Western Midstream Partners LP (WES) 2021 Q4 法說會逐字稿

Welcome to Western Midstream's fourth quarter post-earnings fireside chat with CEO, Michael Ure.

Michael, welcome. It looks like it was quite the eventful quarter, came out with quite a few items in the press release. Before we get started on the enhanced distribution and 2022 guidance, do you want to say a few words about 2021?

I do. Yes. Thank you, Kristen. 2021 was an excellent year for us, despite the challenges that we saw with Winter Storm Uri, COVID as a whole, as well as just the normal disruptions that happened in our business. We're really pleased with the performance that we were able to achieve.

We exceeded our guidance expectations on EBITDA. We came in below the high end of the guidance range on capital. We exited the year at 3.5x net debt to EBITDA, which was our target level for exiting 2022, and we increased our distribution annual rate of about 5%. So as a whole, we really hit on all cylinders as it relates to the targets that we had established for the year, very, very excited about how it is that we performed.

So during the fourth quarter, there was a $26 million unfavorable revenue recognition adjustment. Can you provide a little bit more detail on what that related to?

Sure. All that is, is that it is an accounting adjustment associated with specific cost of service-oriented contracts. What it essentially does is on an annual basis, you reassess the average revenues that should have been recognized over the contract period compared to the volumes that were received during that year. Once we reset the rates at the beginning of the year, you then look back and figure out whether or not that revenue that was recognized was in accordance with the rates that had been set in the previous period. This is a true-up that happens every year, it's noncash in nature and doesn't really reflect at all the incredible performance that the team was able to achieve.

Adjusted EBITDA for the quarter was approximately $481 million and free cash flow was right around $577 million. What led to the increase in free cash flow?

Yes. Free cash flow was higher than EBITDA, which is not something that you normally see in a business like ours, almost entirely attributable to a positive working capital change that we had during the quarter. So again, excluding the noncash item that we just discussed, the $26 million, you also had a positive working capital impact in the quarter, which drove the outperformance for -- from free cash flow relative to our expectations and for that matter, higher than EBITDA.

You also came out with 2022 guidance, adjusted EBITDA between $1.925 billion and $2.025 billion, total capital expenditure between $375 million and $475 million, free cash flow between $1.2 billion and $1.3 billion and full year 2022 distributions of at least $2 per unit. What would need to happen in the business to achieve the high end of 2022 EBITDA guidance?

The same dynamics that would push us to the high end or outside of that guidance range are the same items that were impactful as it relates to 2021, producer outperformance, lower cost than expectations. Within 2022, a little bit different, but our EMIs are expected to be a declining expectation relative to 2021. And so if those do outperform, that should have an impact on us. As well as commodity prices, while it's a small percentage of our contracts that are commodity-based in light of the meaningful and robust commodity price environment, that could have an impact on our performance for the year.

And what are your assumptions around basin activity?

We are very optimistic in our expectations as it relates to activity levels in the Delaware Basin, not only for 2022, but actually for 2023 and beyond. The DJ Basin, we expect to have more muted level of activity despite the great returns associated with that area, in part because of the permitting process, which just needs some time to be able to work through and to perfect the ability to achieve permits to enable sustained drilling in the area. So we do expect overall increased volume levels in 2022 compared to 2021. So very positive from that perspective. And also, we are expecting that activity level to increase as we get into 2023.

And on the CapEx guidance, it looks like there is an increase year-over-year. Is your 2022 CapEx guidance should be read through to what 2023 activities level should be looking like?

It's not a direct read through. There are a couple of items that I would note on that. First, our 2022 capital guidance is inclusive of a little bit of capital that we were expecting to spend in 2021 but actually got spent into 2022. We also do have some corporate projects, about $44 million associated with some system work that we are doing. And those items, I wouldn't expect to be repetitive as we go into future periods.

So if you exclude those items, I think it's a pretty reflective expectation as it relates to capital, assuming activity levels for future periods are what we are currently projecting for 2023. So if 2024 looks like 2023, you exclude those couple of items that I just mentioned, I think that's a pretty accurate guide as it relates to what we might expect in those environments in those years.

So looking at the growth in the Delaware, what are your thoughts on additional processing CapEx? Do you expect to need to add a new train or a new plant?

We don't have expectations -- near-term expectations to need additional processing capacity for us. As we've stated a couple of times, we think it's more capital efficient for us to try and utilize the excess capacity that might exist in the basin as a whole. And the way that we do that is through offload arrangements that our commercial team executes. For us, that is a much more capital-efficient way to be able to handle volumes that may be in excess of what our processing capacity might be.

And so for us, that is the process that we're working under. And we don't have any near-term expectation as to whether or not new processing capacity would be necessary. If it is necessary, the way that we look at those offloads is that they provide a bridge, such that we would be able to continue to take those volumes until such time as that new capacity comes online. But again, that's not an expectation that we have near term as we sit here today.

Also talking about costs, both on the EBITDA side and the CapEx side, are you seeing any inflationary pressures right now?

We do see some inflationary pressure on the labor side as well as on the material side, chemicals and some of our steel and poly pipe. We have seen increases relative to 2021, those are embedded in our forecast that we have today. And so we are seeing some inflationary pressure there.

There are some protections that exist within our contracts. Cost of service is a pretty direct protection associated with inflation. Our minimum volume commitment and fixed fee contracts do have escalators. A lot of them have caps associated with it, but they do have escalators that do protect us to some extent as it relates to those pressures that we're seeing.

All right. And now turning towards the enhanced distribution framework. Can you give us just a general overview of that framework? What are WES' intentions in the next few years? And really, just the thought process behind how you got to this framework.

Yes, sure. So there were a lot of elements that went into it. First, we found ourselves in a much better position from a financial stand than we were expecting to be at this stage. Again, we -- I mentioned earlier about our leverage target of 3.5x net debt to EBITDA exiting 2021. That put us in a better position to be able to enhance the opportunities for capital allocation across our 3 different pillars.

We took a look at taking a balanced approach, so first, we've got $715 million of debt reduction expected in 2022 and 2023. The increase in distribution is roughly $250 million. And then we've authorized a $1 billion unit repurchase program, which will be used opportunistically going forward. The enhanced distribution provides a mechanism, wherein we're trying to make sure that we can sustain that base distribution going forward. We set it at a level that we believe is sustainable today and in order to put some guardrails around it, the enhanced distribution is based upon leverage targets that we expect over the next 3 years, 3.4x net debt to EBITDA in '22, 3.2x in '23, and 3.0x in '24 and beyond.

And so for us, we wanted to make sure it was sustainable. It offered an opportunity for our unitholders to be able to get an excess distribution, in the event that we can't find a better use for that capital on an annual period and then put some guardrails around being able to make that sustainable. It is reflective -- the growth of it will be reflective of the actual business as opposed to just an arbitrary growth number that may or may not, in fact, be reflective of the performance of the company going forward.

The base distribution growth of 53%, how did you guys come to that percentage increase?

Yes. So it was, again, based off of trying to have a balanced approach to capital allocation, also providing a level with which we believe was sustainable. So if you look at our free cash flow guidance for the year of $1.25 billion, on an annual basis, that distribution is just in excess of $800 million. So it still gives us $450 million a year free cash flow after distribution at the midpoint that we could utilize for either additional unit repurchases or debt buyback going forward.

So we tried to set it at a level that was very sustainable. We tried to set it at a level that provided opportunities to distribute capital out to our debt holders and unitholders through other methods and then still allow us to delever over time, as illustrated by the thresholds that we've set from a leverage standpoint.

Do you expect to grow the $2 base distribution?

We don't have any expectation today to grow the distribution -- the base distribution. Again, that growth will actually come in the form of free cash flow after distributions and uses of capital. And so in as much as our free cash flow generation of the company grows, then that base distribution opportunity also grows as well.

And the reason for that is that, again, it's just much more reflective of the performance of the company as opposed to just setting an arbitrary rate that may not necessarily be reflective of the performance of the business.

How does M&A activity impact the refined financial policy and enhanced distribution structure?

Yes. It doesn't actually change our thoughts around it at all or flexibility around M&A at all. The -- any M&A would actually be outside of that framework related to free cash flow, other than the financing structure wherein that M&A would come into play and whatever free cash flow generation would be coming from that acquisition after the period at which it is closed.

So for example, if we were going to buy a company, say it's $100 million, then that $100 million, if it's financed entirely by debt for example, would go into our leverage metric, then we would take the free cash flow of that business from the period which it was closed for the end of the year and then include that in the free cash flow calculation for purposes of the enhanced distribution. But it would be outside of any free cash flow calculation, the $100 million would be outside of any free cash flow calculation that would go into the enhanced distribution amount for that year.

So we think it provides excellent opportunity for us to be able to go out and handle M&A. It also gives us a little bit of a guidance as it relates to how we should finance that M&A, such that it can continue to put us in a good place to be able to offer up an enhanced distribution going forward, in accordance with the leverage metrics that we've set.

Flipping to the $1 billion unit repurchase program, how do you plan to utilize that program?

We plan to utilize it in the same way that we utilized the $250 million program during 2021.

Looking at the 2022 free cash flow, just based off of the guidance that you issued, as well as the distribution growth and the debt maturity coming due this year, does it leave a lot of room for buybacks? Do you expect do buybacks in 2022?

It actually leaves a lot more room than I think many people may understand and for -- and that's for a couple of different factors. First, we came into the year with a couple of hundred million dollars of cash on the balance sheet. Second, as it relates to 2022, the aggregate distribution amount for the year is inclusive of the lower level for the first quarter distribution. And then finally, we do not feel, in any way, beholden to leverage levels as it relates to opportunistically employing the buyback during any one period of time.

So for example, if during 2022, we decided that we wanted to buy back $300 million worth of units, that would likely entail that we wouldn't have an enhanced distribution for the period. But we could still do those $300 million worth of purchases, even if it were to take on a little bit of debt during the year, then the subsequent year, that payoff of debt would reduce the potential enhanced distribution preferred purposes of that specific calculation. So as it relates to the buyback, we have really, as much flexibility as we feel is prudent to be able to employ it on an opportunistic basis in light of those factors.

Terrific. Well, thank you for the time today. Any closing remarks?

Really excited as it relates to the future. Again, a lot of confidence as it relates to activity levels in our business for 2022 and 2023 and beyond. Really excited about the new framework that will provide clarity in certain -- and establish a framework, wherein our investors can take a look at ways and manners in which we intend to return capital to them. So we expect and hope that, that clarity will prove to be a really positive differentiator as it relates to our structure, relative to many of our peers. So really excited. Overall, a great year. Really excited about the future going forward.

Thanks, Michael, and thanks for joining us today. If you have any additional questions, please feel free to reach out to us. Our contact information is on the investor page at westernmidstream.com. Thank you.