Q3 2023 Kodiak Gas Services Inc Earnings Call
Greetings and welcome to the Kodiak gas services.
Third quarter 2023 conference call.
At this time all participants are in a listen only mode.
A brief question and answer session will follow the formal presentation.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
As a reminder, this conference is being recorded.
It's now my pleasure to introduce your host Graham Psalms, Vice President of Investor Relations. Thank you you may begin.
Good morning, we appreciate you joining us for the Kodiak gas services conference call and webcast.
Third quarter 'twenty for me three results.
The savings in the company today are making the key president and Chief Executive Officer, and John Griggs, Chief Financial Officer.
Following my remarks, Mickey and John will provide a high level commentary on the company are market third quarter financial results and our updated 2023 outlook before opening the call for Q&A.
Before I turn the call over to Mickey I have a few housekeeping items to cover.
There'll be a replay of today's call available via webcast and also by phone until November 16 2023.
Information on how to access the replay can be found on the investors tab of our website at Kodiak gas Dot com.
Please note that information reported on this call speaks only as of today November nine 2023.
Therefore, you're advised that such information may no longer be accurate at the time of any replay or transcript reading.
In addition, the comments made by management. During this conference call may contain forward looking statements within the meaning of the United States Federal Securities laws.
Forward looking statements reflect the current views beliefs and assumptions of Kodiak management based on information currently available.
Although we believe the expectations referenced in these forward looking statements are reasonable various risks uncertainties and contingencies could cause the company's actual results performance or achievements to differ materially from those expressed in the statements made by management.
So it can give no assurance that such statements are expectations will prove to be correct.
Listeners are encouraged to read Kodiak prospectus and quarterly report on Form 10-Q available on our website or at SEC Gov to understand those risks uncertainties and contingencies.
The comments today will also include certain non-GAAP financial measures additional details and reconciliations to the most comparable GAAP measures are included in the quarterly press release, which can be found on our website.
And now I'd like to turn the call over to Kodak's CEO, Mr. Mickey Mickey Mickey.
Thanks, Graham and thank you all for joining us today.
I'll start by discussing our recently announced inaugural dividend payment to our shareholders and I will share some highlights from the third quarter and ultimately provide some commentary on the industry and our company.
We haven't finished John will provide additional financial details from the third quarter and discuss some updates to our 2023.
We are excited to have announced our first quarterly dividend on October 24.
Our board has declared a dividend of 38 cents per share for the third quarter of 2023 or $1 52 per share on an annualized basis.
The stable positive cash flow provided by our resilient business model supports returning capital to shareholders through a well covered dividend.
We believe that with the initiation of our dividend Kodiak represents one of the most compelling yields in midstream energy today.
It is an important part of our capital allocation strategy. It also involves reinvesting a portion of our cash flows to grow our fleet given the attractive returns we see in the current market environment.
To be clear, we intend to generate positive free cash flow after growth capital and dividends are funded while driving towards our long term leverage target of three to three and a half times.
Now turning to yesterday's earnings release.
We're very pleased with our third quarter results, which reflect the continued execution of our strategy focused on deploying large horsepower compression infrastructure assets and high quality basins with the best customers.
The compression market remains tight as many of our competitors are near full utilization of their deployable assets and we are well positioned as the compression provider of choice for our customers.
To touch on a few highlights from the third quarter, we maintained our industry, leading utilization rate ending the third quarter at 99, 9% utilization.
We have maintained this high utilization rate for years and now this has allowed us to deliver record revenues of $186 7 million from compression operations and consolidated adjusted EBITDA of $110 million for the third quarter.
Both are the highest figures on record in Kodiak history.
As we have discussed many times, our methodical and intentional deployment strategy of our equipment and contracts generate at least visible steady cash flows that create a very compelling infrastructure investment opportunities.
As we look forward to the fourth quarter and next year, our new unit deliveries are completely contracted and are exclusively large horsepower units.
As I mentioned on our last call. We know the cost of the equipment the customer it will be deployed with and the contract rate.
And because equipment lead times remain extended in about a year, we're already in discussions with our customers related to new equipment orders and customer contracts into 2020.
We're also pleased to be in a position to update some of our previously disclosed guidance ranges for the full year 2023.
We are raising the low end of our guidance and now anticipate record adjusted EBITDA of $430 million to $440 million.
John will cover a few other guidance updates.
I provided a detailed background on Kodiak on our second quarter call for those of you not familiar with our story I won't rehash that in coal, but I do want to cover a few things that differentiate kodiak.
Yeah.
Our purpose built fleet of over $3 2 million horsepower are predominantly large horsepower compression equipment is the youngest most emissions friendly fleet in the sector.
Specifically engineered and built to operate in rich gas environments like the Permian basin, where over 70% of our horsepower is deployed.
We have seen additional consolidation in the Permian basin from our customer base this quarter.
This dynamic is ultimately, creating more contiguous acreage positions and allowing for longer drilled well laterals and ultimately <unk>.
Larger infrastructure buildout, creating more demand for services of a company like Kodiak specializing in large horsepower.
We use this consolidation in the industry as a positive as our customer base continues to trim costly overhead and drive down the ongoing cash production costs.
At Kodiak, we strive to deliver the highest level of service and mechanical availability in the industry.
Also contributing to the superior utilization of our fleet.
We charge a fixed monthly revenue rate for our services and ended the third quarter with less than 7% of our horsepower on month to month contracts.
These factors combined to help insulate our business from short term commodity price cycles.
Natural gas prices have ticked above $3 recently, but remain low by historical standards. However, our customers, which operates primarily in liquids rich oil directed basins continue to exhibit strong demand for compression services.
We continue to be excited about the tremendous amount of LNG export capacity being constructed on the U S Gulf coast, and the resulting growth in natural gas production that's needed to provide gas to these plants.
First data indicates that Theres, almost 14 Bcf per day of LNG liquefaction capacity under construction on the Gulf Coast today, its about 15 Bcf per day of approved projects behind that.
Our view remains that the incremental gas will largely come from the Permian and Eagle Ford basins, and we are well positioned as the leader in those basins to capitalize on this growth.
As every incremental cubic foot of gas produced out of these basins will need to be compressed multiple times over.
Additionally.
Our industry as a whole has shown tremendous capital discipline, while new unit deliveries have extended out over a year with the lack of idle horsepower available to be deployed this means that the supply side of our industry will remain very tight with little relief in sight.
So to quickly recap.
We are pleased with our third quarter results and continue to believe in a supportive energy market with a multi decade runway for conventional energy and particularly large horsepower compression to feed the growing LNG export base on the Gulf coast, providing clean secure supplies of natural gas to the world.
Our strategy is to continue to provide compression services safely and sustainably in the best basins with the best customers, while providing investors with an attractive return on their investment through steady growth and cash flows and a compelling dividend.
Now I'll hand, the call over to John to discuss our financial results for the quarter and 2023 outlook at all.
Come back with some closing comments before we move into Q&A.
John Thanks.
Thanks, Nicky as Micky emphasize it's a wonderful time to be in the contract compression business did even better time to be at Kodiak.
Here's some of the results from the quarter.
Total revenues for the third quarter were approximately $231 million up about 14% sequentially and 27% compared to the third quarter of last year adjusted EBITDA for the quarter was $110 million up over 2 million or 2% from Q2 and up over 8% versus the same quarter of last year.
Both metrics exceeded our expectations.
And since you'll see it in our 10-Q later today I'll mention it now adjusted EBITDA for the quarter included an approximate 2 million dollar allowance for doubtful accounts related to particular compression customer in the midst of a restructuring.
Excluding the impact of that reserve adjusted EBITDA for the quarter would have been about 112 million.
Looking at our segments compression operations revenues were nearly $187 million up about 14% year over year.
Revenue generating horsepower grew by about 112000 on a year over year basis.
System with last quarter revenue growth in this segment was a function of growth in revenue generating horsepower combined with higher overall fleet pricing.
In our other services segment 2023 third quarter revenues were up substantially compared to both last year's third quarter as well as the prior quarter.
This was driven mostly by quality execution faster than expected progress on some project completion schedules and particular on one relatively large job.
From an adjusted gross margin perspective, our compression operation segment generated just shy of a 65% margin up 70 basis points compared to the second quarter.
Our operations team continues to focus on containing costs that are within our control. We continue to chip away at some of the margin compression we experienced in the last couple of years from acute inflationary pressures.
On a dollar basis adjusted gross margin and our other services segment was about $5 5 million up nicely from the prior quarter.
Adjusted gross margin percentage basis, the margin came in at 12, 4%.
As we've discussed each project is different and our third quarter margin percentage reflects a couple of larger projects. They carry lower than normal margins. As a reminder, while the segment has a lower margin profile than our core compression operation segment station construction projects are synergistic with our compression business.
And they require no capital.
Every dollar of incremental cash flow edge to both our overall return on capital employed and discretionary cash flow, which in turn allows us to pay more dividends and invest in high return growth projects.
So long as we manage our contractual and operating risks and project related working capital carefully. This work is beneficial to Kodiak and our investors.
In terms of Capex for the quarter, our maintenance Capex was about $12 3 million.
Higher than the prior quarter.
Capex was 56 million for the quarter and $3 5 million of that amount was non new unit Capex. We've mentioned in the past the growth Capex in 2023 would be backend loaded.
So you saw that in Q3, and you'll see it again in Q4.
Moving to the balance sheet.
So as a quick reminder, we received the proceeds from our IPO on July 3rd.
Simultaneously completed the Paydown and novation of the term loan we described in our S. One.
That reduced our debt by $1 billion at the end of Q3, we had debt of $1 seven 8 billion consisting entirely of borrowings on our $2 2 billion dollar asset based loan.
Our credit agreement leverage was 4.07 times, and we had about $396 million in borrowing capacity at quarter end.
With our IPO and associated deleveraging complete we think we're well on our way to achieving our long term leverage target of three to three and a half times during 2025.
We continue to benefit from our interest rate swaps on a little less than 70% of our debt at fixed.
Our interest rate well below prevailing floating rates.
Now, let's move to our updated 2023 outlook.
Given the clarity that we received from our third quarter results and our expectations for Q4.
We included updated full year 'twenty three guidance in our earnings release yesterday.
For the year, we estimate adjusted EBITDA will range between $430 million to $440 million.
In our core compression operation segment, we're sticking with our prior revenue and margin guidance bottom line, given the constructive market dynamics alongside our crisp execution, we're highly confident in our segment outlook. When we're laser focused on growing long term high quality cash flows.
In our other services segment, we now forecast full year revenue of $95 million to $115 million and segment margins of 15% to 17%.
We're providing a pretty wide range to account for some of the things that we can't control, but can have an impact on outcomes, particularly in the fourth quarter things like weather events customer budget exhaustion and customer of subcontract or holiday season work schedules.
Have smooth sailing on those items.
We'll likely be at the high end of our range on both revenues and margins.
We're not giving official guidance for 2024 until we deliver our full year 2023 results. We do think this year is an outlier to the high side in terms of station construction projects and revenues.
For adjusted SG&A, we're leaving the guidance as is but we noted in our release that we're not including the 2 million dollar allowance for uncollectible accounts that we took this quarter since that was an isolated noncash event, we wanted to keep the guidance focused on normalized expenses.
Turning to Capex.
For the year, we now see maintenance capex coming in between 34 and $38 million.
Our maintenance Capex spend is largely predicated on the age and hours of our units. So the slight move up in guidance is related to the timing of when our team tackles, the scheduled overhauls.
We're working to get a few more things done this year in that area than we previously anticipated.
On the growth side of Capex, we're leaving our prior guidance alone.
<unk> in the forecast is about 15 million in non new unit related capex, which at the midpoint of our updated guidance would suggest that we'll be adding just shy of 140000, new horsepower during the year.
Last thing on Capex recently, our landlord on a few of our more significant operations facilities approached us with a compelling package deal did you buy them out of the properties.
Got a few moving parts, but assuming everything comes together as planned we would incur an incremental $10 million in real estate related capex during the fourth quarter.
Not included that in our updated guidance, which should it occur you'll still be free cash flow positive for the year.
We believe the deal is compelling we were faced with imminent and disrupted news in the near future to accommodate our substantial plane growth.
So this opportunistic purchase allows us to control our own destiny in terms of facility and expansion in our most important growth regions and enables our operations leaders to stay focused on taking care of business.
To wrap things up as Micky noted our board declared an inaugural dividend payment of 38 cents per share and we will pay that tomorrow.
This equates to an annualized dividend of $1 52 per share yielding nearly 9% of recent price range.
Our capital allocation framework.
A crucial aspect of the K G. S investment thesis measured growth alongside attractive return of and return on capital while living within cash flow and deleveraging.
That's it for my prepared comments. Thanks again for your participation support I'll turn it back over to Mickey.
Thanks, John.
In summary, we've built a market leader in contract compression infrastructure with a focus on large horsepower compression and its critical role in the energy value chain.
We've concentrated our purpose built fleet in the most economic cost advantaged basis with the best customers under long term fixed revenue contracts that are resilient to short term commodity price cycles, and we built kodiak with a commitment to sustainability.
We're very pleased with our third quarter results, our initiation of a meaningful dividend and we look forward to continued profitable growth in 2023 and beyond.
I'd like to close the call by thanking the extraordinary women and men of Kodiak gas services their hard work and dedication to safety and our customers are what makes Kodiak special and we wouldn't be an industry leader without their commitment to excellence.
At this point, we'll open up the line for questions operator.
Thank you Lady.
Ladies and gentlemen, I will now conduct a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad.
Confirmation tone will indicate that your line is in the question queue.
You May press the Star key followed by then number two if you'd like to remove your question from the queue for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys, one moment, please while we poll for questions.
Yeah.
Yeah.
Sure.
Our first question comes from Jeremy Tonet with J P. Morgan. Please state your question.
Hi, good morning.
Hey, good morning, Jeremy.
Right.
Just wanted to start off if I could.
With capital allocation, maybe expanding a bit more I realize it's probably more to come on this topic, but.
And so far as it is a market with a lot of growth for our you know compression needs. There you know do you have the healthy dividend yield as it is yeah. It seems like the market's not necessarily giving as much credit as it could for.
For this yield and so when you think about.
For their growth.
Growth capex in the future or if you think about raising the dividend or even possibly buying back stock just wondering at this juncture any high level thoughts you could provide with how you view these different options.
Yeah. Jeremy This is Mickey I think all of those things are possibilities going forward and things that we will be discussing with our board and more of a over the next couple of quarters, but.
I think right now we're focused on executing.
Executing the business and making sure that that we have a good yield.
Returning capital to shareholders and increasing distribute discretionary cash flow. So that we can continue to grow growth capex and dividend over a long period of time.
Got it that makes sense, there and then kind of pivoting towards the compression market as a whole you know very tight market, we've heard about it across the industry how tight it is and the needs. There just wondering if you could expand a bit more on how you're dealing with supply chain challenges out there servicing your customers.
During large equipment fulfilling these orders here.
Given you know.
Some of the disruptions and tightness as we see out there just wondering if you could talk a bit more about that.
Yeah, I mean, it's an ongoing.
Management that we have to do with with not only our customers, but with our suppliers as well to make sure that that a are our customers are planning out well in advance to secure equipment.
At this point with the.
Caterpillar engine deliveries out a longer than a year. It's it's a it's a challenge, but it's something that we work on group pretty much daily with our customers and making sure that they're in the right position.
As well as with our suppliers and making sure that that's deliveries and the ability for them to produce equipment for us to make sure that it's it's ready when they say, it's going to be ready as something.
It's non going supply chain management process that we do every day to seller.
We are out into you know discussing Q1 'twenty 'twenty five.
Potential equipment needs for with our customers right now in la.
Looking at a very productive and fully subscribed kind of 'twenty 'twenty four you already so it's.
It's it's it's a challenge that we deal with on a daily basis, but it's something that we're used to managing in and been doing this a long time so.
We know how to handle it.
Got it makes sense. Thank you for that.
Yeah. Thank you Jeremy.
And our next question comes from Theresa Chen with Barclays. Please state your question.
Yeah.
Good morning, Thank you for taking my question first.
First I'd like to touch on the comments about 2020 for understanding that youre, not giving guidance today, but on that you know fully subscribes on asset level trajectory can we.
Get some color on the puts and takes on the risk to the upside and downside from here as to how you see both pricing and margins evolving and when I look at your 2023 and even some of the base IPO materials like that I'm constantly part here.
Yeah, Jerry says good morning, and thanks for the question.
You know, we we again going back to what we discussed a minute ago with Jeremy we've worked with these suppliers for a long long long period of time, and we know really what's coming down the pipeline from them from the standpoint of price increases.
And when it's going to happen from our suppliers and so you know we're able to plan a plan that out ahead of time and make sure that you know as <unk>.
We price our equipment into 'twenty 'twenty, four and even early 2025 that we're getting inadequate.
Our return on capital and that investment that we're planning.
Making sure that we have to continue to maintain.
Maintain and hopefully expand margins over time.
Got it and on.
Capital allocation and related to it be it small a real estate transaction are there other opportunities similar to this that you see within the realm of possibility within the near term or should we think about you know the capital on pregnant that free cash flow primarily going towards.
And returning cash to shareholders.
I think that we're going to stick to our our kind of stated capital allocation policies that we've had where where you know 35% to 40% of our discretionary cash flow is planning to pay a dividend and.
And the majority of the balance of that discretionary cash flow to go to growth Capex I think this this specific real estate transaction was one that was just pretty opportunistic that came in came along and and we said we looked around and said man. This is a really good opportunity for us to control our own destiny and make sure that we don't have any kind of.
Unforeseen interruptions in our operations group out in the Permian Basin. So it was something that we wanted to take advantage of that but we were in a position to where we can.
Execute on the transaction still remain cash flow positive, but is one of our stated goals.
And still take.
Take advantage of that opportunity and save some money and rents along the way so.
We decided to take advantage of that I don't foresee.
Too many of those.
Too many significant opportunities like that popping up overtime, but if they are if they do we'll evaluate to make sure that we're making the right decisions for the business.
Thank you.
Thank you Jason.
Our next question comes from Neal Dingmann with choice. Please state your question.
Good morning, guys. Thanks for the call nice quarter Nick.
And I ask that just the demand maybe question. Another way that you all had one of the best demand pictures out there, obviously, you're talking to customers and 25 I'm just wondering because of that are.
Are you able to potentially structure contracts longer are you able to say what are the benefits given again I see you all as having as I said one of the best sort of demand pictures out there I'm. Just wondering what are the sort of benefits or changes you might be able to take advantage of this.
Yeah. Thanks for the question Neil Good morning.
I think you hit on it there are some some things that we've been pushing on we have been able to secure a longer contract tenders.
Throughout the last year, we've seen our average contract tenor move up a little bit over time. So that's that's a quality thing that we like see a as I said in the prepared remarks, where we're below 7% of our contracts are month to month contracts right. Now. So we really are pushing to have everything contracted up to a week.
Can have contracted up we think that's the right thing to do.
So really secure the visibility of our cash flows going forward.
As well, we're able to push some some renewal increases that.
We've seen some rate increases along the period of time over the last couple of years that that have.
That had gone to kind of come back to the inflationary pressures. We saw saw last year in and maintain margin, where we expect it to be in that kind of that 64% to 65% percent range and we expect that that we can hopefully continue to expand on that on the positive margin expansion, we had this quarter.
No that's great great to hear and then maybe taking that demand over to John's question John.
How does this sort of long term demand picture you have does that give you all more confidence.
It really materially raised your distribution up 9% again, obviously stock's too cheap.
Should readjust, but I'm just wondering does that give you confidence to continue to raise that or when you think about the shareholder return.
Your coverage seems more than ample so John I'm, just wondering does it factor in when Youre seeing this demand and sort of the certainty around there or what what drivers sort of helped shape that.
Yeah, Yeah. So thanks as it relates to the dividend, it's all part of that Big capital allocation framework that Nicky as described a couple of times, you're obviously regularly discussed the strategy on capital allocation framework with our board for the foreseeable future, we like that 35% to 40% of our discretionary cash flow being paid out in the form of the dividend you just roll our bid.
This model forward based on 24, 25, and kind of demand picture that we see we see the ability to grow EBITDA in that upper single digit range for the receivable future that would translate into increases in discretionary cash flow. So we will evaluate and growth in the dividend over time, but we do think we'll see growth in the discretion.
Free cash flow to afford it.
Awesome, Thanks, guys well done.
Thanks, Dan.
Our next question comes from Jim Rollyson with Raymond James Please state your question.
Good morning, guys and again, congratulations on a good quarter.
Nicky just kind of circling back to the roughly 140000 horsepower being delivered this year.
You, obviously mentioned that you're pretty well fully committed for what's on order next year, just as we think through what you've.
I'm just trying to understand how much incremental horsepower or you think it's delivered next year and based on what your conversations are going for 25, just kind of thinking about that incremental growth rate on horsepower additions beyond 'twenty three maybe some color around that.
Yeah. Thanks.
Thanks for the question, Jim and and good to talk to you.
We are.
Not quite.
Finished up the whole budgeting process, yet with for 2024, and and not ready to provide guidance, yet, but I will tell you that like.
The horsepower deployment for 'twenty 'twenty four will look a lot like what 2023 looked like and maybe a maybe a fraction more and I think that youll see that same kind of trend towards 2025 again, just like John Hussein about our capital allocation strategy here.
Already today.
If we can grow EBITDA by that that upper single digit percentage margin and that grows just discretionary cash flow by that same amount and I think that you can translate that into being able to allocate that both out of dividend and growth capital growth over time.
That's helpful and then since no one else ask I figured I'd ask your one of your largest customers is getting taken out here early next year and just kind of curious.
How you see that from a potential opportunity standpoint going forward given their kind of growth plans.
Yeah, I mean look I mean, Exxon has buy in pioneer and.
And here's one of our biggest customers one of our.
The longest tenured relationships and but we're excited about the opportunity to work with Exxon going forward.
They've got great plans for the Permian basin they.
They wouldn't be making this investment in the Permian unless they had a pretty long term.
Outlook about the opportunities in the Permian, which which we think bodes work really well for our business.
As well as I mean, Exxon has already a customer of ours on a smaller scale. So we already have a relationship with them and so we're.
Excited that gets moved forward working with them in.
They come in one of their bigger providers.
Fantastic Thanks Mickey.
Yeah.
Our next question comes from Jackie <unk> with Goldman Sachs. Please state your question.
Hi, Good morning. Thank you for taking my questions just wanted to start on more on the cost side.
Foreseeing pricing continued to rise could you comment on what you're seeing more so on the cost side and how inflation pressures have been abating and how you see that going into 2024.
Yeah, Jackie Thanks for the question.
You know I think we've dealt over the last couple of years with pretty significant inflationary pressures hitting us.
Kind of left and right and and we've combated that as much as we couldn't and I think done a pretty good job of keeping margins pretty flat.
No.
Looking towards.
2024, I think that we.
Those inflationary pressures to kind of abate a little bit.
And and remained pretty flat going into 2024, I think obviously, you'll have some some increases.
From a labor perspective, as you do every year, but.
But I think that we're kind of expecting our kind.
Kind of our cost of operations metrics, just stay relatively flat next year from the standpoint of.
Cost from our suppliers and lube oil providers.
Okay, great. Thanks for the color there and then lastly, just as a follow up I know that.
The cat engine availability overall is now over here plus specifically worse than what you saw during the second quarter and has there been any update from caught on that easing at all Peter.
In the near or long term.
I haven't had any updates on that easing in anytime soon so we expect to keep having to deal with that and it's kind of typical for these kind of up cycles that those deliveries get out to be that long. Although we expect for this up cycle two to last longer than traditionally you've seen them.
In the past just because.
We think that the supply supply side is so so depressed and as well as such incremental high demand for compression services with with the dynamic of the fact that the Permian basin is providing a lot of the gas.
Production growth in the United States and it requires so much more compression to just produce that the Permian basin gas to get out of their shots feed LNG plants. So.
Like I said high demand that we foresee for a long time and really tight supply for a long time. So so we expect this to continue on and I don't I don't foresee much relief in.
In delivery.
Delivery times from Caterpillar anytime soon either.
Okay, great. Thank you so much.
Thank you and there are no further questions at this time I'll hand, the floor back to making Mckee for closing remarks. Thank you.
Okay. Thanks, operator, and thanks to everyone for participating in today's call.
We look forward to speaking to you again in the new year and with our fourth quarter and full year 2023 results.
<unk>.
Thank you we conclude today's conference all parties may disconnect have a good day.