Q4 2021 SM Energy Co Earnings Call - Q&A Session

Forward looking statements that could cause actual results to differ we will also refer to non-GAAP measures.

Please see slide 30 through 33 in the accompanying slide deck and pages, 15% to 23 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 also look for our 2021 10-K filed this morning.

With that I will turn it over to her for brief opening commentary.

Thanks, Jennifer.

First off I want to acknowledge the gravity of current events. Our prayers go out to the people of Ukraine oil and gas are central and geopolitics and SM energy is positioned to maintain a sustainable long term plan under a range of macroeconomic scenarios, while recognizing the importance of providing reliable affordable energy.

Second I would like to add some color regarding the oil production component of our guidance.

Importantly, I will reiterate something we say every quarter production and the components of oil Ngls and gas our output of our three year plan to optimize free cash flow.

Our 2022 plant is expected to roughly doubled free cash flow over 2021, delivering a highly attractive free cash flow yield.

Two things are going on at the same time in the 2022 plan that impact our oil rates.

One the increased allocation of capital to South, Texas, 45% versus 35% of Capex last year.

The production mix to more natural gas and Ngls and in 2021.

And two we had unique quarterly phasing of Midland completions last year and this year, which was the result of the Texas freeze in the first quarter of last year.

Some key points to keep in mind, we completed a total of 64 net wells in Midland in the second and third quarters last year. The subsequent two quarters, we complete nine wells in the Midland Basin the.

The first year decline rate on new wells was approximately 75% to 80%.

So we'll simply have a decline in Midland production in the first half of 2022.

New Austin Chalk wells will on average have a projected mix of 42% oil, 30% Ngls and 28% gas.

The increased capital allocation to South, Texas, therefore contributes to higher gas and NGL changing the mix at the company level.

In addition, our repeat waves comment from yesterday that our 2022 capital spend includes a good portion of the capital for 20 wells in the Midland Basin that will not turn in line until early 2023. So again, it's timing that will affect the oil percent in 2022.

As we have demonstrated with actual well performance the returns in our Austin chalk compete with the Midland Basin as shown in the deck are 2021, Austin chalk wells are expected to have an average nine month payout per well <unk>.

Development of the Austin chalk is a sizeable opportunity to build NAV and realize that value creation for shareholders.

Again free cash flow is expected to roughly double year over year, because we have a highly efficient high return operating plan, where production is an output.

Thank you and I will turn it back to the operator to take our first question Ted.

Ladies and gentlemen, if you would like to ask a question you can press star one on your telephone keypad.

And your first question comes from the line of Gabe Daoud with Cowen.

Thanks, Good morning, everyone.

We're just hoping we can we can maybe.

Just to get a little bit more on the guide I. Appreciate all the remarks last night in your comments just now but just also just trying to get a sense of what's baked in from a conservatism standpoint, whether it's PDP downtime for offset fracs or.

Just kind of how you handicap weather events or just trying to get a sense.

Because that plus just given.

The improved the Austin Chalk program, obviously, Midland wells getting better I would have thought even with the increase in.

Austin chalk capital allocation that the oil volumes would've would've been a little bit better to what you had guided to so could you maybe just give us a little bit of comfort around how much if at all.

Conservatism is baked in the guide.

Yes.

So we just basically assume normal events normal performance, we don't really do anything where we steer something in one direction conservative or aggressive in any way.

It's what our well performance is expected to be and then if we have outperformance like new completion designs.

We've been very fortunate with those Midland Basin wells.

How well they've performed with normal weather and then we do assume a certain number of offset fracs from offset operators, where we have to shut in and sometimes theres more sometimes there is less in those can influence. So in the fourth quarter, there were less offset fracs from offset operators.

And that helped US we also had really good weather in the Midland Basin. So those are really the key thing, but we don't do anything in terms of trying to be conservative we're trying to be aggressive.

Okay. Thanks Thats helpful.

Then.

Regardless of what the production output is as you mentioned it is just an output of your capital allocation framework. There is still a lot of free cash flow coming so could you maybe just talk about.

Once you get to your leverage targets, whether it's the onetime net debt to EBITDA figure, which we think you kind of get there next quarter could you maybe.

Just talk about steps or use of free cash flow. Once you get there any thoughts around capital return to equity holders.

Well Gabe I'll start on this one and then I'll hand, it over to Wade, but I would just say, we're just really pleased with how fast we've got to this point, we are way beyond our expectations, we've got a tailwind with commodity prices, but just the performance of both the chalk and Midland Basin has really enabled us to be at this point.

Faster than we ever expected and we are obviously thinking about what are what are the best means for return of capital to shareholders over time and ill turn it over to way to just give some thinking about it from our perspective.

Sure. Yes, good question and I will just kind of reiterate a few guideposts that we laid out I think last quarter for the first time it didn't actually mentioned it again on the.

On the call yesterday.

As Howard mentioned, we arent getting there quicker which is very exciting.

I think we mentioned that Delevering is really really important to us and we're pleased how that's going we.

We want to get down to one times, but we also look at absolute debt is very important as well. So we said, we said one and when basically you get down to one times and $1 billion.

Absolute debt. So as you mentioned the one times, assuming the macro engineers coming pretty quick.

Sometime around the middle of this year.

<unk> and the $1 billion I think I mentioned.

Looking at our forecast just assuming.

The prices that we assumed.

We are somewhat conservative compared to today's strip, but it looks like something towards the end of this year or maybe early next year or so so it is on the horizon.

We'll start as we get close to that we will start considering what the right options are and that certainly includes meaningful dividend or potentially buyback program people led to ask which one of those.

I think it's I think it's too early to declare which one of those we think would be the appropriate one I think stock valuation is a big factor in that compared to <unk> at the time so.

So that would be a factor when we start contemplating those decisions.

Just just just two.

Add color to that if we were if we were considering it today I would I think it would be shouldn't shock anybody.

To assume we might be leaning towards buyback given our view of the stock valuation versus AAV, but that's the theoretical answer today.

It'll be a more prudent answer when we get closer to reality.

Thanks, Mike.

Great color and just before I go so just to confirm Theres no difference in the way.

You issued or prepared 'twenty, two guidance versus versus years past right.

Good.

Same consistent approach.

Awesome. Thanks, guys.

Yes.

And your next question comes from William Howell with Stifel.

Hey, good morning, guys and congrats on the quarter. My first question is on inflation in the prepared remarks, you mentioned that you have about 15% inflation baked into Wildcards I'm wondering if you could talk a little bit more about where you're seeing that and how much efficiency gains are factored into that.

Yes.

Okay. Thanks, William Yes, definitely the topic of the year inflation so.

You've seen that activity did ramp up to some degree last year and.

<unk>.

What when we look at the supply chain, we are well positioned in terms of having availability of everything we need definitely through the first half.

Most everything is locked in for us So we know what those.

Cost increases are over last year, and we baked in that 15% the areas, where we're seeing inflation obviously.

Like diesel.

Clearly with oil prices up diesel prices are up steel prices are up.

Labor trucking those sorts of things not as much on the drilling rig side or on the completion spread side. If you run a continuous program and lock in the contracts but.

Overall, we don't know what the geopolitical events recently are going to do the supply chain.

So that's an unknown, but we did bake in 15%.

Which seemed reasonable based on what we're seeing right at year end.

Okay got it thank you and my other question is on.

The decision to allocate about half almost half of the capital the south tax Dave could you talk a little bit more about that kind of long term economics that you see there and how that stacks up against the Midland Basin.

Yes, so thats what were really are pleased.

Pleased about so we've shown over time now we have 40, Austin chalk wells producing and based on the results that we're seeing in the commodity price environment, we have.

And last year started this year that they are comparable returns and we saw big potential.

In addition from getting recognition for the Austin chalk. So we've allocated 10% more of the capital to the chop and we had last year. So we went from $65 35 to $55 45.

To accelerate that recognition of the chalk and the returns are very comparable between the two.

Commodity mix is somewhat different but the returns are the same.

Okay. Thanks.

Your next question comes from Zach <unk> with JP with J P. Morgan.

Yeah.

Thanks for taking my question.

Just a follow up on the oil guide.

Maybe could you talk a little bit about your base decline rate for oil as of year end really just trying to reconcile that the <unk> got.

At the midpoint implies 18% sequential decline in oil during a quarter when youre still going to turned in line I think around 15 wells.

Okay.

I think I heard your question there.

So we showed in the slide deck that year over year, our base decline on a BOE basis was 38%, but the key here is that in the second and third quarter last year in the Midland Basin, we turned on 64 wells.

In the fourth quarter, we've turned on for in the first quarter return on five.

So those wells that started up in Q2, and Q3, 75% to 80% annual decline like normal unconventional so youll see a relatively rapid decline while the base is at a certain decline like 38% those new wells or more rapid decline and since we don't have a ratable program.

Because of that <unk> event last year, that's why you're seeing this dip in the first half of 2022, and then Youll see it come back around.

It's really really the quarterly phasing of oily Midland wells versus the gas year, NGL rich Austin chalk wells.

Got it okay. Thanks for that color.

I guess one just following up on Dave's question on cash return you get the one turn of leverage and $1 billion debt target out there for the balance sheet.

Do you want to reach both of those before considering cash return or would you consider some level of cash return while also reducing leverage.

Once you've hit one of the targets.

Yes good.

Good question I would say generally speaking we want to reach both we put them both out there as a target.

It doesn't mean once we reach one and start approaching the second one we wouldn't start considering something.

Meantime, I guess is the way I would say that.

Got it.

That's helpful. Thanks, a lot.

Yes.

And your name and if you'd like to ask a question. Please press star one on your telephone keypad.

Your next question comes from Karl Blunden with Goldman Sachs.

Hi, good morning, Thanks for the time.

Didn't hear a lot of discussion about M&A, but with the balance sheet in a better position.

When does that come into consideration if at all.

Yes, Karl Thanks, Thanks for the question. So the M&A, we've been pretty consistent over time, and we really don't see any need for a change in our position there. So first of all.

<unk> two looking at somebody approached us and we are open to considering an acquisition that makes sense and when we say makes sense. What are we talking about really have to have really high quality assets with high returns that we have in our portfolio. We don't want to diminish the portfolio or where you wouldn't be able to drill the acquired acreage for several.

Years out because the returns aren't there second.

Have to be comparable from a leverage standpoint, so not.

Basically levering its up significantly and then from a from a earnings standpoint cash flow standpoint, it should be accretive. So those are really our criteria asset quality.

Not impeding us from a leverage standpoint, and then helping us out on a cash flow standpoint, but we are open.

Makes sense.

You've outlined and reiterated this plan for about $1 billion of debt reduction which is encouraging.

When you think about the different parts to get that you have a couple of different opportunities you have some bonds due in 2025 and 2026.

Some of the 25 bonds of higher coal prices, how do you go about prioritizing taking out high coupons, such as paying high coal prices just interested in how you do those NPV calix internally.

Sure.

Great question, and you kind of outlined a summary of it we just we'll just kind of walk forward as we as we move through the year generating free cash.

And take out the.

The notes that make the most sense from a math standpoint, but that also.

Obviously I have mentioned in the past the second lien notes, we haven't we have a high desire to get those out of the capital structure.

So they become callable in about.

About four months.

So those are a target.

We'll run math on that as we as we get closer and into.

25% unsecured notes as we approach mid year callable at 120.

Get out of Henry <unk>, nine I think when we get to the middle of the year and.

And then moving on into this 26 is by the time you get those paid off in Europe towards the end of the year.

102, so the math is.

I think it's always going to be compelling and we always we're always going to have compelling options with the cash to get that down to the to the level, we desire to get to hopefully that helps yeah. That's helpful. Thanks very much for the time.

Yes.

Your next question comes from Nicholas Pope with Seaport Research.

Good morning, everyone.

Good morning, good morning.

I was hoping you could.

Talk a little bit about.

Austin chalk performance down in South, Texas and.

Maybe.

Really understanding how how consistent the results have been it feels like that's been a knock on the formation across Texas and Louisiana in the past as kind of consistency and repeatability of performance and I guess, maybe what's changed there and how has the performance kind of what's that spread look like as you kind of have a much bigger.

<unk>.

I'll put a wealth.

Yes, Nicholas Thats, a great question and I'll give you kind of a long answer to that.

First of all just starting with the consistency of the Austin chalk across our entire position, we had 600 wells drilled to the Eagle Ford through the Austin chalk. So we can map it extremely well.

Then we have core.

And we also have done an enormous amount of science data and we're going to get more science data, we have not yet optimized the completion, but when you look at our results you have to consider two big factors. One is there is variation in the fluid quantities, but from the northwest spoiler.

And it gets progressively gas here in NGL rich as you move east and south as it gets deeper and higher pressure.

So the variability there is going to be fluid type variability and that's very predictable.

Other is the lateral lengths will Barry and then what we really look at it per thousand lateral feet performance and there. It's much narrower P. 10, 90, then you would have seen from the Austin chalk, but I would have been developing in east Texas.

In the late eighties.

So a lot of people say, well Austin chalk knock it's not predictable well here it is actually quite predictable.

The properties are quite <unk>.

Uniform compared to the days of old which were more a fracture system that was unloading for the wells here, it's much more consistent.

I hope that helps.

That's great actually I mean, you guys have kind of outperformed.

My model for four quarters in a row. So just trying to get a little understanding of how repeatable that is so I. Appreciate the time Thats all I had thanks.

Thanks.

We have no further questions in queue at this time I would now like to turn the conference back over to Herb Vogel, President and CEO for closing remarks.

Okay. Thank you Deb and thank you all for joining us.

Best wishes for the rest of the year.

Okay.

And ladies and gentlemen, this does conclude today's conference call. Thank you for your participation you may now disconnect your lines.

Yes.