SM Energy Company (NYSE:SM) Q2 2024 Earnings Call Transcript

SM Energy Company (NYSE:SM) Q2 2024 Earnings Call Transcript August 7, 2024

Jennifer Martin Samuels: Good afternoon and welcome to SM Energy’s Second Quarter 2024 Results Webcast. Before we get started on our prepared remarks, I remind you that our discussion today will include forward-looking statements. I direct you to Slide 2 of the accompanying slide deck, Page 6 of the accompanying earnings release, and the risk factors section of our most recently filed 10-K, which describe risks associated with forward-looking statements that could cause actual results to differ. We will also discuss non-GAAP measures and metrics. Definitions and reconciliations of non-GAAP measures and metrics, to the most directly comparable GAAP measures, and discussion of forward-looking non-GAAP measures, can be found in the back of the slide deck and earnings release. Today’s prepared remarks will be given by our President and CEO, Herb Vogel, and our CFO, Wade Pursell. I will now turn the call over to Herb.

Herb Vogel: Thank you, Jennifer. Good afternoon and thank you for your interest in SM Energy. We had a terrific second quarter and have enjoyed excellent operational performance year-to-date. We have also successfully been expanding our top-tier portfolio while managing a very strong balance sheet. Turning to Slide 4. Every quarter I speak to progress we are making on our core objectives for the year. I’ll start with our objective to expand our high-quality portfolio with low breakevens. Today we announced that we are exercising our option to acquire 26,100 net acres adjacent to the XCL acquisition in Utah, commonly referred to as the Altamont acquisition, for approximately $70 million. Combined with the XCL acquisition, we are adding 63,300 net acres in the core, over-pressured oil window of the Uinta Basin, including approximately 44,000 Boe per day of high oil content production and an initial estimate of 465 net locations.

Assuming PDP valued at $35,000 per Boe per day, we paid around $1.25 million per location, based on our preliminary counts, including Altamont. This is highly accretive to financial metrics including NAV. Second, production performance exceeded the mid-point of guidance by about 2,500 Boe per day with higher oil content, successfully demonstrating our core objective to focus on operational execution. In addition, we turned-in-line our first Woodford-Barnett test wells in the Midland Basin and are very pleased with early results and the potential to add more than 20,000 prospective net acres in this deeper formation. More about that in a minute. The third core objective is return of capital. We repurchased more than 1 million shares in the second quarter and, in combination with our sustainable dividend, returned approximately $72 million to stockholders.

Our Board authorized an 11% increase in the quarterly dividend to $0.20 per share and reloaded the share repurchase authorization to $500 million through 2027, so we are positioned to continue our return of capital program in the coming years. It was a very successful quarter, and I’d like to thank everyone on the SM Energy team for a lot of hard work and outstanding results. Let’s look at some detail behind these highlights, turning to Slide 5. Starting with expanding our high-quality portfolio, we have added significant scale over the past year-plus. Summing the Sweetie Peck extension, Klondike, South Texas drill-to-earn extension, XCL and Altamont acquisitions, we have added more than 90,000 net acres, that’s nearly 40% growth in core acreage, and added, preliminarily, 465 drilling locations from XCL and Altamont alone, and this is just the beginning.

The bottom of the chart includes a timeline for your reference. The Uinta acquisitions have an effective date of May 1st and, pending approvals, we anticipate closing October 1st. Turning now to slide 6 and the Uinta Basin. We have a very high bar in evaluating acquisitions to ensure value creation, and the Uinta acquisitions met all of our strategic objectives, listed here on the left side. These top tier assets: immediately compete for capital; extend our high-quality inventory by three-plus years, including our preliminary estimates for Altamont; will increase 2025 oil production an estimated 45% versus a stand-alone scenario; and are accretive to all key financial metrics at a purchase price of less than 3 times the projected 2025 adjusted EBITDAX contribution.

Q&A Session

Continuing with more about the Uinta on Slide 7. We showed this slide when we announced the XCL acquisition, and I am showing it again to reiterate the quality of the assets and the upside potential of the XCL acquisition that is expected by our differential geosciences and engineering team. These charts show comparisons of Uinta Upper and Lower Cube cumulative oil production performance based on normalized lateral lengths. The left graph compares average oil production from both cubes in the Uinta to SM’s average cumulative well performance in Midland and South Texas, demonstrating the competitive performance of the Uinta that translates into competitive returns. The right-side graph compares cumulative oil production performance of both Uinta cubes to top basins in the industry.

Again, this highlights the quality of the Uinta, including the prospectivity of the Upper Cube. We did our homework and look forward to demonstrating this value as we develop this asset. And Tim Rezvan did some further research into the results in the area and agrees, as quoted here “we believe there are sufficient data points to acknowledge that the Uinta is a prolific, stacked-pay oil play. We come away impressed by the overall rock quality of the Uinta”. Let me just say, “We agree!” Moving on to the Midland Basin and Slide 8. We have been tight-lipped about our activity in the greater Sweetie Peck area for some time as we added acreage. Now that production data is public, we are pleased to report today early data related to our first Woodford-Barnett test wells in the area that just reached peak IP30.

Our first two tests have impressive results with one 10,200 foot lateral reaching peak IP30 averaging 1,622 Boe per day and a shorter 5,900 foot lateral reaching peak IP30 averaging 830 Boe per day. The graph on the left compares these initial results, based on normalized lateral lengths, to peer wells in the same formation. These initial results compare favorably to peers in the area. Based on our two new wells, and existing peer wells in the surrounding acreage, we have confidence in the prospectivity of the Woodford-Barnett and believe our greater Sweetie Peck position may have more than 20,000 net acres prospective in this formation. Moving now to Slide 9. Again, we update this slide that compares the performance of SM wells in both the Midland Basin and the high-liquids area of the South Texas Austin Chalk to our peers, looking at cumulative oil production normalized to 10,000 foot laterals.

This underscores the superior performance of SM Energy wells. SM average well performance in Midland remains about 30% better than the peer average. As a reminder, we co-develop, so the SM averages include multiple zones, same for our Austin Chalk well performance, which is 35% better on average. And, as we have pointed out, the oil cumulative curves for Midland and Austin Chalk are similar, leading to comparable returns. Turning specifically to the Austin Chalk on slide 10. New Briscoe C wells continue very strong performance, including fully bounded tests at 625 foot spacing. Outperformance and positive spacing tests in the Austin Chalk continue to provide upside, and we look forward to results in the new, drill-to-earn acreage to the west expected in the fourth quarter.

The quotation here from Enverus emphasizes the upside potential from successful spacing tests, saying: “SM’s Briscoe C spacing pilot in the Austin Chalk is performing in line with more conservatively spaced offsets and could add over 60 locations to our existing inventory”. In summary, the combination of outstanding performance year-to-date; the pending close of the Uinta acquisitions that add substantial scale in terms of production, inventory and cash flow; as well as continued strong performance and expansion of our assets in Midland and South Texas. We are positioned for enhanced scale, a great second half of 2024 and an exciting 2025. We are truly hitting on all cylinders. I’ll now turn it over to Wade to discuss financial results and recent financing activity.

Wade?

Wade Pursell: Thank you, Herb. Good afternoon. I will certainly echo that it has been a terrific year, and the SM team has done a great job on a number of fronts. I’ll start on Slide 12. In regards to the second quarter financial results, we beat guidance and consensus expectations driven by higher than projected production volumes, which as Herb mentioned came in about 2,500 Boe per day above the mid-point. Importantly, this included over 4,000 barrels per day more oil production than the mid-point of guidance. This was driven by continued strong performance from base production in the Midland Basin and new South Texas wells that came on with higher-than- expected oil content. Second quarter results were pretty straightforward, so there is not much need to go into detail by line item.

Capital was slightly above guidance, which was a result of taking advantage of favorable terms on a bulk pre-purchase of pipe that had not been considered in second quarter guidance. This added around $12 million whereas, otherwise, we would have come in below guidance. Bottom line, adjusted EBITDAX was $486 million, adjusted free cash flow was $98 million and return of capital was $72 million. An excellent quarter. Moving to Slide 13. Summarizing the return of capital program, we have repurchased 8% of shares outstanding since inception. We repurchased more than 1 million shares in the second quarter, repurchased 1.8 million shares year-to-date and repurchased 10.1 million shares since inception of the program. Including return of capital through dividends, we returned to stockholders approximately $72 million, or 73% of adjusted free cash flow, in the second quarter, $125 million, or 75% of adjusted free cash flow, year-to-date and $0.5 billion, or 54% of adjusted free cash flow, inception-to-date.

Confidence in our expanded portfolio supported a further increase in the sustainable quarterly dividend to $0.20 per share and reloading the repurchase share authorization to $500 million. Over the course of the next several months, we intend to direct a greater portion of adjusted free cash flow to debt reduction, transferring that enterprise value to the equity holder, before resuming our recent pace of share buybacks. Turning now to Slide 14. In regards to the balance sheet, let’s look at that as of quarter-end and then consider subsequent events. At second quarter end, the cash balance was $488 million and there was zero drawn on the revolver. The cash balance excludes restricted cash of $102 million placed in escrow, required for the XCL acquisition.

Net debt was $1.1 billion and the net debt-to-adjusted EBITDAX ratio was 0.6 times. This strong balance sheet supported the all-cash terms of the Uinta acquisition. In July, we completed very successful, upsized bond offerings of $750 million of 6.75% five-year senior notes due 2029 and $750 million of 7% eight-year senior notes due 2032. The 2029 Notes are subject to a special mandatory redemption contingent on consummation of the XCL acquisition by July 1, 2025. The $1.5 billion in proceeds will be used to fund the Unita acquisitions as well as the redemption of the $349 million senior notes due 2025. A combination of cash on hand and the revolving credit facility will be used to fund the remaining portion of the Uinta acquisitions, which we anticipate to close October 1st.

Due to the highly cash flow accretive nature of the XCL transaction, based on our $78 oil and $3.25 gas commodity price deck at the time of the announcement, we expect to return to an approximate 1 times net debt-to-adjusted EBITDAX level sometime mid-2025. Even assuming a $60 oil and $2 gas long-term price deck, peak leverage remains in the 1.5 times area. Skipping ahead to Slide 16. In regards to guidance, let’s also look at this pre- and post-transaction. For full year 2024, on a standalone basis we are increasing oil production as a percent of total production given the strong performance in Midland and higher oil content we are seeing in South Texas. We have also adjusted cash taxes to approximately $30 million net of refunds, reflecting a projected increase in book income.

Other than increased oil percentage and cash taxes, our guidance remains unchanged. Last quarter, we increased full year guidance for production and decreased full year guidance for capital expenditures. We are maintaining full year expected production at 57 to 60 million Boe, or 156,000 to 164,000 Boe per day, but increasing the oil percentage from 44% to 45%. Capital expenditures guidance remains at $1.14 billion to $1.18 billion and includes an updated estimate for net wells drilled and flowing completions to 123 and 125, respectively. All other line items remain unchanged. Third quarter guidance includes: production volumes of 15.0 to 15.4 million Boe, or 163,000 to 167,000 Boe per day, at 45% to 46% oil. Capital expenditures are expected to range between $300 million and $310 million and include drilling 33 net wells of which 14 are planned for South Texas and 19 are planned for Midland and turning- in-line approximately 39 net wells of which 22 are planned for South Texas and 17 for Midland.

I will also mention that LOE per Boe came in below the guidance range in the second quarter, but we expect third quarter LOE to fall within the range due to higher expected water handling and generator costs. In regards to additional production and capital associated with the Uinta assets, this will affect fourth quarter results, assuming the proposed October 1st close date. In the fourth quarter, the Uinta assets are expected to add approximately 44,000 Boe per day at 87% oil. Of note, at the time of the XCL acquisition announcement, we included September production in the numbers, so the total production contribution for 2024 is slightly different. Of course, the May 1st effective date is unchanged, so the benefit of the September production is simply recognized as a purchase price adjustment.

We expect capital expenditures for Uinta to add $100 million to $120 million to the fourth quarter. Looking ahead to 2025, in June we presented a generalized scenario for capital allocation across the three assets: Uinta, Midland and South Texas. All of these areas offer very high returns and high-quality, long-duration inventory. As we work towards our detailed 2025 program, we have the luxury of allocating capital across three high return assets, and we will seek to demonstrate the quality and value of the Uinta while optimizing the capital efficiency and free cash flow of the combined program over a multi-year period. This entails right-sizing the rig to completion crew ratio for the combined program. We expect to reduce the combined rig count from currently nine, to six to seven during 2025, while maintaining approximately three completion crews.

We will be working through detailed pad-by-pad scenarios during our fall strategic planning process. It is an exciting time at SM and we are very well positioned to deliver around 45% oil production growth in 2025 as we roll together the highly accretive acquisitions and continue to see excellent results from our Midland and South Texas programs. We look forward to the live Q&A webcast and call tomorrow morning. Thank you.

End of Q&A: