Earthstone Energy, Inc. (NYSE:ESTE) Q2 2023 Earnings Call Transcript

Earthstone Energy, Inc. (NYSE:ESTE) Q2 2023 Earnings Call Transcript August 3, 2023

Operator: Good afternoon, and welcome to the Earthstone Energy’s Second Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference call is being recorded. Joining us today from Earthstone are Robert Anderson, President and Chief Executive Officer; Mark Lumpkin, Executive Vice President and Chief Financial Officer; Steve Collins, Executive Vice President and Chief Operating Officer; and Scott Thelander, Vice President of Finance. I’ll turn the call to Clay Jeansonne, Director of Investor Relations. Thank you. You may begin.

Clay Jeansonne: Thank you, and welcome to our second quarter 2023 earnings conference call. Before we get started, I’d like to remind you that today’s call will contain forward-looking statements within the meaning of federal securities law. Although management believes these statements are based on reasonable expectations, they can give no assurance that they will prove to be correct. These statements are subject to certain risks, uncertainties and assumptions as described in our annual report on Form 10-K for the year ended December 31, 2022, our quarterly report on Form 10-Q for the quarter ended June 30, 2023, and the second quarter of 2023 earnings announcement. This document can be found in the Investor Relations section of our website, www.earthstoneenergy.com.

Should one or more of these risks materialize or should underlying assumptions prove incorrect, actual results may vary materially. This conference call also includes references to certain non-GAAP financial measures. Reconciliation of these non-GAAP financial measures to the most directly comparable measure under GAAP are contained in our earnings announcement issued yesterday. Also, please note information recorded on this call speaks only as of today, August 3, 2023. Therefore, any time-sensitive information may no longer be accurate at the time of any replay listening or transcript reading. Today’s call will begin with comments from Robert Anderson, our President and CEO, followed by remarks from Steve Collins, our COO; and Mark Lumpkin, our CFO.

And then we’ll have some closing comments from Robert. I’ll now turn the call over to Robert.

Robert Anderson: Thanks, Clay, and good afternoon, everyone. Thank you for taking time to join us on what has been probably a very busy day for you all. Earthstone’s operational excellence continued during the second quarter, with production setting record levels for the company. We reported second quarter production over 105,000 BOE per day, with the oil component of our second quarter production over 44,000 barrels per day. We have now had three quarters in a row with production approaching or exceeding 105,000 BOE per day. This record level of production volume has us now tracking well above our original stand-alone full year guidance. Our low decline, stable production base and strong new well results drove our production outperformance for the quarter.

This record-setting production level once again continues to showcase the quality and productivity of our inventory, and the strength of our underlying asset base. Steve will highlight several wells that drove our strong quarterly outperformance here in. The execution of our disciplined operating plan and the strength of our operational performance translated directly into strong quarterly financial performance, culminating in approximately $239 million of adjusted EBITDAX and about $42 million of free cash flow for the quarter. Over the past few years, we strategically positioned the company as a significant operator in the Permian Basin with more than $2.5 billion of acquisitions completed. A key piece of our strategy has been the initial entrance into the Northern Delaware Basin in February of 2022 through the acquisition of Chisholm and the addition to that position with the acquisition of Titus last August.

For the past 12 months, we have been searching for the next complementary asset acquisition to our New Mexico deals, while we integrated and executed on our development plan. This quarter’s results really show what we can do with these assets. Our recent announcement and pending close of the Novo acquisition supplements this strategy with our asset base shifting further to focus on the prolific Northern Delaware Basin to which the large majority of our capital activity will be dedicated going forward. With four of our five rigs focused on the Northern Delaware Basin, we expect to see continued improvement in capital efficiency. We believe the Novo transaction has all the right qualities to add significant shareholder value for Earthstone and all of our stakeholders.

I just want to spend a few minutes highlighting several of those qualities. First, we are high-grading and deepening our portfolio of future inventory in the premier Northern Delaware Basin. Noble adds 200 high-return derisked low breakeven oily drilling locations, Upon closing, we will hold over 1,000 future drilling locations with approximately twp-thirds of those in the highly economic Lea and Eddy counties of New Mexico. We currently estimate an inventory life of approximately 13 years at our current rig base providing years of high-quality drilling inventory and future profitable growth for Erste. Second, Novo significantly enhances our scale and operational synergies. We estimate fourth quarter production in the range of 130,000 to 135,000 BOE per day.

This represents an increase of nearly 30% growth compared to our second quarter reported volumes. This production level will propel us into being one of the top producers in the Permian mid-cap group. The proximity of this asset to our existing assets should allow for synergies with a constant focus on operating efficiencies and costs. Third, Novo increases our financial scale. Looking into 2024, the Novo transaction will meaningfully increase Earthstone’s financial scale through higher EBITDAX, but perhaps even more so a significant expected increase in our free cash flow generation as we intend to maintain our five-rig drilling program. We expect free cash flow to increase by more than 60% in 2024 as compared to our Earthstone standalone plan before we agreed to acquire Novo.

Fourth, we will maintain our financial strength and low leverage profile. Even though we will finance the transaction with all cash, and we will not issue equity, we will not sacrifice the balance sheet. As stated when we announced the acquisition, in the fourth quarter being the first full quarter with Novo, we expect to meet a forecasted 1.1x leverage ratio based on the last quarter annualized adjusted EBITDAX, and we expect to further deleverage to below onetime debt to adjusted EBITDAX in 2024. And finally, we will create a stronger, more resilient Earthstone. The Novo transaction will meaningfully strengthen our operational and financial base. We will have over 223,000 net acres in the Permian Basin with proved reserves of 460 million barrels of oil equivalent.

Upon closing, we will have a production profile of over 130,000 BOE per day and an inventory of over 1,000 locations, representing approximately 13 years of drilling inventory at our current five rig pace. All of these factors lead to generating significant free cash flow loan growth making Earthstone stronger and more resilient. Given the profile of the Novo transaction, we strongly believe this is a value-creating transaction for Earthstone. We will continue to focus on the small things that make a difference in our business as well. For instance, we have divested over $100 million of non-core assets in the past year, including more than $50 million in the second quarter of this year. This continued housekeeping will improve our margins and streamline our operations.

Lastly, I want to highlight our inaugural sustainability report, which was published last week, and can be found on our website. We are committed to providing ESG-related information and metrics to our shareholders and other stakeholders. With that, I’ll turn the call over to Steve to provide an update on our operations.

Steve Collins: Thanks, Robert. Good afternoon, everyone. As you can see from our second quarter results, it was another outstanding quarter for the operations group. We maintained our rig count at five during the quarter with three in the Delaware Basin and two in the Midland Basin, allowing us to spud a total of 21 gross wells and 16.9 net wells and put on production a total of 17 gross, 12.5 net operated wells. As Robert mentioned, our operations team continued bringing some great wells online. We have shown the areas and results of these wells on Page 11 of our updated corporate presentation, which is available on our website. Our earnings release highlights a couple of pads that we recently brought online in both the Delaware Basin and the Midland Basin.

I’ll give a high-level summary of those results. In the Delaware Basin, we brought online two pads both in the state line area, which average — with an average IP 30 of approximately 1,800 Boe per day on one pad and 1,900 Boe per day on the other pad. In the Midland Basin, we brought online a pad a few weeks ago in Irion County, with the IP 20 was over 1,000 Boe per day and around 86% oil. We also brought online two Wolfcamp D wells in the Midland County in mid-July that are still flowing naturally, but are looking good with average daily production over 800 Boe per day and close to 90% oil on a Boe basis. As we mentioned the Novo announcement, we will be transitioning from a rig from our Midland Basin acreage to the Novo acreage and shutting down the rig that Novo is operating.

Novo should finish drilling in August, and we expect to move one of our Midland rigs in September to the Novo asset. At Earthstone, we take pride in increasing value by improving the operations of our acquired assets. Given that mindset, we remain highly focused on overall operating expenses. We made significant progress on reducing LOE during the quarter, lowering LOE per Boe by $0.23 versus the first quarter. This was achieved through lower costs for repairs, maintenance and chemicals during the quarter, partially offset by higher gathering, processing and transportation costs and slightly higher work over expenses. We will continue to focus on reducing our LOE per Boe, and I can assure you that our entire team is working through their specific areas of responsibilities to achieve this goal.

We are starting to see some good news on the service cost front. Rig rates have shown signs of softening, and we are beginning to benefit as our rig contracts are renewed. Over the past month, we renewed contracts on two of our five rigs and negotiated price reductions of 10% to 15% and we expect that trend to continue as our remaining three rig contracts roll over in the next two months. We also see a softening for cementing services, pressure pumping and the cost of production casing and tubing. We are cautiously optimistic that we have seen the high point on service costs. We won’t see those flow through our results in any material way in the current quarter and don’t expect to see the full impact of those reductions until 2024. I want to provide a little color on the cadence of our expected well counts for the next few quarters.

For the third quarter, we expect to spud 24 gross wells or 18.1 net wells and 17 gross wells or 14 net wells put on production. And for the fourth quarter, we expect to spud 24 gross wells or 16.7 net wells and 30 gross wells or 22.9 net wells put on production. With that, I’ll turn it over to Mark.

Mark Lumpkin: Thank you, Steve. As usual, I’ll focus my comments today on providing some additional details on some meaningful metrics and key highlights, but I would want to remind you that a detailed breakdown of our results is available in our earnings release and in our 10-Q. So let me start with some have financial results. Adjusted net income for the second quarter was $76 million or $0.53 per share. Adjusted EBITDAX was $239 million, and free cash flow was $42 million all driven, as Robert mentioned, by record levels of daily production. Now let me take a minute to walk you through our debt and cash balances as of quarter end, which incorporates several significant transactions during the quarter. At June 30, we reported having slightly over $1 billion of debt, which is comprised entirely of two tranches of senior unsecured notes.

We had no borrowings on our credit facility, and we had approximately $50 million in cash at quarter end. These debt and cash balances are inclusive of our having paid a $75 million deposit toward the Novo acquisition, having issued $500 million face amount of new senior unsecured notes and having received over $50 million in net proceeds from selling noncore assets. From a leverage standpoint for the quarter, we posted an LTM leverage ratio of 0.8 times. We do expect the Novo transaction to close on August 15, and we estimate a downward purchase price adjustment of approximately $100 million to $120 million. Upon closing and incorporating the estimated purchase price adjustment in our July 31 debt and cash balances, we expect to have net debt of roughly $1.8 billion or perhaps a little bit lower than that.

We have with this all laid out on Page 25 of our new investor deck that was published on our website yesterday. After closing on Novo, we do intend to utilize significant free cash flow to pay down borrowings under our credit facility in the near term. Also upon closing the Novo transaction, the elected commitments on our credit facility will increase to $1.75 billion, which should leave us with close to $1 billion of undrawn credit facility capacity. From a production standpoint, our second quarter results really were fantastic because we had record average daily production of over 15,000 BOE per day, and that was comprised of 42% oil, 32% natural gas and 26% natural gas liquids. As you know, this significantly exceeded our forecast in both our full year production guidance and our informal second quarter production guidance and really was driven largely by better-than-forecasted well performance which really applies both to new wells that came online during the quarter, during the first quarter, but also to PDP in general.

Our year-to-date average daily production of 105,000 BOE per day has exceeded the top end of our 2023 production guidance. Last August, if you recall, we closed on the Titus acquisition, which similar to Novo had significant flush production, and we did anticipate the time seeing some decrease in our daily production rate in 2023 relative to the fourth quarter of last year. Given the lower combined rig count post close and on Titus. As we sit here today, we’ve now reported three full quarters that’s closing on Titus, and we’ve essentially held production flat right around 105,000 BOE per day which again includes the record production for the second quarter. And I would just point you to page five of our IR deck where we’ve laid this out of what our guidance has been on production over the past six quarters and what actual results were.

And you can see how we’ve been able to maintain the 105,000 BOE per day since closing on Titus. This is really a — this is really attributable to both the quality of our asset base and our efficient operations, and we’re really pleased that this is working out as well it is, and we’re able to hold production at those levels. We’re looking forward to closing on the Novo acquisition in the next couple of weeks, which really continues our pathway of high grading our asset base, which, as you know, is now largely focused on the Northern Delaware Basin. Full details of our updated guidance is in our earnings release. and investor presentation, but I did want to provide some color today on production and CapEx guidance in particular. Including and assumed closing date for Novo of August 15th, we’re guiding towards third quarter production of 115,000 to 120,000 Boe per day in to fourth quarter production of between 130,000 and 135,000 Boe per day, both 41% oil.

Given Novo’s flush production profile, we do expect some decline in production as we head into 2024, relative to the fourth quarter of this year and we do expect production will fall below 130,000 Boe per day, which is the low end of our fourth quarter guidance range. We’re not really in a position to get much more granular than that, but we do expect after some initial decline in production in the first half of next year, that pressure will flatten out during 2024, especially on the oil side. Moving on to our CapEx guidance. We invested $174 million in the second quarter, which is a little bit lower than anticipated, and I’m pleased that we’re tracking well on CapEx. As you can probably see from the math, we’re right at $375 million of CapEx spent year-to-date.

So, that’s exactly 50% of our midpoint, $750 million guidance range from the beginning of the year, which we are maintaining here. During the second quarter, we did spend a little bit less on infrastructure. Some of that will shift in the third quarter. But net-net, we still expect to invest between $725 million and $775 million for the full year, as we previously guided are reaffirming now. And we also expect this to be a little bit more weighted towards the third quarter versus the fourth quarter, something like a split if you’re assuming the midpoint of $375 million would be roughly $200 million in the third quarter and $175 million in the fourth quarter, partially related to some completion activity we’re picking up in progress from Novo upon closing here.

I would say all things considered. We feel really good about the CapEx plan. And it looks like we’re going to complete three to four more net wells by the end of the year than we had previously planned, and we’re going to be able to do that within the same capital budget — so we feel like that’s a very positive element of how things are going from an operational and spending standpoint. Taking a sneak peek into 2024 and assuming the same five rig program throughout the year, we do expect that full year capital expenditure should be a little bit lower than 2023 and we’re starting to see some of these service price reductions come into play. As Steve mentioned, most of those won’t really hit until 2024 and even some of benefits we’ve got contracts run through about the first quarter.

So, we’ll see continued decreases in the service costs throughout the year — throughout the remainder of this year and really into the first half of 2024, based on what we can see and think right now. Let me turn to the expense side before I wrap it up and hand things over to Robert. From an LOE standpoint, as Steve mentioned, the $9.13 per Boe for the quarter was a $0.23 per Boe improvement over the first quarter. And as Steve mentioned, his team is working hard to optimize LOE costs, including, as we incorporate the Nova assets into Earthstone. We did put some guidance for the second half of $8.75 to $9.25 per Boe and really would expect that to be a little bit higher in 3Q and a little bit lower in 4Q. From a cash G&A perspective, we incurred about $12 million of expenses in the second quarter, which brings us to $25 million year-to-date, which is when you annualize it at the bottom end of our prior $50 million to $55 million for the year range, and it represents the cost on a per Boe basis of $1.27, which compares very favorably to our peers.

With that, I’ll turn it back over to Rob for closing comments.

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Q&A Session

Robert Anderson: Thanks Mark. We believe we have transformed Earthstone into a company that offers an attractive value proposition to investors including having a solid balance sheet with one of the highest free cash flow yields at one of the lowest enterprise value to EBITDA multiples in the E&P sector and a pro forma valuation that is significantly below our total proved reserve value which stands at $5.4 billion, which is $1.4 billion higher than our pro forma enterprise value Our deep inventory, long history of operational excellence and consistent performance position Earthstone to continue outperforming for years. Our team has a long history of creating value for our shareholders. We will continue to work diligently to ensure that the long-term value we’ve created for our shareholders is ultimately recognized. With that, I’d like to now turn it back over to the operator for any questions.

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first questions come from the line of Scott Hanold with RBC Capital Markets. Please proceed with your question.

Scott Hanold: Yes. Thanks. Good afternoon. I was wondering if you could give us a little color behind those 1,000 wells you have in terms of like what is the lateral length of those? And as you bring all these assets together and continue to kind of look at opportunities to enhance efficiencies and returns over time, how much opportunity is there to extend those laterals to like swaps, Bolt-Ons or obviously, tactical kind of M&A?

A – Robert Anderson: Scott, Thanks. Good question. I’m going to really generalize here. But what we put in probably at the beginning of the year in terms of our guidance and footages there, which are a little bit longer in the Midland Basin and a little bit shorter in New Mexico. So we’ll go 9,500 to 9,000 feet for the two different areas, probably stands about the same. Most of the Novo wells, 7,500 to 10,000-foot laterals. So we’re going to fall into that bucket again. So that’s the first half of your question, so it’s about the same. And we can probably come up with a little bit more granularity there, if it would be helpful for you. Secondarily, the ability to extend laterals is — continues to get tougher and tougher as offset operators develop their asset, and we develop ours.

We will look to make trades. There could be some opportunities remaining in our Chisholm acreage, along with some of the tightest acreage and perhaps even in this Novo where we can do some trading around acreage and maybe improve some lateral lengths and increase efficiencies, things like that. But for the most part, I’d say we have what we have and our job now is to go out and find bits of acreage where we can go develop smaller units, but still very economic.

Scott Hanold: Understood. Thanks for that. And maybe a little bit of context around what you’re doing on the cash OpEx. I mean it seems like it’s been a bit stubborn in terms of trying to work it down. Can you give some context of some of the efforts you’re putting in place to see that drop. And I think the Novo’s assets do have a lower LOE. So it will probably mix it down, but just on the base assets, just things that have been a little bit stubborn and what you’re doing to kind of make improvements there?

A – Robert Anderson: Well, from a high level, and then I can let Steve dive into the details. It is stubborn because you have some things that are contracted like compression, for instance. And all our compression contracts, for the most part, were up at the beginning of the year, and I can tell you they didn’t go down. They went all went up. And labor is a fixed cost. So whether it’s our guys or labor that we use in the field, that’s not going down. So where we use that labor, including our own team, we’re continuing to see some increases there and will continue to see increases over the year. I’ll let Steve address the things that we have done and where we are seeing some savings.

Steve Collins: We worked hard to renegotiate sand contracts, workover rigs, like Robert said, compression and field labor stay about the same or increase. Part of that is left over from the supply problems back from COVID. But we worked hard on chemicals field, not our field labor, but contract field labor and workover rigs, and we’re balancing out by working hard to get those down.

Mark Lumpkin: Hey, Scott, one thing I would just add, this is Mark speaking too. We don’t report GP&T separately from LOE. So it is embedded in LOE. And as we do our internal benchmarking against our peers, like that’s one apples to oranges pieces because a lot of folks don’t include that in their LOE. And I’ll say that was another piece earlier this year caused us a little bit by surprise because a lot of these GP&T contracts have inflation, escalators relative to CPI. I mean, I want to say like on that basis alone, the first quarter increased our LOE by $0.20 per BOE relative to the model. Like that’s sticky. That’s not going away. That’s just the reality of the inflation linked to the contract. But it does sometimes when you’re comparing across peers, if you don’t include that or some folks might even have part of that embedded in their revenues. It is a bit of a non-apples-to-apples basis.

Robert Anderson: I’ll end on — you’re right, Novo probably will help us out a bit. But I guarantee that Steve and his team will continue to look for other opportunities to reduce costs. And when you look at it on an all-in cash cost basis, our G&A per BOE continues to be working in the right direction and down, and we will continue to work hard to lower our fixed cost side of our business.

Scott Hanold: All right. I appreciate the context from all you. Thank you.