Northern Oil and Gas, Inc. (NYSE:NOG) Q3 2023 Earnings Call Transcript November 2, 2023
Operator: Greetings and welcome to the NOG Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It’s now my pleasure to introduce your host, Evelyn Infurna, Vice President, Investor Relations. Thank you. You may begin.
Evelyn Infurna: Good morning. Welcome to NOG’s third quarter 2023 earnings conference call. Yesterday, after the market closed, we released our financial results for the third quarter. You can access our press release and presentation on our Investor Relations website. Our Form 10-Q will be filed with the SEC within the next few days. I’m joined this morning by our Chief Executive Officer, Nick O’Grady; our President, Adam Dirlam; and our Chief Financial Officer, Chad Allen; and our Chief Technical Officer, Jim Evans. Our agenda for today’s call is as follows. Nick will provide his remarks on the quarter and our recent accomplishments, and Adam will give you an overview of our operations and business development activities, and Chad will review our third quarter financials and walk you through updates to our 2023 guidance.
After our prepared remarks, the executive team will be available to answer any questions. Before we begin, let me cover our Safe Harbor language. Please be advised that our remarks today, including the answers to your questions, may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from the expectations contemplated by our forward-looking statements. Those risks include, among others, matters that we have described in our earnings release, as well as in our filings with the SEC, including our annual report on Form 10-K and our quarterly reports on Form 10-Q. We disclaim any obligation to update these forward-looking statements.
During today’s call, we may discuss certain non-GAAP financial measures, including adjusted EBITDA, adjusted net income, and free cash flow. Reconciliations of these measures to the closest GAAP measures can be found in our earnings release. With that, I’ll turn the call over to Nick.
Nick O’Grady: Thank you, Evelyn. Welcome, and good morning, everyone, and thank you for your interest in our company. All right, I’ll get right down to it with five key points. Number one, all is well. Operationally, things are going swimmingly. Last quarter’s activity slowdown became this quarter’s acceleration, and our Mascot project well performance continues to impress. Production was near the upper band of our guidance, the oil cut was up significantly, and our operating unit costs were lower. Additionally, we’re pleased to have raised our dividend again for the eleventh straight quarter. Our ROCE ticked up 160 basis points this quarter to 24.5%, even as we capitalized a large transaction and continue to invest heavily in our future.
It’s a testament to the rigor of our investment process and the scale we built. Number two, we have entered harvest mode, but we’re pursuing a dual path. We generated significant free cash flow from our assets this quarter, about 2.7 times the amount in the prior period, and we head into Q4 looking towards a potential record quarterly figure. Free cash flow has not empirically proven to be a driver or valuation marker for stock performance, but it is definitively a provider of shareholder returns. And more importantly, it is a powerful convexity tool, which provides optionality for dynamic capital allocation, something we believe we’ve proven to be adept at doing. When you have free cash flow, you effectively can choose your destiny. Our choice has been and will continue to be to serve both masters, deliver solid, dependable, and growing cash returns, while also driving total return by investing to grow our longer term profits.
Number three, opportunity and dominance. We continue to see compelling investment opportunities, big and small. We had elevated Ground Game success in Q3, and larger and smaller packages are spooling in the Permian and Appalachia. NOG’s capital allocation has benefited from the domination of our niche. We find ourselves involved in nearly every operated and non-operated M&A process, which is providing us an incredible range of opportunities. So even as we’re larger, we’re finding that options in front of us allow for increased returns and more flexibility. Shorter term, this has driven capital spending higher, but spending today provides the returns for tomorrow. Adam will give more details. Number four, bigger and stronger. When we started this journey back in 2018, our board chair was clear in his belief that scale would drive powerful outcomes for NOG.
Scale was the key to grow the company beyond the over levered balance sheet we inherited, and scale would provide more stability and diversity to our asset base. It would lower our long term cost of capital and provide access to a larger investor pool. Over time, scale would lead to higher return opportunities with more influence for us. Scale would grant access to capital to purchase assets that our competitors could not because of size or concentration. Scale has never been more important, and our thesis has borne itself out over the past several years. The perpetual challenge of this strategy was and always has been to maintain our high asset level return standards and to keep focus on core assets. We could have simply bought lower quality assets to temporarily create scale, but the harder path was to actually improve our asset quality and return profile while simultaneously growing the business.
We have achieved this and then some. With interest rates and the overall cost of capital the highest in over a decade, never has size been more important. What we’re finding is that scale begets scale. Now that we’re bigger, the opportunity set has grown in lockstep. The theme of bigger and stronger ties into my final point. Number five, optionality leads to potentiality. We recently raised $290 million of equity capital in a bought deal. And many of you, rightfully so, might be asking why. After all, I just described how we’re generating significant free cash flow and that our leverage levels are in good shape and set to improve further. So why did we raise capital? As we discussed our future with the board, we highlighted to them that the investment opportunities big and small coming to us.
We also discussed how the economic and geopolitical situation in the world, candidly, is as complicated as it’s been since the financial crisis 15 years ago. And so knowing what’s in front of us and also knowing the conflicting signals in the capital markets, we collectively decided to simply de-risk the path to delivering growth to you in the future. We now have the flexibility to act no matter what happens in the macro environment. The options in front of us now carry less risk. To the extent we see a market meltdown we can aggressively purchase securities or assets for sale. To the extent things stay the same or better, we can continue to do what we’ve been doing while staying within our self-imposed leverage constraints. Our capital raise was not a call on our stock price and certainly not because the capital was needed at this very moment, as you can see from the results today.
Rather, we have shrewdly, astutely, and carefully found growth opportunities that have driven this business and our profits higher over time. With the extra capital that you provided, trust that when the time is right, we will allocate it to benefit all stakeholders. Doing this is why our corporate returns have been driven ever higher as risk has declined and it’s how we’ve delivered superior total return. As I have said in the past, we are a company run by investors with a goal of growing value for our investors. It’s our fiduciary duty and it’s how we are incentivized. In the short-term, we may make difficult decisions that aren’t always popular, but those decisions are focused on driving long-term value. And what is most exciting is that I am confident that we can continue on a similar path for the foreseeable future to drive growth for our investors.
We will keep our focus on delivering strong results over time. We thank you for taking the time to listen to us today and your continued trust in us and interest in our company. With that, I’ll turn it over to Adam.
Adam Dirlam: Thanks Nick. In the third quarter, we saw an acceleration of activity on all fronts, setting up for a solid 2024 campaign. I’ll start by reviewing this quarter’s operations and then turn to the M&A landscape and our business development efforts. During the third quarter, turned in-lines rebounded to a company record of 22.6 net wells, a 64% increase quarter-over-quarter. Our organic assets did the heavy lifting with 18.9 net well additions, while our Ground Game turned in-line 3.7 net wells, the majority of which came online towards the end of the quarter. Activity had a healthy balance between the Williston and the Permian, and as we enter the fourth quarter, we expect to see elevated turned in-lines before seasonal easing during the winter period.
Well performance has been encouraging as our Mascot prospect continues to outperform expectations, and while it is early, our new operating partners in vital, Earthstone, and soon-to-be Permian Resources have all been making improvements to our recently acquired co-developed assets. Continuing with the theme of acceleration, our wells in process again grew to an all-time high as we ended the quarter at 74.2 net wells, a nearly 10% increase quarter-over-quarter. Driving activity levels, our organic acreage added 14.6 net wells and accounted for one-third of our Permian activity as our acquired acreage over the last two years continues to show its value. We added another 9.3 net wells from the closing of our Novo transaction, and the Ground Game accounted for an additional 5.5 net wells.
In total, the Williston and Permian combined to account for nearly 80% of our wells in process, while the Permian has grown to 60% of our oil-weighted wells on the D&C List. As we have taken market share, we’ve also seen our average working interest grow to 13% from under 10%. This is a 34% increase relative to our producing wells, which will enable us to do more with less rig activity if we so choose. In-bound well proposals also saw an acceleration as we reviewed 194 AFEs, up from 140 proposals in the second quarter. This was driven by the Permian, where activity levels more than doubled from Q2 to Q3 and also accounted for the highest number of net wells evaluated during the year. Our Williston activity has remained stable and consistent as we have seen over 100 well proposals in every quarter this year.
While activity levels have increased across the board, the quality of wells continues to be strong with the expected rates of return far exceeding our hurdle rate even as we sensitize our evaluations for a lower commodity price environment. This translated to a greater than 95% consent rate during the quarter as we partner with our top-tier operators. Turning to well costs, we saw absolute well costs rise this quarter, primarily from higher cost Permian wells making up a much greater proportion of the total activity. Normalizing for lateral length and basin, estimated well costs were relatively flat quarter-over-quarter. Given the volatility in commodity markets, we remain conservative in our views on costs as we plan for 2024. We continue to have conversations with our operating partners and we’ve seen some of our larger operators along with some of our more adept operators drive costs down while seeing others get squeezed as contracts roll off.
Moving on to our business development efforts and the M&A landscape, we continue to adapt to the ebbs and flows of the market. As I alluded to on our second quarter call, there was a bit of a low in quality large-scale assets in the market over the past few months. During that time, we were able to pivot early in the quarter and capitalize on the dislocation we observed with lower commodity prices and stayed busy with our Ground Game. We closed on 8 transactions, adding an estimated 5.7 net wells in process and 514 net acres weighted towards the Permian. This brings our year-to-date activity to 31 transactions for an estimated 24.9 current or future net wells and approximately 1,800 net acres. Since the beginning of the year, we have reviewed over 400 Ground Game deals and continue to leverage our proprietary technology and data to run these evaluations.
This has afforded us the ability to focus on only the high quality transactions, which is translated to an expected ROCE north of 30% on our 2023 Ground Game. As I mentioned earlier, we closed our Novo transaction in the middle of the quarter and are excited to get to work with our new operating partner, Permian Resources. We know the Permian Resources team well, and having greater exposure to PR will provide incremental benefits from their increased scale and cost synergies. Governance through our joint operating agreement and our area of mutual interest with Earthstone remain intact and we expect nearly a decade of self-funding continuous development within our Tier 1 inventory. Through leveraging partnerships with our operators, we have been able to aggregate in high quality areas while gaining line of sight to development.
We continue to reap the benefits of more opportunities to deploy capital to accretive transactions as we scale the business with resilient assets. In the past 12 months, we have added over 25,000 net acres in the Permian, more than tripling our position. Looking ahead, there are a number of high quality prospects that we are reviewing, ranging from traditional non-op packages to minority interest sell-downs from operators to joint development programs. Put simply, we estimate that the universe of on- and off-market opportunities that are available to us has never been broader. However, we will remain consistent in our underwriting, focusing only on potential transactions that will benefit the business for the long term and that generate superior returns that our investors expect.
With that, I’ll turn it over to Chad.
Chad Allen: Thanks Adam. I’ll start by reviewing our third quarter results and provide additional color on the operating update we released on October 25th. Our Q3 average daily production topped 100,000 Boe per day for the first time in company history, a 13% increase compared to last quarter. Oil volumes were up 16% over Q2 as we rolled in our Forge and Novo acquisitions and benefited from the reversal of most of the prior deferments in the back half of the quarter, but the real story is the addition of record levels of turned in-line wells and the continued strong well performance across all of our basins. Our adjusted EBITDA was $385.5 million in Q3, up 32% over the same period last year, and our third quarter free cash flow was $127.8 million despite continued elevated levels of organic and inorganic investment, commodity price volatility, and to a lesser extent TIL deferrals.
Adjusted EPS was $1.73 per diluted share. Oil realizations were better than internally expected due to continued strong in-basin pricing and a higher percentage of barrels coming from the Permian, which is typically priced tighter than the Williston. Natural gas realizations were 82% of benchmark prices for the third quarter, below our year-to-date run rate, with realized actuals in the Marcellus down over 30% from last quarter as basis spreads widened for the shoulder season. The biggest driver is the NGL to natural gas ratio, which moved back to more normalized levels in the quarter as NGL prices were relatively flat quarter-over-quarter and natural gas prices were higher. LOE came in at $8.76 per Boe, below our annual guidance range, driven primarily by increased Permian volumes, which have a lower cost structure than the Williston.
On the CapEx front, we invested $216.6 million in drilling, development, and ground game capital in the third quarter, with roughly two-thirds allocated to the Permian and one-third to the Williston. We had previously expected our CapEx cadence for the second half of the year would be equally weighted between Q3 and Q4. However, as a result of having access to high-quality opportunities, success on the ground game, along with the pull-forward of organic activity on higher commodity prices, we shifted more investment into the third quarter. This shift in spend led us to adjust our full-year CapEx guidance, which I’ll discuss shortly. After quarter end, we took the opportunity to further enhance our balance sheet. In early October, we completed a $290 million equity offering, priced down just 475 basis points from the closing price, truly highlighting our access to capital.
More importantly, it was done in a manner that had minimal effect on our existing investors and provides us with capital to pursue significant M&A opportunities within the confines of our stated leverage goals. Our expectation is that the near-term dilution from the offering can be more than offset over time through value-enhancing acquisitions. In the meantime, we have accelerated a path towards our stated leverage target. Now turning to annual guidance, we have made a few adjustments, which are highlighted on Page 16 of our earnings presentation. We are tightening our annual production guidance to $97,000 to $99,000 Boe per day. The main drivers for Q4 will be the timing of completions, giving a record number of net wells in process, and seasonal factors, particularly in the Williston, where well timing can be highly sensitive to weather.
We now expect net well spuds for the year in the range of 76 to 79 net wells, which along with our TIL guidance should assist in modeling. The higher level of net wells explain the bulk of the move in the CapEx, which is ultimately just growing 2024 activity stacked under this year’s capital. Our annual CapEx guidance has been revised to a range of $790 million to $820 million, reflecting year-to-date investment activity ahead of our prior forecast and, as I just mentioned, the increased spud count. Our full year gas realization guidance has been improved to a range of 95% to 105% of Henry Hub to reflect year-to-date realizations, which implies more typical levels for the remainder of the year. And lastly, we have also tightened the expectations for oil differentials to a range of $3 to $3.75 for the year.
As we exit driving season and oil prices have increased, we began to see seasonally wider oil differentials starting at the end of the third quarter and expect that trend to continue through the winter. As we finish out 2023, we are extremely well positioned for another year of strong growth in 2024 given our recent acquisitions and record wells in process. We are still working through our 2024 budget and look forward to providing guidance details on our year-end call. With that, I’ll turn it back over to the operator for Q&A.
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Q&A Session
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Operator: Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] And our first question came from Scott Hanold, RBC Capital Markets. Please sir, go ahead.
Scott Hanold: Yes thanks. Good morning, all. Hey, Nick, I can’t help thinking back a few years ago when you and I chatted with Brom about just growing scale, what’s important for the long-term for Northern, and certainly you guys have moved quite a bit from that, I think, up somewhere around three-fold. When you kind of think about the future and the opportunities that you see in front of you and just in general the maturation of certain parts of the U.S., like, is there an optimal level you think that there is for Northern? And if you could also kind of parlay into this answer, how does the higher interest rates kind of impact your ability to kind of do M&A transactions or see just things out there?
Nick O’Grady: Yes, I mean, I think I will answer the latter part first, Scott. When the cost of capital goes up, so too do the discount rates, and so we’ve observed that clearing discount rates have risen. From a strategic perspective, it’s definitely benefited us as our cost of capital has probably been more static than that of our private peers, and they just require bank capital or things like that, so it’s definitely helped us. But you see it particularly, you saw kind of a wave in the last couple years of people using asset-backed securitizations to finance PDP-heavy acquisitions, and that game gets really tough when base rates are over 5%. To the other point, I think, I got asked this question recently by one of our investors, and I think, my answer would be our fiduciary responsibility as a company is not to decide what size is the right size.
Really our job is to earn high returns, and grow the business and make more money for our stockholders. And I think that that’s our path going forward. And I think while shale overall is maturing from a non-operated perspective, I think, it’s wide open for us. The opportunity set in front of us is as big relative to the size of our company as it was three or four years ago, and so I feel very confident that our team can continue the path that we have. From a law of large numbers, maybe that percentage doesn’t move quite at the same pace, but from an opportunity set, frankly, we are as busy as we’ve ever been. I don’t know, Adam, if you want to add to that.
Adam Dirlam: I think it touched on the majority of it, scale begets opportunity, right, and I believe I touched on it in my prepared remarks in terms of kind of the different structures that are now available to us. I think that gives us the optionality to deploy capital where we see fit. If you rewind five years ago, it was really just the ground game and the non-op packages that we’re beholden to, and now we’re looking at co-bidding exercises, minority interest buy-downs, joint development agreements, and all of that is at scale, right. And so I think we are a much larger and better capital provider and partner to a lot of our other operating partners that gives us significantly more opportunity.
Scott Hanold: Okay, appreciate that. And as my follow-up, I know it’s going to be a little bit early for your 2014 – 2024 thoughts, but I was kind of curious, especially with respect to the Mascot, which was your first JV, you talked about the well looking good. Can you talk about the pace of that – going – the pace of completions for that and production going into next year and just your kind of thoughts on how that sets you up for 2024?
Nick O’Grady: Well, I’ll cover just a little bit, which is obviously we shifted some of the development into 2024, and so it really would have been peaking, I think, both in terms of volumes and in terms of capital in the fourth quarter, and some of that shifts out. I mean, I think that the next batch of wells is really, it’s obviously been performing extremely well, and we would expect that the next major batch of wells comes on sort of early in the second quarter. Adam?
Adam Dirlam: Yes, performance is kind of at 13% better overall versus kind of our forecast, Scott. And as far as kind of the modified schedule goes that we discussed last quarter, we’d expect production to decline a little bit in the fourth and the first quarter, and then begin ramping materially in late March. So, to Nick’s point, that’s when the larger batch of wells come online.
Scott Hanold: Okay. So then from an overall cadence perspective, I mean, you guys should be starting next year in a pretty good spot overall.
Nick O’Grady: Yes.
Adam Dirlam: Yes, I think Q2 and Q3 is really where we see kind of the bulk of the tills coming on the Mascot project.
Nick O’Grady: Yes. And we typically see a seasonal slowdown in the first quarter, particularly in the Williston just around kind of the winter weather piece, but that’s been the pattern for almost every year.
Scott Hanold: Right. Okay, thank you.
Operator: Our next question came from Neal Dingmann, Truist Securities.
Neal Dingmann: [Indiscernible]. Nick, my first question is on M&A. Specifically, it sounds to me like you all have more than, I mean, continue to have now more than ample M&A opportunities ahead, having the – what I call, the non-op market cornered. I am just wondering, can you speak now when you look at your deal criteria, how these requirements have changed, maybe different standards today versus when you were looking at maybe a year or two ago, because again, it just seems like just how creative the deals are today. So, I’m just wondering, like when you and Adam, Chad are looking at some of these deals, how the requirements have shifted.
Nick O’Grady: Yes, I mean, I think, discount rates have definitively gone up. It doesn’t always show up in the multiple, Neal, the multiple is going to be a function of the longer term growth and value of the undeveloped piece, right? So, the short term multiple to the investors might not seem obvious, but we’ve seen in the last three or four years, probably even on the ground, probably a thousand basis point increase in our own clearing price. And that’s a function of the cost of capital, it’s also a function of where we’re targeting. And we’ve really changed some of our focus to where we feel like we can get a much – we’ve become much more critical to that part. That’s generally through concentration or scale and size. I don’t know if you want to answer the other part?
