SM Energy Co (SM) 2021 Q2 法說會逐字稿

Good morning. Thank you for standing by. And welcome to the SM Energy Second Quarter 2021 Financial and Operating Results Q&A Call.

(Operator Instructions)

Please be advised today's conference is being recorded. I'd now like to turn the conference over to Vice President of Investor Relations, Jennifer Samuels. Please go ahead.

Good morning, and thank you for joining us. We are very pleased to report second quarter across-the-board beat in conjunction with an improving outlook for free cash flow generation and absolute debt reduction in 2022. To answer your questions today, we have our President and CEO, Herb Vogel; and CFO, Wade Pursell.

Before we get started, our discussion today may include forward-looking statements and discussion of non-GAAP measures I direct you to Slide 2 of the accompanying slide deck, Page 5 of the accompanying earnings release and the Risk Factors section of our most recently filed 10-K and 10-Q, which describe risks associated with forward-looking statements that could cause actual results to differ. And refer to Slides 26 through 28 of the accompanying slide deck on Pages 12 through 15 of the accompanying earnings release for definitions and reconciliations of non-GAAP measures to the most directly comparable GAAP measures and discussion of forward-looking non-GAAP measures. Of note, our second quarter 10-Q was filed this morning.

With that, I will turn it back to the operator to take our first question. Colley?

(Operator Instructions)

Our first question is going to come from the line of Leo Mariani with KeyBanc.

I was hoping to talk a little bit about CapEx. You guys obviously are expecting to kind of be at the higher end of the range for the year. It looks like CapEx sustained pretty robust here in 3Q. And I guess to get to the high end, it kind of implies a pretty big drop in the fourth quarter. Are you seeing a fourth quarter activity cut? And can you just talk about the dynamics that are getting you to the high end of the range?

This is Wade. I'm going to make a few comments, and Herb can add some color if he'd like. But yes, you summed it up pretty well. I mean we gave a range for the full year, and we're still seeing that, but down towards the high end with some moderate inflation assumption in there. But in terms of the cadence, we did accelerate the program and that's enabled us to achieve our objectives. The quarter-to-quarter kind of is what it is, and it will tail off in the fourth quarter from a CapEx standpoint for sure.

Okay. I just wanted to ask about projection. I think you guys put a comment in the transcript where you're talking about kind of low single-digit growth in 2022. I'm not really sure if that's just kind of a high-level comment for now, you guys will refine that going forward? But if I just kind of run the math, you guys are talking about second half '21 production of around 142,000 BOE per day at the midpoint. And if I was to hold that 142,000 even flat for next year. I guess that would get me closer to 7% year-over-year growth. So I'm just trying to understand the comment around the low single-digit growth next year?

Yes, Leo, this is Herb. Yes, it's a real simple number when we say that. So it's really just we take the annual average for '21, and then we say, what annual average for '22. And depending on the actual cadence of the capital spend and when the wells come on in '22 will determine that quarterly phasing. And we have not budgeted for '22 yet. We just do an outlook at this stage. And then as we get into September through November, then we really lock it in more. So I wouldn't read a whole lot into that. It's just low single-digit growth when we look at the annual average for '21 and '22.

Yes. I'll just remind you that, that absolutely out. I mean we put this plan together to generate the most free cash flow that we can. And that's exactly what's going to happen. It generates a significant amount of free cash flow next year and beyond and delevers the balance sheet. And the production number that comes out is where it is, and we just as Herb said, got it generally today, right now, that looks like a low single-digit growth rate, but we will refine that as we get closer to the end of the year.

Okay. That's helpful. But there's no plan for any like big activity decline or anything like that, is it?

No. I mean we don't have it all worked at this stage. So no. I mean, nothing big change in that.

It's as what we call an optimal activity level projected out into the future, and that's still the case.

(Operator Instructions)

Our next question will come from the line of Michael Scialla with Stifel.

Maybe just a follow up on Leo's first question. The

implied drop in activity for fourth quarter. Is that anticipated to be in both your operating areas? Or is it concentrated in South Texas? Or can you say any more color on what that activity might look like for fourth quarter?

Mike, we're just basically just executing on the program through the year and meeting kind of the expectations overall on the number of completions and the number of drill wells and the CapEx spend. So yes, well it dropped from 3Q to 4Q, but there's nothing really remarkable or intentional about anything other than those free cash flow objectives we have in our plan longer term.

Okay. And I guess as you look forward, and I realize you just said you haven't finalized the '22 budget, but you're obviously getting some very positive results out of the Chalk. Just wondering, as you think about allocating capital in South Texas and the Permian next year. Thoughts on the Chalk getting -- or South Texas getting a bigger percentage of the capital for '22 versus what you saw this year?

I've been asked that several times, and we obviously have not set our '22 allocation between the 2 assets yet. And what we really find is that it doesn't make that much difference from a free cash flow delivering perspective longer term, whether it's 60-40, 70-30, 80-20 where we allocate it. But commodity price will make a little bit of difference. And so we'll just look at the time and decide on the allocation of the time. But I will say we're really pleased with the way the Austin Chalk has been performing. I'll call one of our asset managers that said some of the well there's a little engine that could that the yields are hanging in there longer in some cases than we expected, and that leads to the outperformance on oil. So we're happy with the program. We're continuing to delineate and test development, and we'll continue to do that at the right pace. And that right pace will be determined as we learn more, we'll continue to design the program in the out years.

Okay. Then just wanted to follow up on one of Wade's comments in the prepared remarks. What you'd said you probably hedged less as the debt leverage comes down. Can you give any color there on? What you're thinking the appropriate level of hedging might be for next year? It looks like you did add some hedges for next year. But I wanted you to give a little more detail on that.

Yes, it's good. It's a very relevant question. Yes, and it's still consistent with what we've been saying regarding our strategy, which is always tied to leverage. And as we look out and see leverage falling pretty dramatically, I think I said right now, the forecast based on strip and current cost estimate shows us getting below 1.5x by the end of next year.

So looking at those metrics, we're much more inclined to target a hedge percentage no more then 50%. So that's kind of the number we're looking at as we approach next year because we're forecasting a leverage number still well out 1.5 years from now. So we'll be want to lock in some of the cash flow to protect that, but not near the levels that we would have -- when the leverage was a higher number, which is what you see this year and last year. So I hope that helps.

Our next question will come from the line of Nicholas Pope with Seaport.

Just a couple of questions. I guess as you -- you've done a lot with the balance sheet here 2021. So looking at free cash flow from here on out with kind of where commodity prices are set up for the next 2 years. I guess how are you thinking about where our priorities are? There's not a lot of near-term debt that can be paid down anymore. So when you look -- as you look at kind of the opportunity set with additional balance sheet work? Or I guess, maybe how do you think about the dividend that's in place? And how that's related to the free cash flow profile going to look?

No great question. Yes, great question. I -- as I just said on the last answer, we do project getting below 1.5x by the end of next year based on what we see right now, current market conditions. And our -- we put forth this long-term plan that focuses on free cash flow focuses on debt reduction, and that is absolutely still the case. So as we move along next year getting to that point that I mentioned, there certainly are still prepayable options, no question about it.

Not -- they're not near term anymore, which is great because we moved out the near-term maturities. But if you look at the debt structure, there's call features within them and -- and for example, the 25, as we move into next year, callable at a pretty pretty favorable area of 100 to 101-ish. But then you have the more expensive second lien notes, which I think I've mentioned before by us doing the refi transaction, I'll call it, late in the second quarter, that really enables us to use free cash flow to really target some of the more expensive debt in the structure, which obviously the second lien notes qualified to that. And the will they start becoming callable in the middle of next year.

So we'll be targeting those things and continuing to delever. Your question about at what point do we consider like dividends or raising dividends, things like that. That will definitely be on the table. Once we start getting to those low leverage levels. And so as I've said in prior calls when the question is asked, let's get to that point, and then let's look around and see what the market conditions that are creating that. In other words, if you're at a really, really high oil price that would -- I think that would be a factor in whether it's kind of a mid-cycle type level at a comfortable level. But if it feels more like sustainable, as I think you said, then something along the lines of the dividend program, we'll definitely be on the table at that point.

Got it. That's very helpful. And how do you think -- I mean I know there's been a lot of questions trying to get you guys to zone in on where CapEx might be next year. But I mean, what do you think the triggers might be as you look at that cash flow profile for when maybe adding a sixth rig? Like what -- I guess, what would you need to see from a high level for that to be incorporated into what the 2022 program might look like?

Yes. Nick, this is Herb. So we're really just sticking to the plan and want to generate that free cash flow and getting our asset debt down. So we're not really laying out there to add activity. We're really steady activity. We can be very capital efficient, and that really helps on the free cash flow generation side of things.

Got it. And the -- just a little bit of clarity on -- in South Texas of the 11 wells, I guess, that have been drilled in '21, but are any of the -- what's the split with Austin Chalk versus kind of the more traditional Eagle Ford wells?

Well, let me talk about completions because actually, we probably build more than that. On the completion side, we completed 3 Eagle Ford wells down in that JV and 3 Austin Chalk wells down in that JV. And -- so then we talked about the 3 additional Eastern Eagle Ford, Eastern Austin Chalk wells. And then we've got a couple more online. We saw that where that total is 17, I think, total number of wells, 9 were last year. And then we got several more that are just started producing or will start to be some late in the year.

Our next question will come from the line of Karl Blunden with Goldman Sachs.

So a couple of different items touched on in terms of capital allocation, but I didn't hear much discussion of M&A, whether it's acquisitions or divestments, is there any update on that front that you could share with us?

Yes, Karl, this is Herb.

Yes, really, no real big update on M&A. We've been pretty consistent in our messaging there. Really no change in our views at all. We do think scale does matter, and it's more than just lower G&A. And when we talked about our criteria, and it's really got enough comparable quality assets, and that's -- we've got really high-quality assets, as everyone is aware. It's got to be accretive to free cash flow and then it ought to be neutral to benefits of the leverage at the levels we're talking about now. And when we look at scale, it would really help to have some industrial logic behind it and improve capital efficiency and then that could lead to lower cost of capital. And then there's some benefits on the ESG side from scale also. But yes, no action at this time.

Got you. And then you've done some nice work in reducing revolver borrowings and it's down to a relatively low level. When you think about the next time you have discussions with the banks in terms of extending and setting up a new or updated facility, can you remind us when that happens? And what your goals might be in those discussions?

Sure. That's a good question. Our revolver, it doesn't mature until second half of '23. So it's still a little early. I would anticipate we'll be -- I think there are several peers that are doing new revolvers this fall. We'll be watching those closely just to kind of see what the market looks like and and maybe start thinking strategically maybe as early as the spring of next year as far as looking at possibilities for extending that. But we still have a little time to watch. And in the meantime, generate free cash and basically get out of the revolver, frankly, so and not be using it, which is typically our strategy.

Our next question will come from the line of Gail Nicholson with Stephens.

You guys just finished your first 2 simultaneous frac operations in the Midland. Can you guys talk about the cost savings you saw there? And how applicable that is across the remainder of your Midland inventory? And do you have any plans to test it in South Texas?

Yes, it was a great accomplishment on simul-frac. It went really smoothly. We've run the 2 different pads. We got 2 service providers on those. And so what the bottom line is you can see the way the efficiency gains would be is because you have about 60% more horsepower on site than you would with just regular zipper fracking. But you're pumping at twice the rate, the number of savings you can do in a day. So you can see the intrinsic efficiency that we anticipate. And so when you schedule it out, though, there are certain pads where they're very amenable to simul-fracking. So if you've got a larger number of wells on the pad, it's easy to do. If you just have a single well, it's obviously not going to work and then you just stick to a single frac operations, if you have 2 wells and zipper fracking.

So when we look at 2022, we'll be lying out on those places that you can use simul-frac and those where you zipper fracs versus single-well operations. We line that out. And the benefit is if we have a spread or a provider that can do both simul-frac and zipper fracking operations, clear efficiencies in the scheduling side of things. So yes, we do anticipate on a like-for-like basis, we could achieve some savings. Hard to put a percentage on it because we have a combination, not every pad is amenable to simul-fracking. So we sure like to have work for us in these 2 cases.

Great. And then you also did a 4-mile lateral this quarter in the Midland. Can you just talk about how that was? Does that change the technical difficulty of the drilling? And how applicable that those super-long laterals are in the 2022 plan potentially?

Yes. Thanks for pointing that Gail. Yes, it feels really good for our team to have done the record long lateral in the state of Texas, which there's a lot of wells in Texas, right? So felt really good. And where it is real applicable is it obviously gives us a lot of capital efficiency. It works in some areas to access acreage that's quite far out and that you may not get to for a while. So it's best that it works like a charm. We drilled that in 20 days. We -- I think it's 105 frac stages in that well, which is a lot, and then we drilled it out without any difficulties and we brought it online on June 25.

And now it's producing right. So keep a look out for the performance of that well. Still the same size pipe, the 5.5-inch pipe down the well. So you can't get that many more barrels out faster and this leads to a plateau level and a little bit lower decline rate than if you have a shorter well. But in terms of the economics, the efficiencies, they are great. So -- but we'll see how we apply it. But we also -- you've seen in the slide deck, we tend to be the longest lateral well growing in a basin.

And seeing no further questions in queue. I'll turn the call back over to CEO, Herb Vogel. We do actually have a question that does came into the queue, that will come from Scott Hanold with RBC Capital Markets.

But you've had a lot of success in the Austin Chalk and obviously, more recently, continue to see very good results. And can you talk a little bit about those 400 locations you've identified is the success you've seen so far give you more confidence in those 400 wells? And do you think there could be potential to expand that given what you've seen so far?

Scott, yes, thanks for noting that. So we have quite a bit of confidence in the Austin Chalk, and I've talked about this before, where we had 600 penetrations of the Eagle Ford that went through the Austin Chalk, so we could map it extremely well. We got core then with the dilatation program, we spread over a large area. Now we're expanding that area, and we're also testing development in a number of locations. And there's been a tremendous amount of geoscience work and just what the mechanism of the high permeability is and where the land is and that we've improved upon quite a bit.

So the recent well results kind of just come in line with what we were expecting. And then we got, I think the first 1 we put online was in July of 2018. So we've got some performance history that makes us feel good. So the 400 well inventory estimate is a round number and assumes 11,000 foot lateral. If we choose to go shorter laterals, then the number might go up, if we go longer, then the number would go down.

And then we've talked about being very oily up to Northwest and then gas here in the South. So we'll do our normal thing in terms of the conversion in the proved reserves over time, under SEC guidelines, staying within the 5-year plan and going that route. So bottom line is just depends economics at the time, and we'll just watch that number as time goes on and how something is working. But the confidence level continues to improve as we get more well results.

I got it. So what I'm hearing here is you guys have seen -- expected some good results, those 400 locations, certainly underpinned by what you've seen. But I guess from our perspective, it should continue to give us more confidence to do risk that inventory over time, some upside. Okay. If I could just one more in. And I apologize for hitting on 2022, but certainly, there is some questions around the commentary on the path of potential production into next year. But I guess as a basic question, when you look at going forward, and it's not as much 2022, but it's even beyond that. I mean is your base view -- and I know it's about maximizing free cash flow, but as part of that, I would assume it's going to also include some level of at least maintaining production. And so it looks like 2022 sort of soft guide talks about -- and it feels like it's maintaining production throughout the year. Is that the right way to kind of think about it? I know you're maximizing free cash flow, but part of that has to be strategically having some sort of a maintenance level in production?

Yes, Scott. I mean, we truly do line out our plan based on the free cash flow generation targets and getting certain leverage targets, that's where we start from and then the production truly is an output. And just so happy that, that winds up being on an year-over-year single-digit production growth. And that can vary quarter-to-quarter on where that sits, just like it did in '21. And that's really how we to plan it out. So it isn't -- I don't anticipate a production decrease at all if we're meeting our free cash flow objective. And it's just a matter of how much it grows and that's year-over-year.

Yes, the key is it's a long-term plan. It's been together a long-term plan that generates a lot of free cash flow, not just 1 year. Obviously, if there's 1 year you could blow down and that would not achieve long-term objectives at all. this is long term. So it is flattish to single-digit production growth is what becomes the output because it's sustainable long term.

Yes. And I guess that's spot on to the point. And I guess the only nuance is with year-over-year comparison, obviously, the the shut-ins -- or I'm sorry, not the shut-ins, but obviously, the weather issues early this year had an impact on production. So year-over-year, arguably, if you're keeping flat from exit rate, should be up, is that a fair way to think about it?

We don't really look at exit rate, that's just too short a time period to worry about. And I think that whether that's a classic example, right? We have to shut-in and our power got cutoff, right? Not because we didn't pay our bills because of the lack of power. And so a lower production, but then we made up for in second quarter and third quarter and the rest of the year.

So 2021 will look quite lumpy, but we reached our overall objectives or we intend to reach our objectives over the entire year. And that's just the way you have to look at it. You can't pin down an exit rate for the last month of the year because it depends on timing of completions and they can find that on this side of the end of the year, and if they can wind up on the other side of the end of the year, just a matter of execution and when you get the wells actually hooked up and producing and how quickly the flowback happens. So you really got to look at a longer time period.

I think one point worth reminding everybody is that the long-term plan we put forth is a less than 75% reinvestment rate, which delivers continued low-digit growth in production. And if people are getting cut out by quarter, maybe it's not a straight line over 5 years, but it delivers annual...

Year-to-year.

Year-to-year growth in production at that investment rate, which, quite frankly, with higher commodity prices may be less.

I'd now like to turn the call over to CEO, Herb Vogel, for closing comments.

Okay. Well, thanks all for joining us and your in fact some questions. We'll then see you at EnerCom in mid August.

Thank you for participating on today's conference call. You may now disconnect.