Western Midstream Partners, LP (WES) Earnings Call Transcript & Summary

Welcome to Western Midstream's Fourth Quarter and Full Year 2022 Post-Earnings Fireside Chat with our Chief Financial Officer, Kristen Shults. Kristen, let's dive right into it. What were the primary drivers affecting throughput and margin results in the fourth quarter of 2022?

Thanks, Daniel. Let's start off with the throughput aspect of your question. So looking at Q3 to Q4, our throughput on the gas side decreased by about 1%. Some of this was due to Winter Storm Elliott, which we saw pop out in the natural gas throughput numbers as well as the produced water numbers. The other aspect on the natural gas was noncore assets and lower throughput from our equity investments. For crude oil and NGL throughput, we saw that decrease by 9% quarter-over-quarter, primarily resulting from the declines in the DJ Basin and then less throughput from the sale of Cactus II. In fact, we only got 1 month of throughput related to Cactus II for the whole entire quarter. Looking at the gross margin per unit and the sequential quarter decrease that we saw on the gas side, $0.06 quarter-over-quarter, this was from a lower contribution from our retained residue and NGL volumes and lower commodity prices associated with those volumes. We also did our cost of service rate redeterminations during Q4, and we had a favorable rev rec adjustment related to the cost of service for South Texas, which helped to support that natural gas per unit. On the oil side, we saw an increase of $0.20 quarter-over-quarter. We actually received the distribution payment related to Cactus II. That didn't have a full quarter of volumes associated with that so that helped to push that gross margin per unit up. That was partially offset by an unfavorable revenue recognition adjustment that was associated with a lower cost of service rate related to the DJ oil system. Water went down by around $0.02 per barrel, and that was just lower deficiency fees revenues that we're seeing there as the throughput in the Delaware is increasing.

What about our thoughts in the first quarter of 2023 when it comes to margins?

So on the gas side, we expect first quarter of 2023 to be relatively in line with what we saw for fourth quarter. You adjust out the favorable revenue recognition adjustment that we saw during the fourth quarter, but at the same time we're expecting higher throughput in the Delaware Basin, which has a higher-than-average per Mcf gross margin associated with it. So overall, I just expect that to be right in line with what we saw for Q4. On the oil side, we expect the first quarter to be higher than what we saw in the fourth quarter. Once again, that fourth quarter gross margin per unit was impacted by the unfavorable revenue recognition associated with the DJ oil system. So when you take that out, I expect that gross margin per unit to go up. On the water side, we're expecting the gross margin per unit to continue to decrease as we get into Q1. As the volumes continue to increase in the Delaware Basin, we won't see the deficiency revenues that we've been seeing. Additionally, there were some cost of service impacts related to water, and that's going to impact that gross margin per unit starting in 2023. There wasn't a cumulative catch-up that impacted the 2022 gross margin per barrels, but 2023 and forward would be impacted by that.

Lots of questions on guidance. Can you walk us through the different components of WES' 2023 adjusted EBITDA guidance?

Sure. So taking a step back for 2023, we've seen incredible strength and growth coming out of the Delaware Basin. We talked all last year and on the call actually around the number of wells that we see coming online that was very strong in 2022 and even stronger now in 2023. So the gross margin coming from there just continues to increase, and we're very hopeful about what the future beyond this looks like. We talked last year around the DJ Basin and the declines that we're seeing in the DJ Basin. This year, in 2023, we don't expect it to be quite as steep as what we saw in 2022. But that decline is leading to a decrease in the gross margin associated with the DJ Basin. Our other noncore assets that we have, specifically Wyoming and Utah and then in South Texas, those have also been experiencing throughput declines. Additionally, we've got some deficiency revenue and MVCs that are rolling off in 2023, and so we're losing some gross margin from those areas as well. Lastly, Cactus II being sold last year, that's around $30 million of EBITDA that won't be in 2023 as a result of that sale. So when you take all those factors into consideration, really great performance that we're expecting out of the Delaware Basin. And that's helping to offset some of the performance that we're seeing from the noncore areas and just some of the declines we're seeing in the other areas that we have. The other thing that shouldn't be much of a surprise, but as we see that increased throughput, as we see that increased activity in the Delaware Basin, the variable costs that we have in OpEx are also going to increase. So for example, as we increase water throughput, we have to pay higher land fees associated with that higher throughput, additionally higher salaries and wages, asset integrity, maintenance and repairs, all those types of OpEx-related expenses that's going into the Delaware Basin.

What are some of the factors that could get WES to the high end or the low end of the adjusted EBITDA guidance range?

So when we look at some of those drivers, throughput and specifically producer activity levels, that could push us more towards the high end, or if it's a little slower or even the cycle times are a little slower, it might push us closer to the low end. Commodity prices, we've put a sensitivity into the deck. As commodity prices change, that could impact where we fall within the range as well. We've been incredibly focused on our costs but there are inflationary pressures that are out there. And so while we have that baked into our guidance, if that shakes out favorable or unfavorable related to the expectations that we had, that could impact where we're falling in the range as well. Our commercial team is hard at work at bringing new customers or even existing customers and new business from those existing customers onto our system. So depending on how some of those transactions work out, you could see us fall higher or lower in the guidance range as well.

Okay. Let's talk about 2023 expected CapEx. Can you talk about the expected 2023 capital expenditure guidance range?

Sure. So our guidance range for 2023 for capital is $575 million to $675 million, implying a midpoint of $625 million. When you look at 2022 capital, where we ended up, $538 million for 2022. So that increase that you have between 2022 and 2022 relates to Mentone. A lot of capital being spent obviously in the Delaware Basin, expansion capital, so new well connect, new saltwater disposal facilities, additional compression, really setting us up not only for the increase in wells that we're seeing in 2023 but just for the future volumes that we're looking at as well.

Shifting to our capital return policy. Can you talk about management's recommendation to the Board to pay an enhanced distribution of $140 million in 2023 based on WES' 2022 financial performance?

So our enhanced distribution calculation that we outlined last year and the policy around that looks at free cash flow less base distributions, less debt reduction, less buybacks. When we did the calculation for 2022, there wasn't an enhanced distribution that was calculated at that time. We took a step back, have always thought that we would look at M&A on a case-by-case basis and whether or not that would be included in the calculation, and the Board should use their discretion to include that in the calculation. At our financial and operational performance for 2022, we felt like the company performed incredibly well. We actually had to go back and revise guidance in May of last year upward. So where we ended up from a financial aspect was much higher than we originally thought at the end of the year from an EBITDA perspective. Our leverage was much lower than we thought originally as well. The threshold for the enhanced distribution was 3.4x. We ended up at 3.1x. Additionally, between the $488 million of buybacks we did and the debt reduction that we did last year, we've significantly reduced our cash burden as well. Just the buybacks alone, on an annualized basis, that's reducing our cash distribution burden by $40 million. So taking into account the EBITDA that we've lost from the sale of Cactus II on an annual basis, which is around $30 million, we're still free cash flow positive based on just the activities that we did to reduce the size of the balance sheet last year. We felt like taking all those aspects into consideration, it would be appropriate to include the M&A proceeds from Cactus II in the calculation, and that's how we came to the $140 million for enhanced distribution. That $140 million and the inclusion of the M&A proceeds into the enhanced distribution calculation was part of the recommendation that we gave to the Board. And then we'll be requesting formal approval in April to pay that distribution in conjunction with our first quarter distribution payment in May.

What are management's thoughts on a go-forward basis when it comes to more unit buybacks versus enhanced distributions?

Our thought process on buybacks is still the same. Those buybacks will be opportunistic in nature. If the opportunity presents itself in the market, then we'll take advantage of that. But at the end of the day, if we don't find another good use for the cash that we have, it will go back to the unitholders through the enhanced distribution framework.

Kristen, thank you for joining us today. For our listeners, if you have any additional questions, please feel free to reach out to us. Our contact information is located in the Investor Relations section of our website at www.westernmidstream.com.