. For National Fuel, after the retained stake is monetized, we expect to be 2 to 3 notches higher than our current investment-grade rating. This will provide the financial strength to deliver on our long-term growth plans. Equally as important, with the ability to generate free cash flow in most years, National Fuel's growth can be delivered without the expected need for dilutive equity raises, which for many of our peers, acts as a headwind to converting rate base additions into earnings per share growth. This will differentiate National Fuel for most regulated companies. For the IUG business, we expect its credit rating will be consistent with similarly sized upstream peers. Scale is an important rating factor, and given our current base of reserves and production, we'd expect to fall comfortably in the BB category. This is a level at which many of IUG's peers successfully operate and have full access to the capital markets. As a result, we don't see any issues efficiently capitalizing this business. nor do we see any liquidity concerns as a stand-alone company. We expect IUG to target maintaining a long-term leverage ratio at or below 1x, which we view as an important strategic goal. The business will likely start modestly higher than that, but given the expected significant free cash flow generation and current natural gas strip prices, we believe a path to sub-1x is achievable within a year or 2 after separation. Each entity's financial strength will also provide meaningful opportunities to build on our long history of returning cash to shareholders. For National Fuel, we'd expect the company's dividend to adjust to reflect the payout ratio that is in line with similarly situated utility peers. With a strong credit rating, cash flow profile and growth trajectory, we believe there's a clear path to meaningful long-term dividend growth post separation. For IUG, we'd expect free cash flow to be balanced across 3 prongs: optimizing the balance sheet, delivering growth and returning cash through share repurchases. Collectively, our long history of prudent balance sheet management and capital allocation have positioned us to be very thoughtful in this separation. Both companies will start from a position of strength, have access to a broader suite of financing tools than they do today, and we'll be able to return an increasing amount of cash to shareholders over time. This is a strong value proposition for investors. Moving to the specifics of the transaction. We intend to separate our nonregulated business through a distribution of IUG shares to National Fuel shareholders in a manner intended to be tax free. Immediately following completion of the planned separation, National Fuel investors will own shares in both companies on a pro rata basis in accordance with their existing stock ownership. We expect to complete the separation during the second half of calendar year 2027, subject to customary conditions, including the effectiveness of a Form 10 registration statement with the SEC and the completion of financing arrangements. In closing, National Fuel shareholders have long benefited from our integrated structure, which afforded us the opportunity to build the collection of high-quality assets we have today. With the closing of our Ohio utility acquisition, we now have the scale and full size of the company to operate as independent entities. More importantly, the backdrop for natural gas across the entire value chain is as strong as we've seen in a long time. which we expect to deliver significant growth opportunities across each business. We believe the separation positions both companies to best pursue and execute on these opportunities. Once complete, investors will have the ability to own 2 differentiated investment platforms. National Fuel, which is supported by stable regulated cash flows, predictable growth and a robust credit profile as well as a continued focus on affordability and IUG supported by a high-quality resource base, low-cost integrated operations, disciplined growth and flexible capital returns. Each company will have a tailored capital structure, a strong financial foundation and a focused, experienced team that is best able to capitalize on the anticipated growth opportunities. We are confident this transaction is the right step for our shareholders customers, employees and other stakeholders. With that, I'll turn it back to the operator to open the line for questions.

[Operator Instructions] Your first question comes from the line of Tim Rezvan with KeyBanc Capital Markets.

I just want to start on the financial side, just to confirm, Tim, the leverage parameters were helpful. So just thinking about this leverage maybe for the IUG segment, you talked about a little over 1x. So I'm not going to pin you down to a number, but are you thinking maybe roughly kind of like $1.2 billion, $1.3 billion or like 1/3 of the debt would kind of move over with IUG? And then longer term, do you believe that maybe this is for Justin, but is a one time leverage target, do you believe that's appropriate for the business?

Yes, Tim, it's a fair question. Ultimately, more details will come out when we publish the Form 10 and get it on file with the SEC. Some of those decisions will get made as we go through time. So I would just stick to the numbers that I laid out in the prepared remarks around slightly over 1x out of the gate with a path to getting below 1x in the year or two that falls. I'll let Justin chime in on the thoughts around the business as it goes out into the future.

Yes. Thanks for your question, Tim. Tim just laid out kind of the big picture there. And I would just further add that we believe that around that 1x is a good place to operate. Of course, that could move around some, depending upon commodity prices and other opportunities that we see from a perspective of growth, et cetera. But that's generally how we thought about the long-term focus, creating that flexibility to be nimble through various market conditions.

Okay. I appreciate the color. I know it's early for details. As my follow-up, just maybe one for David. I was wondering if you can kind of unfortunately, I had to dial back in a couple of minutes in. But as you think about the path to this sort of moment where you make the decision to separate, can you give any details like did you receive an offer unsolicited for Seneca on its own? And maybe bigger picture, why is this a superior outcome to an outright sale?

Yes. I guess I don't want to talk about any sort of market speculation. What I would say is that the Board took a thorough review of all of the alternatives that were at hand, including tax implications of various alternatives and concluded that this was the right path forward for the company.

Your next question comes from the line of Neil Mehta with Goldman Sachs.