Magnolia Oil & Gas Corporation (NYSE:MGY) Q1 2023 Earnings Call Transcript

Magnolia Oil & Gas Corporation (NYSE:MGY) Q1 2023 Earnings Call Transcript May 7, 2023

Operator: Good day, and welcome to the Magnolia Oil & Gas First Quarter 2023 Conference Call. Please note that this event is being recorded. I’d like to turn the conference over to Mr. Jim Johnson. Please go ahead.

Jim Johnson: Thank you, and good morning, everyone. Welcome to Magnolia Oil & Gas’ First Quarter Earnings Conference Call. Participating on the call today are Chris Stavros, Magnolia’s President and Chief Executive Officer; and Brian Corales, Senior Vice President and Chief Financial Officer. As a reminder, today’s conference call contains certain projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. Additional information on risk factors that could cause results to differ is available in the company’s annual report on Form 10-K filed with the SEC.

A full safe harbor can be found on Slide 2 of the conference call slide presentation with the supplemental data on our website. You can download Magnolia’s first quarter 2023 earnings press release as well as the conference call slides from the Investors section of the company’s website at www.magnoliaoilgas.com. I will now turn the call over to Mr. Chris Stavros.

Chris Stavros: Thank you, and good morning, everyone. We appreciate you joining us today for a discussion of our first quarter 2023 results. I will make some brief comments about the latest quarter, talk about where we stand currently and address some actions that we are taking around our capital spending and how this will impact our outlook for the rest of the year. Brian will then review our first quarter financial results in more detail and provide some additional guidance before we take your questions. Our first quarter results delivered a solid start to the year, supported by strong well performance in both the Karnes and Giddings areas. Steady activity and ongoing operating efficiencies at Giddings provided production growth of 10% versus last year’s first quarter.

Additional D&C efficiencies realized in our Giddings assets have helped to partly mitigate the higher costs. We generated more than $60 million of free cash flow during the quarter despite sustaining lower operating margins caused by weaker oil and gas prices as well as higher costs associated with oilfield service inflation. Since our inception, Magnolia’s focus has remained consistent and includes a disciplined approach toward capital spending, targeting moderate annual production growth with high pre-tax operating margins while generating reliable free cash flow. We strive to achieve these goals while continuously improving our per share metrics and maintaining a strong balance sheet with low levels of debt. Oil and gas prices have moved significantly lower since late last year and into 2023, while oilfield service and materials costs remained elevated.

This combination has weakened our operating margins and returns. The current cost structure for oilfield services materials does not reflect the sharp decline in overall product prices as compared to last year. So how have we responded to this? Instead of allocating more capital to achieve higher growth, which would drive our F&D costs higher and further dilute our margins, we have taken prudent actions to better align our capital spending to reflect the current environment. Beginning in the first quarter, we proactively worked with our top service providers and material suppliers to reduce our costs while planning to defer only a modest amount of our operated activity. So how do we expect this to impact Magnolia? These measures should result in at least a 10% reduction in this year’s capital spending, deliver full year 2023 production growth in the range of 5% to 7% and provide us with greater operating flexibility while generating greater amounts of free cash flow during the year.

We currently expect our total D&C capital for 2023 to be in the range of $440 million to $460 million, which represents at least a 10% reduction from our original guidance. This new level of spending, which is expected to be lower than our full year 2022 capital focuses on achieving improved returns and higher free cash flow until service and material costs are better aligned with oil and gas prices. As I mentioned, the discussions with our service providers and suppliers and the modest adjustments to our activity began during the first quarter and were proactive decisions on our part to reduce our capital costs. The impact of our actions is expected to be immediately evident and is reflected on our second quarter guidance for D&C capital of approximately $100 million, which is about 30% lower than first quarter levels.

This plan also allows for operational flexibility, should the cost and commodity environment become more aligned later this year. The overall outcome is consistent with our business model, which includes limiting our capital spending approximately 55% of our EBITDAX, along with achieving mid-single-digit annual production growth. I want to praise our teams for working collaboratively and creatively to find solutions in adapting to the current environment to preserve our capital and maximize efficiencies. Our valued partners with whom we build strong relationships continue to work cooperatively with our teams to help us reduce costs, which allows us to maintain a steady pace of activity without losing the momentum around operating efficiencies that we have worked hard to achieve.

Photo by Jonathan Petersson on Unsplash

Despite the deferral of a modest amount of our operated activity, we plan to continue operating 2 drilling rigs through the remainder of the year. One will drill development wells at Giddings while the other rig will drill in both Karnes and Giddings, including some appraisal wells at Giddings. We continue to gain efficiencies at Giddings with several recent pads establishing new company records for completion stages per day. These efficiencies provide us further flexibility and options to maximize our free cash flow. Giddings is currently producing well over 50,000 BOE per day and represents approximately two-third of the total company production. Most of Magnolia’s growth this year will come from our Giddings asset as a larger proportion of our capital is allocated to this area.

Our disciplined approach around capital allocation ideally positions us to create value through the cycle while supporting our differentiated return of capital program, which focuses on increasing the per share value of the company in pursuing actions to increase our dividend payout capacity. This balanced strategy is underpinned by targeting moderate annual production growth we are purchasing at least 1% of our outstanding shares each quarter and pursuing small accretive bolt-on oil and gas property acquisitions. These activities reinforce our investment proposition of providing 10% annual production growth over time. I’ll now turn the call over to Brian.

Brian Corales: Thanks, Chris, and good morning, everyone. I will review some items from our first quarter and refer to the presentation slides found on our website. I’ll also provide some additional guidance for the second quarter of 2023 and the remainder of the year before turning it over for questions. Beginning with Slide 3. Magnolia continued to execute on our business model as demonstrated by our strong first quarter financial and operating results despite softer commodity prices. As Chris detailed, the objective for Magnolia is creating long-term value for our shareholders and with an eye towards focusing on our operating margins and returns. We believe the actions outlined today help to achieve that goal by taking prudent steps to better align our capital spending with the current product price environment to generate more free cash flow, which can be used to enhance the per share value of the company.

During the first quarter, we generated GAAP net income of $107 million. Excluding the non-cash impairment associated with our Louisiana well, our total adjusted net income for the quarter was $119 million or $0.56 per diluted share. Our adjusted EBITDAX for the quarter was $217 million, with total capital associated with drilling, completions and associated facilities of approximately $140 million. First quarter production volumes grew 10% year-over-year to 79,300 barrels of oil equivalent per day and 8% sequential growth from the fourth quarter of 2022. During the first quarter, we repurchased 2.4 million shares and our diluted share count fell by 6% year-over-year. Looking at the quarterly cash flow chart on Slide 4, we started the first quarter with $675 million of cash.

Cash flow from operations before changes in working capital was $214 million, with working capital changes and other small items impacting cash by $12 million. During the quarter, we allocated $46 million toward share repurchases and paid dividends of $25 million. We ended the quarter with $667 million and approximately at the same level that we started. Looking at Slide 5. This chart illustrates the progress of the reduction in our total outstanding shares since we began our repurchase program in the second half of 2019. Since that time, we have reduced our total diluted share count by 54.7 million shares or approximately 21%. Magnolia’s weighted average fully diluted share count declined by 2.4 million shares sequentially averaging 213.9 million during the first quarter.

We currently have 6.5 million shares remaining under our current repurchase authorization, which are specifically directed towards repurchasing Class A shares in the open market. Turning to Slide 6. Our dividend has grown substantially over the past few years, including a 15% increase announced earlier this year to $0.115 per share on a quarterly basis. Our next quarterly dividend is payable on June 1 and provides an annualized dividend payout rate of $0.46 per share. Our plan for annualized dividend growth of at least 10% is an important part of Magnolia’s investment proposition and supported by the overall strategy of achieving moderate annual production growth and reducing our outstanding shares by at least 1% per quarter. Magnolia has the benefit of a strong balance sheet, and we ended the quarter with a net cash position of $267 million.

Our $400 million of gross debt is reflected in our senior notes, which do not mature until 2026. Including our first quarter ending cash balance of $667 million and our undrawn $450 million revolving credit facility, our total liquidity is more than $1.1 billion. Our condensed balance sheet and liquidity as of March 31 are shown on Slides 7 and 8. Turning to Slide 9 and looking at our per unit cash cost and operating income margins, our total adjusted cash operating costs, including G&A, were $12.65 per BOE in the first quarter of 2023. That’s a decrease of $0.53 per BOE compared to year-ago levels. The year-over-year decrease was primarily due to lower production taxes, lower GP&T and lower exploration expense, partially offset by higher LOE.

Our DD&A rate of $9.90 per BOE increased roughly 20% compared to last year and is directly related to higher well costs resulting from rising oilfield service, material and labor costs. Excluding our non-cash impairment, our adjusted operating income margin for the first quarter was $19.98 per BOE or 46% of our total revenue. The year-over-year decrease in our pre-tax operating margins is primarily driven by the decrease in commodity prices. Turning to guidance for the second quarter and for the remainder of 2023, we are currently operating 2 rigs and plan to continue this level of activity through the end of the year. One rig will continue to drill multi-well development pads in our Giddings asset. The second will drill a mix of wells in both Karnes and Giddings areas, including some appraisal wells in Giddings.

As Chris mentioned, we’d expect our total D&C capital for 2023 to be in the range of $440 million to $460 million, which represents at least a 10% reduction from our original guidance. The reduction comes from a mix of both cost savings and a modest decrease in activity. At this level of reduced spending, we expect to deliver full year 2023 production growth of between 5% to 7% with most of the growth expected to come from our development program at Giddings. The reduction to our capital is expected to generate more free cash flow for Magnolia and provide us with increased flexibility going forward. For the full year 2023, we expect our effective tax rate to be approximately 21%, with most of this being deferred. Our cash tax rate is expected to be approximately 6% for 2023.

Looking at the second quarter of 2023, we expect total production volumes to be approximately 80,000 barrels of equivalent per day with overall volumes anticipated to be more gas weighted compared to the first quarter. Our D&C capital was estimated to be approximately $100 million, which is approximately 30% sequential decrease. Oil price differentials are anticipated to be a $3 per barrel discount to MEH. Our fully diluted share count for the second quarter is estimated to be approximately 212 million shares, which is 5% below year-ago levels. We are now ready to take your questions.

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Q&A Session

Operator: Thank you. First question will be from Neal Dingmann of Truist. Please go ahead.

Neal Dingmann: Hi, good morning, thanks for the time. Chris, I definitely appreciate the latest CapEx change and how you guys have always been among the most capital disciplined company. My question is, has your thoughts on uses of the cash balance you have now changed as the commodity overall market continue to break down?

Chris Stavros: Yes. Thanks, Neal. I guess I’ll address the cash aspect first from a capital angle, and then I’ll address it a little bit more on cash after capital. Again, just to be clear, we’re choosing to do this, take these actions that we talked about today really from a proactive approach towards our costs. We want to be sort of early movers on this rather than late movers. The reasons, as I said in my remarks, the reasons that we’re doing is really to get – try to get price concessions from our vendors and suppliers. It just – it’s a situation where going into the year, pricing and costs were out of kilter with prices that you’re seeing on the screen and certainly relative to last year. And so we can sort of mosey on along here and continue to do what we’re doing and not try to capture any improvements.

But we’re basically capitalizing our reserves at last year’s higher costs. And I just don’t think that’s a good outcome. I would lean more on the savings – the capital savings coming from the benefit that we’re going to see on materials and services because I will tell you, at these prices, these things are going to start coming down even more than we probably already are thinking. On the growth, on the production growth, we adjusted that a little bit. But just keep in mind, we could grow faster if we wanted to. We’re just simply choosing not to, and we retain that option. In other words, the importance of reducing the capital from a cost perspective allows for more activity to fit into the program with time. So I think as things become more balanced, the growth could be better, but this is what the outcome is at the current level of costs.

On the cash, some of the winnings – the cash winnings were accumulated during a period, peak period of the cycles. Certainly, we’re not looking to squander the winnings. So we’ll continue to run the business model using what I would call a balanced approach, which again calls for this mid-single-digit growth, share repurchases on the order of 1% per quarter of outstanding. Certainly, if things get out of whack or the stock sort of doesn’t perform as well as we think or doesn’t perform in line with the model or perform in line with the peers, we could sort of lean in more on that. We have the ability to do that. And we continue to expect to pay our base dividend, which will grow as we talked about, 10% a year just based on the outcome of the model and strategy.

The M&A market, I figured somebody who asked sort of may as well address it. So it’s soft right now. And as you can imagine, with all the volatility and uncertainty of product prices, there’s been things that have just been yanked from the market or sellers are lesser inclined, certainly around natural gas assets, lesser inclined to offer up assets that just might not command what they’re interested in getting. We’ll continue to be disciplined around this and focus on things that look more like singles and doubles as opposed to Grand Slams. And I think it’s very much an opportunistic approach and ground game strategy that we have around improving the business and looking to pick up assets here and there that fit into the model just as we are with Giddings.