Magnolia Oil & Gas Corporation (NYSE:MGY) Q2 2023 Earnings Call Transcript August 2, 2023

Operator: Good morning, everyone. And thank you for participating in Magnolia Oil & Gas Corporation Second Quarter 2023 Earnings Conference Call. My name is Marlese and I will be your moderator for today’s call. At this time, all participants will be placed in the listen-only mode, as our call is being recorded. I will now turn the conference over to Magnolia’s management for their prepared remarks, which will be followed by a brief question-and-answer session. Please go ahead.

Jim Johnson: Thank you, Marlese, and good morning, everyone. Welcome to Magnolia Oil & Gas’s second quarter earnings conference call. Participating on the call today are, Chris Stavros Magnolia’s President and Chief Executive Officer and Brian Corollas, 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 second quarter 2023 earnings press release, as well as the conference call slides from the Investor 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, Tom. And good morning, everyone. We appreciate you joining us today for a quarterly update and comments around our second quarter 2023 results. I plan to reiterate some of Magnolia’s primary corporate goals and discuss some of what we’ve accomplished most recently help us achieve those goals and objectives. I’ll also briefly speak to our latest quarterly results, specifically around the strong execution we’ve had related to our cost reduction efforts. Brian will then review our second quarter financial results in more detail and provide some additional guidance before we take your questions. As we marked our fifth anniversary earlier this week as a publicly traded company, Magnolia is recognized for having established a unique organization with high quality assets and a differentiated business model for EMP companies.

This is guided by the principles of low debt, high operating margins and a focus on capital discipline. These principles provide us with an orderly framework to help achieve our overall goals. In terms of our objectives, first, Magnolia strives to be the most efficient operator have best-in-class oil and gas assets, and generating the highest returns on those assets while employing the least amount of capital for drilling and completing wells. Second, the return of a substantial portion of our free cash flow to our shareholders in the form of share repurchases and a secure and growing dividend. And finally, utilizing some of the excess cash generated by the business to pursue both on oil and gas property acquisitions that helped to improve our overall business, sustain our high returns and increase our dividend share per share payout capacity.

As we crossed this milestone as an organization is important to recognize some of our achievements toward these goals. Five years ago, Magnolia was a much smaller company with a production base weighted towards our Karnes asset with a large relatively unknown acreage position and Giddings. Five years later, our teams have been instrumental in transitioning Giddings into full development, and an asset to compete with some of the best shale plays in the U.S. in terms of growth, low reinvestment rate and returns. The majority of Magnolia’s current production now comes from Giddings where we have learned a lot, and is still in its earlier stages of development. This has enabled Magnolia’s total production and reserves to each grow by more than 50% over the past five years.

We achieved this growth through the efficient reinvestment of only 45% of our cumulative operating cash flow for drilling and completing wells, allowing us to generate significant free cash flow while maintaining a strong balance sheet. We utilized 23% of our cumulative operating cash flow, or more than $850 million to repurchase 22% of our outstanding shares, and toward continuously improving per share metrics. We established the security dividend which has grown by 64% since 2021, to an annualized rate of $0.46 a share. Cumulative capital return to our shareholders over the five years has exceeded $1 billion. We’ve also improved our business and added to our asset base by completing numerous bolt-on acquisitions totaling more than $460 million.

The strength of our second quarter financial and operating results were supported by our efforts initiated earlier this year to address higher capital and operating costs, which did not appropriately reflect the decline in product prices as compared to last year. Our teams were proactive and engaging early and working cooperatively with our oilfield service partners and material suppliers to reduce costs while sustaining activity levels. That work is evident in our lower capital spending for the quarter, which was approximately 15% below or earlier guidance, in addition to our cash operating costs, which declined 18% sequentially. The current product prices or action should provide improved pretax operating margins and more free cash flow to potentially redeploy the business during the back half of the year.

With the benefit of these cost savings initiatives, we now expect a total D&C capital for 2023 to be in the range of $425 million to $440 million to below our previous guidance of $440 million to $460 million. This represents a 14% reduction from our initial 2023 capital spending plan. This year’s capital outlays are now expected to be lower than our full year spending during 2022. The reduction in our capital spending and cash operating costs result of our efforts highlight Magnolia’s focused on capital efficiency, generating high operating margins and delivering strong and consistent free cash flow. We also continue to see strong well productivity out of our Giddings asset, and where most of our D&C capital is being allocated. As a result, we’re raising guidance for a full year 2023 production growth to between 7% and 8% compared to earlier growth expectations of 5% to 7%.

Again, this speaks to the high quality of our assets, and matches our goal of being a low-cost capital efficient operator those assets with D&C spending to only about half of our cash flow. With lower capital spending and increased production, our free cash flow generation has improved and providing us with greater flexibility. During the quarter Magnolia generated $93 million of free cash flow, supporting our dividend and share repurchase program with approximately three quarters of the free cash flow return to our shareholders through these initiatives. Earlier this week, our board of directors increased our share repurchase authorization by 10 million shares, bringing the total current remaining authorization to just over 14 million shares and allowing us to opportunistically repurchased our stock into next year.

We plan to continue to repurchase at least 1% of our outstanding shares per quarter. Finally, at the end of July, we closed on a small oil and gas property acquisition and the Giddings area for approximately $40 million. This is an example of continuing to execute on our strategy of pursuing bolt-on assets and adding to our high quality bench in and around areas that we understand well, and then improve our overall business. This asset is outside of our core development area in Giddings and was a direct result of some of the appraisal efforts and significant knowledge we’ve gained through operating in the Giddings seal. We’ll continue to pursue similar type transactions that add to and complement our asset base and improve the business. I’ll now turn the call over to Brian.

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Brian Corales : Thanks, Chris. And good morning, everyone. I will review some items from our second quarter and refer to the presentation slides found on our website. I’ll also provide some additional guidance for the third quarter of 2023 and remainder of the year before turning it over for questions. Heading with Slide 3, despite lower commodity prices, Magnolia continue to execute on our business model as demonstrated by our excellent second quarter financial and operating results. As Chris detailed, Magnolia focus is creating long-term value for our shareholders through a differentiated operating model and a balanced approach to shareholder returns. We have been successfully executing our strategy during the first five years as a public company and plan to continue our disciplined approach going forward.

During the second quarter, we generated total GAAP net income of $105 million with total adjusted net income for the quarter of $97 million or $0.46 per diluted share. Our adjusted EBITDAX for the quarter was $203 million with total capital associated with drilling, completions and associated facilities of $86 million, well below our expectation and a testament to our team’s hard work and reducing costs. Second quarter production volumes grew 10% year-over-year to 81,900 barrels of oil equivalent per day and 3% sequentially from the first quarter of 2023. During the second quarter, we repurchased 2.3 million shares, and our diluted share count fell by 5% year-over-year. Looking at the quarterly cash flow waterfall chart on Slide 4. We started the second quarter with $667 million of cash.

Cash flow from operations before changing in working capital was $204 million with working capital changes and other small items impacting cash by $26 million. During the quarter, we allocated $49 million towards share repurchases, paid dividends of $25 million and added $7 million of bolt-on acquisitions. We ended the quarter with $677 million of cash and above the level that we started the quarter. Looking at Slide 5. This chart illustrates the progress in reducing 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 57 million shares or approximately 22%. The Magnolia’s weighted average fully diluted share count declined by more than 2 billion shares sequentially, averaging 211.4 million shares during the second quarter.

As Chris discussed, the board recently approved a 10 million share increase to our share repurchase authorization, leaving 14.2 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 September 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 our overall strategy of achieving moderate annual production growth and reducing our outstanding shares by at least 1% per quarter.

Magnolia has a benefit of a very strong balance sheet, and we ended the quarter with a net cash position of $277 million. Our $400 million of gross debt is reflected in our senior notes, which do not mature until 2026, including our second quarter ending cash balance of $677 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 June 30 are shown on Slide 7 and 8. Turning to Slide 9 and looking at our per unit cash cost and operating income margins. Total revenue per BOE declined by nearly 50% due to substantial decrease in product prices than in the second quarter of 2022. Our total adjusted cash operating costs, including G&A, were $10.33 per BOE in the second quarter of 2023, a decrease of $3.71 per BOE or 26% compared to year ago levels.

The year-over-year decrease was primarily due to lower production taxes and GP&T, lower exploration expenses and reduced G&A. Our DD&A rate of $10.34 per BOE increased roughly 20% compared to last year is related to higher well costs resulting from increased oilfield service material and labor costs. Our adjusted operating income margin for the second quarter was $16.29 per BOE or 43% of our total revenue. The year-over-year decrease in our pretax operating margin was driven by the significant decrease in commodity prices. Turning to Slide 10. We are happy to have recently published our third annual sustainability report, detailing Magnolia’s progress on ESG metrics. Key highlights from the report, such as such a record low flaring rate are highlighted on the slide and the full report can be accessed on our website.

Turning to guidance for the third quarter and for the remainder of 2023, we are currently operating two 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 rig will drill a mix of wells in both Karnes and Giddings areas, including some appraisal wells in Giddings. As Chris mentioned, we are further reducing our D&C capital guidance for 2023 to between $425 million to $440 million which represents approximately a 14% reduction from our original guidance this year. Despite lower capital spending expectations, we are increasing our full year 2023 production growth guidance to between 7% and 8% with the growth expected to come from our development program at Giddings.

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 third quarter of 2023, we expect total production volumes to be similar to the second quarter, and our D&C capital is estimated to be approximately $100 million, with some small amount of variability subject to the timing of our activity. Oil price differentials are anticipated to be a $3 per barrel discount to MEH. Our fully diluted share count for the third quarter is estimated to be approximately 210 million shares, which is 4% below year ago levels. We’re now ready to take your questions.

Q&A Session

Operator: Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is coming from Neal Dingmann from Truist. Neal, please go ahead.

Neal Dingmann : Good morning. Nice quarter. My first question is on your $40 million Giddings bolt-on on oil and gas acquisition. Specifically, maybe Chris, is there anything we could read into this deal, such as any near-term potential for you all and now it’s more delineated acres or how you’re thinking about the existing 20,000 acres [ph] delineate based on what you seem like you’re seeing out there?

Chris Stavros : Sure. Thanks, Neil. So I got to be careful on what I say on this a little bit. But look, the facts are that we purchased approximately 20,000 acres in the Giddings field area. And that came with a very small amount of production, no more than a few hundred BOE a day. The acreage is outside of our core development area, and it was generated, as I said, out of our appraisal program and some of the details and broader work we did in the field through a lot of the learnings that we picked up over the years. So this is an area that we like, and it was not a marketed deal, which is also sort of a better way for us to go about things. It’s more direct and usually leads to a better outcome. Look, obviously, this is a very competitive industry and business.

And so for competitive reasons, I wouldn’t want to say too much. But we may have stumbled on a potentially new area for development. I think it’s a little too early for us to say for sure, but we like what we see so far. So that’s about all I can say about this and hopefully more to come.

Neal Dingmann : No, that’s that’s going to be exciting to hear. And then my second question, maybe just on the GOR specifically. Can you speak — I know you kind of have an ebb and flow on what goes on in the GOR and the mix. But I’m just wondering, how should we think about that GOR mix maybe for the remainder of the year or ’24? I’m just wondering, if the change product where placing wells or with your ops or there other drivers or just how to think about this?

Chris Stavros : Yeah. The answer is we don’t know. And not just because of just uncertainty because I don’t know, I just — things are tend to be lumpy quarter to quarter just in terms of the mix, and it depends on the timing of the wells coming online the inclusion of any Karnes activity, both operated and non-op. So we’ll sort of see. But some of what we’ve done, probably we should repeat here. We talked about this a lot, and you can see this in terms of where we’ve allocated the capital and activity over the last several years. The emphasis for us has been skewed towards Giddings more so than in Karnes. Giddings wells are generally a little gassier than Karnes, but that’s not always the case. We’ve talked about this before, but as I said, it probably bears repeating, our wells in Giddings typically produce more hydrocarbons and more oil over their life than a Karnes well.

The F&D costs in Giddings are generally lower and the full cycle returns are higher. And the decline rates of the Giddings wells are normally shallower than Karnes well. And so we like our Karnes area. Better full cycle returns. This is an asset that has driven double-digit production growth in the area with a reinvestment rate of less than half of our free cash flow. So I think it’s sort of evident in terms of what we’ve done, the outcome that is and in the financials. And so the returns have been good. We like where this is headed, and it’s still in its relatively early stages. So we’ll see. I mean I smiled to myself whenever I get this question because it wasn’t very long ago like within the last calendar year, that people wanted us to drill more gassy wells or gassier wells, and so there you go.

Neal Dingmann : No, [indiscernible] all the upside. Thanks, Chris for the details.

Operator: Our next question comes from Umang Choudhary from Goldman Sachs. Uman, please go ahead.