Western Midstream Partners, LP (NYSE:WES) Q3 2023 Earnings Call Transcript

Western Midstream Partners, LP (NYSE:WES) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Thank you for standing by. My name is Keyo Baker [ph] and I will be your conference operator today. At this time, I would like to welcome everyone to the Western Midstream Partners Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the call over to Director of Investor Relations, Daniel Jenkins. You may begin.

Daniel Jenkins: Thank you. I’m glad you could join us today for Western Midstream’s Third Quarter 2023 Conference Call. I’d like to remind you that today’s call, the accompanying slide deck and last night’s earnings release contain important disclosures regarding forward-looking statements and non-GAAP reconciliations. Please reference Western Midstream’s most recent Form 10-Q and other public filings for a description of risk factors that could cause actual results to differ materially from what we discuss today. Relevant reference materials are posted on our website. With me today are Michael Ure, our Chief Executive Officer and Kristen Shults, our Chief Financial Officer. I will now turn the call over to Michael.

Michael Ure: Thank you, Daniel and good afternoon everyone. During the third quarter increased throughput from all operated assets and across all products led to improved adjusted gross margin and adjusted EBITDA on a sequential quarter basis. Specifically, in the Delaware Basin our throughput increased across all three products mostly due to new production coming online and continued high facility operability. In the DJ Basin, both natural gas and crude oil and NGLs throughput increased quarter-over-quarter, a trend we expect to continue into the fourth quarter and throughput also increased from our other assets, specifically in South Texas as additional volumes from new customers came online. Focusing on the Delaware Basin, we achieved record natural gas, crude oil and NGLs and produced water throughput during the third quarter.

For the first time in WES’s history we averaged more than a Bcf/d of natural gas gathered from third parties for the months of August and September, demonstrating our focus on growing the entirety of our business. This throughput record is a testament to our team’s ability to successfully compete for new business by reducing costs and providing superior customer service. Since 2021, WES has grown its third party volumes in the Delaware Basin by approximately 65% which is more than twice the rate of natural gas volume growth from the entire Delaware Basin. I would also like to highlight a new contract extension that WES recently executed with one of our largest producing customers in the Delaware Basin bringing total dedicated acreage from that producer to roughly 40,000 acres and extending the duration of our agreement by 10 years to 2035.

An aerial view of an industrial natural gas refinery, with smoke billowing out.

This extended dedication keeps significant natural gas volumes on WES infrastructure of the long-term and supports expected volume growth over the coming years. Before I turn the call over to Kristen, I wanted to discuss the Meritage Midstream acquisition we announced in early September which is the second largest unaffiliated corporate level M&A transaction in WES’s history and our first significant acquisition since becoming an independent partnership in 2020, we have consistently said that our M&A strategy is focused on accretive deals that optimize the value of our existing asset base and allow us to leverage our operational expertise to generate incremental value for our unitholders. We believe that the Meritage acquisition fits within our strategy for a number of reasons.

First, the Meritage deal transforms and significantly expands WES’s existing Powder River Basin asset base, adding natural gas gathering and processing facilities and increasing WES’s total processing capacity in the region to approximately 440 million cubic feet per day. Through the Meritage acquisition, we were able to optimize our previously subscale position to become the largest gathering and processing provider in the basin, which places us in a strong strategic position to compete for additional blocks of undated gated acreage in the basin. Second, this transaction provides meaningful customer diversification by adding several new investment grade customers as well as several high quality financially strong private customers to WES’s customer base.

Third, we acquired numerous long-term contracts secured by large acreage dedications or substantial minimum volume commitments that are expected to contribute to WES’s earnings and free cash flow over the coming years. Finally, we consummated the deal at an extremely attractive valuation of approximately 5 to 6 times 2024 adjusted EBITDA, not including the synergies we have identified for 2024 and beyond that are expected to reduce the forward acquisition multiple. Overall, the Meritage acquisition enhances WES’ future profitability and our free cash flow generation profile, which should in turn increase our ability to return more capital to stakeholders over time. This starts with our third quarter base distribution which we just increased by $1.25 per unit or $0.05 per unit on an annualized basis.

The Meritage acquisition was funded with cash, including amounts received from our recent issuance of $600 million of five-year senior notes and from borrowings on our revolving credit facility. As a result, our trailing net leverage ratio will increase in the near-term, but we expect to return to pre-meritage leverage levels by year end 2024 as we grow adjusted EBITDA and capture cost synergies. Additionally, our focus over the past several years on strengthening our balance sheet by reducing costs, capturing operational efficiencies and growing adjusted EBITDA paired with meaningful debt reduction put our partnership in a position of strength to execute an all cash transaction such as Meritage. Finally, it is important to note that while we meaningfully strengthened our legacy asset base in the Powder River Basin, our other core basins continue to experience increased producer activity levels.

In 2024, the Delaware Basin will continue to be the main driver of throughput growth and we continue to invest meaningful amounts of capital towards meeting growing customer demand with the expansion of Mentone and the construction of our Greenfield plant at North Loving. In the DJ Basin, which generates roughly 50% of our free cash flow, we reached the trough of the throughput decline and we expect to see producers gradually grow volumes over the coming quarters. The Powder River Basin has favorable producer activity levels and acreage with competitive economics and when paired with our existing core basins will support WES’s long term growth strategy for years to come. With that I will turn the call over to Kristen to discuss our operational and financial performance.

Kristen Shults: Thank you, Michael and good afternoon everyone. Our third quarter natural gas throughput increased by 5% on a sequential quarter basis, primarily due to increased throughput in the Delaware Basin from new production coming online from our other assets, specifically in South Texas, and from our equity investments. Additionally, we achieved increased throughput in the DJ Basin due to increased completion activity from both affiliated and third party producers. Our crude oil and NGLs throughput increased by 7% on a sequential quarter basis, primarily due to increased throughput from our equity investments and Delaware Basin oil system. Of note, we saw our first sequential quarter increase in crude oil and NGLs throughput from the DJ Basin since the fourth quarter of 2021.

Produced water throughput increased by 14% on a sequential quarter basis due to increased completion activity and high facility operability in the Delaware Basin. Our per-MCF adjusted gross margin for our natural gas assets was flat compared to the prior quarter. Higher throughput from our South Texas assets, which have a lower than average per-MCF margin as compared to our other natural gas assets and lower distributions from our natural gas equity investments had a dilutive impact on our per-MCF adjusted gross margin, which was offset by increased throughput from both the Delaware Basin and DJ Basin. Excluding any potential impact from cost of service, we expect our fourth quarter natural gas per-MCF adjusted gross margin to increase slightly, primarily due to the addition of volumes from the Meritage acquisition.

Our per barrel adjusted gross margin for our crude oil and NGL assets decreased by $0.31 compared to the prior quarter, primarily due to a decrease in distributions coupled with an increase in throughput from our equity investments, which have a lower than average per barrel margin as compared to our other crude oil and NGL assets. Excluding any potential impact from cost of service, we expect our per barrel adjusted gross margin in the fourth quarter to increase slightly, primarily due to a lower throughput expectation from our equity investments. Our per barrel adjusted gross margin for our produced water assets increased by $0.01 compared to the prior quarter, mostly due to contract mix. We expect our per barrel adjusted gross margin in the fourth quarter to be in line with our third quarter results.

During the third quarter, we generated net income attributable to limited partners of $271 million. Adjusted EBITDA in the third quarter total $511 million, a quarter-over-quarter increase of 5%. Relative to the second quarter, our adjusted gross margin increased by $35 million. This was mostly due to increased throughput across all three products in the Delaware Basin paired with increased natural gas throughput in the DJ Basin. As expected, we experienced a sequential quarter increase in our operation and maintenance expense, primarily due to increased utilities and asset maintenance and repair expenses. The sequential increase in utility cost was driven by higher electricity prices as well as higher utility usage, which is typical during the hotter summer months of the third quarter.

Keep in mind that approximately 25% of our overall utility expense impacts our adjusted EBITDA as the remainder is reimbursed through either cash reimbursements of electricity costs or contribution of fuel gas for reimbursement of electricity equivalent costs. We expect our operation and maintenance expense in the fourth quarter to be in line with our third quarter results as lower utility costs are partially offset by the inclusion of 2.5 months of contribution from Meritage. Our property and other tax expense decreased on a sequential quarter basis from a reduction in the ad valorem property tax accrual related to the finalization of rates in West Texas and lower property values in Colorado. Turning to cash flow, our third quarter cash flow from operations totaled $395 million, generating free cash flow of $200 million.

Free cash flow after our second quarter distribution payment in August was the use of cash of $21 million. From a capital markets perspective, at the end of the third quarter, we accessed the debt capital markets for the second time this year, issuing $600 million of five-year senior notes with a 6.35% coupon, the proceeds of which were used to fund a portion of the Meritage acquisition. We were pleased with how well the issuance was received by the market with an order book more than four times oversubscribed and a deal that ultimately priced at 170 basis points above the five-year treasury rate. Since we expanded our unit buyback program to $1.25 billion in November of 2022, we have repurchased approximately 50% of the total aggregate consideration allocated towards our unit buyback program or just over $622 million.

This includes 5.1 million common units purchased from Occidental in the third quarter for total aggregate consideration of $128 million and for an average price of $25 per unit. Focusing on the base distribution, in October, we declared a distribution of $57.50 per unit an increase of just over 2% compared to the prior quarter’s distribution payable on November 13 to unit holders as of November 1st. We remain committed to our capital allocation framework and we will continue to maintain a balanced approach of retiring debt, buying back units opportunistically and increasing our base distribution over time. We will continue to be good stewards of our unitholders investment by efficiently allocating growth capital that will create the greatest value for our unitholders with the ultimate goal of prudently growing adjusted EBITDA and free cash flow.

Moving to annual throughput growth rates with 2.5 months of contribution from the Meritage assets we now expect average year-over-year natural gas throughput growth to be in the mid-single digit range for 2023. We continue to anticipate low single digit growth for crude oil and NGLs throughput and upper teens throughput growth for produced water. Keep in mind that our crude oil and NGL’s growth expectations for 2023 exclude the impact of Cactus 2 from our 2022 throughput actuals. Focusing on basin specific activity, we still expect the Delaware Basin to be the main driver of throughput growth and we continue to expect average year-over-year throughput growth across all three products in the basin as we exit this year. Although we believe the throughput declines in the DJ Basin have subsided, we still expect average year-over-year throughput to decrease for both natural gas and crude oil and NGLs relative to 2022.

Steady on loan activity and increased producer activity levels that resulted in additional wells coming online contributed to the end of this decline and should provide continued modest growth for both products during the fourth quarter. These projected changes in natural gas and crude oils and NGL’s throughput in the DJ Basin are expected to have a minimal impact on our Adjusted EBITDA in the near-term due to the current structure of demand and efficiency fee revenues. Pivoting to our financial guidance, we now expect to be at the high end of our previously revised adjusted EBITDA guidance range of $1.95 million to $2.05 billion. This is based on our third quarter financial performance and the expected adjusted EBITDA contribution from Meritage in the fourth quarter.

With that said, we are maintaining the following 2023 guidance ranges from the prior quarter. Total capital expenditures of $700 million to $800 million. This includes additional growth capital for Meritage as well as capital for both Mentone Train III our North Loving Plant. While we expect some Mentone and North Loving Plant capital to push out of 2023 and into 2024 based on construction timelines, we still expect the plants to be operational by the end of the first quarter of 2024 and the first quarter of 2025 respectively. Free cash flow of $900 million to $1 billion, which includes the incorporation of the Meritage capital expenditure plan for the remainder of 2023. Based on our most recent increase to the base distribution in conjunction with the closing of the Meritage acquisition, we’ve grown the base distribution to approximately $2.21 per unit for 2023, slightly exceeding our base distribution guidance range of at least $2.00 and $18.75 per unit.

We will continue to evaluate the base distribution on a quarterly basis and will consider recommending an increase in the base distribution to our Board as the underlying fundamentals of our business support additional adjustments. We also remain committed to our enhanced distribution framework with a net leverage threshold of 3.2 times per year in 2023. With that said, we remain committed to the concept of returning excess free cash flow to unitholders if we can’t find a better use for that capital during the year. And as Michael said earlier, we see a path to pre-Meritage leverage levels by year end 2024. Finally, focusing on 2024, even though we have not yet provided official guidance, we expect our average year-over-year throughput for our operated assets to increase relative to 2023.

In the Delaware Basin, producer activity levels remain strong and we expect more wealth to come to market year-over-year. In the DJ Basin, we reached the trough of the decline in the third quarter. Going forward, we expect modest increases in total volumes over the coming quarters and more noticeable growth in the back half of 2024, especially for natural gas volumes. But crude oil and NGL volumes would be at a slower, more moderate pace. Increased throughput in the DJ Basin in 2024 will have a minimal impact on our adjusted EBITDA due to demand and deficiency fee revenue we collect associated with minimum volume commitments. We also expect healthy natural gas throughput growth in the Powder River Basin associated with the addition of Meritage assets.

Turning to capital expenditures, we are seeing some of our capital needs push into 2024. Due to updated plant construction timelines, certain capital expansion projects moving into next year and select producers pushing wall connects into early 2024. As such, we expect some of the capital costs for Mentone and almost all of the costs for North Loving plant to come in 2024 as we look to bring those facilities online in early 2024 and early 2025 respectively. Additionally, now that the transaction is closed, we continue to evaluate the capital needs for the new Meritage assets. We expect 2024 to be a slightly heavier capital year for these assets in order to complete certain expansion projects needed for increasing throughput in both 2024 and 2025.

With that, I will now turn the call back over to Michael.

Michael Ure: Thank you, Kristen. Before we open it up for Q&A I would like to highlight a few key points and reiterate why WES is in a strong position as we exit this year and transition into 2024. WES is very well positioned for throughput and adjusted EBITDA growth in 2024 relative to 2023. We expect to benefit from capital efficient organic projects such as Mentone Train III by the end of the first quarter of 2024 and we are on track to complete the North Loving plant by the end of first quarter 2025. Keep in mind these capital expansion projects are supported by significant minimum volume commitments and we continue to expect that the plants will be full once they come online. These plant expansions will put us in a strong position to capture more value for our partnership through increased natural gas processing capacity.

The Meritage acquisition was consummated at an extremely attractive valuation which should result in approximately $155 million to $175 million of incremental adjusted EBITDA based on the five to six times pre-synergy multiple we highlighted when we announced the transaction. Additionally, we continue to be focused on returning capital to stakeholders, which is demonstrated in our leading total capital return yield amongst midstream companies. Our view is that M&A opportunities like Meritage enhance capital return opportunities overtime with expanded adjusted EBITDA and increased free cash flow generation. We remain committed to a balanced approach to capital return as seen with the additional increase in the base distribution upon closing of the Meritage transaction and our opportunistic unit buyback from Occidental in September.

Finally, WES continues to screen favorably relative to midstream companies and members of the Russell 3000 Index. When comparing the midstream sector relative to the Russell 3000 Index WES is now the leading midstream investment opportunity with an investment grade credit rating and a trailing 12-month distribution yield of nearly 9%. I would like to close the call by thanking the entire WES workforce for all of their hard work and dedication to our organization. I would also like to extend additional thanks to all of our employees that have been part of the Meritage acquisition. Your efforts enabled us to close the transaction quickly and begin moving forward with integration. Whether it’s working on strategic acquisitions or enhancing our daily operations, our employees’ contributions continue to yield substantial results that are creating additional value for our stakeholders.

I look forward to finishing the year on a strong footing and updating you on additional progress as we transition to 2024 on our fourth quarter call in February. With that we’ll open the line for questions.

Operator: [Operator Instructions] Your first question comes from the line of Spiro Dounis with Citi. Your line is open.

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Q&A Session

Spiro Dounis: Thanks. Good afternoon team. Maybe starting with Meritage if we could, Michael, as you said in your prepared remarks, M&A really hasn’t been part of the strategy historically. So this is kind of new. So just curious, is this a shift in strategy or just seeing a more conducive M&A environment? And if you can maybe just provide a little more context on how Meritage came together?

Michael Ure: Yes. Thanks, Spiro. Definitely not a shift in strategy. Our strategy has always been that we would be opportunistically looking for M&A opportunities. This is an acquisition opportunity as we looked at our existing footprint out there. From our perspective it was either we needed to potentially exit the area or get larger. As we looked at this particular opportunity and at the area as a whole, we got really excited about what this might be able to become for us and for the company overall. And so it’s a company and an opportunity that we’ve actually been following for quite some time. And then the timing just made a lot of sense post our transformation for us to be able to feel confident that we can tuck in these assets and be able to achieve greater synergies and potential opportunities for growth on the heels of the work that we’ve been doing in order to get more efficient across the board in our operations.

So definitely not a shift in strategy, just executing opportunistically as we had indicated and that opportunity really found a home as we executed that transaction in the third quarter.

Spiro Dounis: Got it, got it, helpful. And switching gears a bit to CapEx, Kristen, sounds like in your remarks there a few factors coming together that maybe keep CapEx a little bit elevated next year. Sounds like Delaware obviously those two processing plants are your biggest spend which makes sense. But in looking at the DJ and Meritage, once again kind of a two-part question here, DJ growing again, should we expect more capital to be allocated there as a result or do you kind of have a long run rate of sort of available capacity? And then with Meritage you also mentioned higher capital needs next year, just maybe a sense of what is the nature of that spending, is that well connect CapEx or something more substantial?

Kristen Shults: Yes. So on the DJ, you’re right, Spiro, we’ve got extra capacity in the DJ right now. So I’d say any capital that we’re spending there will be relatively minimal kind of what you’ve seen in 2023, just as we’re connecting new pads so forth and so on. For Meritage, yes, there’s a little bit more growth capital next year for Meritage. And so well connect compression, things of that nature that I would expect to hit the 2024 budget.

Spiro Dounis: Got it. Helpful color. Thanks for the time, guys.

Michael Ure: Thanks, Spiro.

Operator: And your next question comes from the line of Brian Reynolds with UBS. Your line is open.

Brian Reynolds: Hi, good afternoon everyone. Maybe to follow up on Spiros CapEx question, Kristen, I think you mentioned that you expect the processing plants to effectively open full. So how should we be thinking about the next processing plant just given that you know it seems like WES is gaining more and more acreage dedications on the Delaware? Thanks.

Michael Ure: Yes, Brian, thanks. It’s great question. Yes, the way that we’ve managed that is we’ve offloaded volumes in order to bridge the timing between when it is that we receive the commitments from our customers as to when those commitments kicked in to take sort of the interruptible volumes we’ve offloaded in order to bridge that timing to when that plan comes online. And so that’s our expectation of when those plans come online that they’re ultimately full. As we sit here today, first we expanded the North Loving area in a new Greenfield area with the opportunity for us to expand more that footprint should the need arise. But as we sit here today, we don’t currently see the need in order to offer up additional expansions on North Loving.

Brian Reynolds: Great, thanks. I appreciate that. And then looking ahead to 2024, it sounds like there’ll be some growth. Clearly the Delaware is growing and the processing plants are running full. But is there any way to sensitize how many volumes are currently being offloaded and potentially the impacts that will have on margin as that comes back onto your system? And then as it relates to DJ some tailwinds there, but the first quarter of growth, when should we expect to be above those NBCs [ph] at this point? Is it second half of 2024 or early 2025 at this juncture? Thanks.

Kristen Shults: Yes. So on the growth side of things, as Michael was saying, we’re offloading volumes today and so as we’re bringing Mentone III online, that — the capacity of that train right, you would expect that to get on our system and decrease those offloads so quite a bit. That’s being offload today obviously when we’re saying that we expect Mentone III to be full on day one. And then sorry, if you can repeat your last question that you asked [indiscernible]?

Brian Reynolds: Just as it relates to margin, I mean could we see some margin benefits just given that you’re not, no longer offloading the volumes and some unit…

Kristen Shults: Yes, we definitely will, we expect to see a little bit of margin benefit incremental every month from that. So higher OpEx on our side as we’re obviously running that plant and we’ve got the people to run that plant maintenance as well and that, but yes, would expect to see some adjusted gross margin benefit as the offload fees are reduced.

Michael Ure: And then Brian to answer your question on the DJ, we would — we currently would still expect that there would be minimum volume commitments received primarily on the oil side throughout 2024 as it sits here today.

Brian Reynolds: Great. All makes sense. I’ll leave it there. Enjoy the rest of your afternoon.

Michael Ure: Thanks, Brian.

Operator: And your next question comes from the line of Jeremy Tonet with JP Morgan. Your line is open.

Jeremy Tonet: Hi, good afternoon.

Michael Ure: Hey, Jeremy.

Jeremy Tonet: I just wanted to take a step back and think about the — your portfolio as it stands right now your base business and if you think about just the organic growth that’s possible, how do you think about that right now in general as far as the low single digit, mid-single digit, otherwise just wondering how you think about organic growth, obviously not giving 2024 guide, but just trying to get a sense for how you think about the business at this point?

Michael Ure: Yes. So I would, I’d call your attention to Slide 9 in the deck where we talk about our estimated growth rates for 2023 and as we look into 2024 our expectation that that will actually grow on top of 2023. And so we’re seeing positive tailwinds frankly pretty much throughout our operated portfolio which are contributing overall to an expected growth in 2024 over 2023.

Jeremy Tonet: Got it. And from an EBITDA perspective, any color that you could share there?