Civitas Resources - Q2 2023

Transcript

Operator (participant)

Morning, ladies and gentlemen. Thank you for standing by. My name is Erica, and I will be the conference operator today. At this time, I would like to welcome everyone to the Civitas Resources Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star one, followed by the one on your telephone keypad. If you would like to withdraw your question, press star one again. Thank you. At this time, I'll be turning over everything to John Wren. Go ahead, John.

John Wren (Director of Investor Relations)

Thanks, operator, and good morning, everyone, and thanks for joining us this morning. I'm joined today by our CEO, Chris Doyle, CFO, Marianella Foskey, COO, Hodge Walker, and Brian Kane, our Chief Sustainability Officer. I hope you've reviewed our earnings release 10-Q and slide deck, all of which are available on our website. We will make forward-looking statements which are subject to risks and uncertainties that could cause actual results to differ materially from our projections. Please read our full disclosures regarding forward-looking statements in our 10-Q and other SEC filings. We may also refer to certain non-GAAP financial metrics. Reconciliations to certain non-GAAP metrics can be found in yesterday's release and our SEC filings. After Chris' brief prepared remarks, we will all be available to take your questions.

As always, please limit your time to one question and one follow-up, as this allows us to get to more of your questions. I'll now turn the call over to Chris.

Chris Doyle (CEO)

Thanks, John. Good morning, everyone. We've been extremely busy year to date, and certainly this quarter in particular, capturing and now closing two transformative deals in the Permian while continuing to deliver on our DJ business. You can see that our second quarter financial and operating results are very strong and top consensus estimates for both production and cash flow. In addition, we're managing our investment and activity levels with capital expenditures under expectations for the quarter and allowing us to reallocate some of our capital savings to value-adding projects in Colorado. Our teams are laser focused on continuing to build upon our track record of delivering on our promises. Our results continue to prove that an E&P company with high-quality assets can return cash to shareholders through commodity cycles, while also maintaining a strong balance sheet.

Inclusive of our dividend payment next month, Civitas will return more than $800 million year-to-date to our shareholders, one of the highest dividend yields alongside an active stock repurchase program. When we announced our recent Permian acquisitions, we've reiterated our unwavering commitment to a strong balance sheet. We're well underway with our plans to divest $300 million in non-core assets by mid-2024. The proceeds will allow us to quickly reduce debt while high-grading our portfolio away from assets that simply are not part of our near-term development plan. Looking forward, we'll target three quarters of return of leverage at mid-cycle pricing. Again, maintaining a strong capital structure is key to building a sustainable business that can deliver top shareholder returns. Before taking your questions today, let me quickly discuss our recently closed Permian transactions and cover our second quarter highlights.

Our new Permian assets are a perfect fit for Civitas and advance our strategic pillars. The new Civitas is scaled, diversified. It's a platform with duration in three of the best oil basins in North America. These deals create instant scale and provide an accretive entry into the Permian. As we've said before, scale really does matter in this industry, but we're not focused on getting bigger. We're focused on sustainably generating free cash and rewarding our shareholders through the commodity cycle. These deals check those boxes. A diverse asset base provides Civitas with flexibility in how we allocate capital, reduces risks, and enhances the certainty of delivering on our metrics. Civitas now has about a decade of high quality, low break-even locations across three top oil basins in the U.S.

Our proven business plan, matching high-quality assets with scale and a deep inventory, provide us with duration and confidence in our ability to deliver value for our shareholders. In today's deck, we provided production and activity updates for our new Permian assets. Production was in line with expectations, averaged about 107,000 BOE per day, of which 50% was oil during the second quarter. Currently, the assets are running around 100,000 BOE per day in the third quarter, which we'll look to maintain heading into the fourth and exit the year around 110,000 BOE per day. There are currently seven rigs running on our Permian assets. With close, we can now optimize our activity levels and look for ways to best allocate investments across the DJ, Midland, and Delaware basins.

We expect to run about six total rigs in the Permian and DJ throughout 2024. For full year 2023, we provided preliminary guidance when we announced the transactions. Today's materials include the 2023 outlook for production, capital investments, total cash operating costs, production taxes, and oil price differentials. Bottom line, our outlook for Permian production costs are unchanged since the day of announcement. Our full-year capital investments, including five months of our new Permian assets, are expected to be about $1.3 billion at the midpoint. We're encouraged by some of the recent softening we've seen in certain services and consumables, including drilling, casing, mud, and sand. It's early, we're maintaining our capital guidance for the combined company. As we said, coming into this year, we will be opportunistic and disciplined in how we allocate capital.

Any potential savings or efficiency gains on the back half of the year can be allocated back to our development programs or to our balance sheet or back to our shareholders. Certainly, too early to model deflation heading into 2024, but we like seeing the market beginning to correct. Since the announcement, we've been planning for integration. We have recent experience, obviously, successfully combining companies, and this integration in particular is going well, be it very early innings. We're very impressed with the teams behind these assets, and we look forward to building upon their success. We have a six-month transition service agreement in place with both Hibernia and Tap Rock to ensure a seamless transition. Concurrently, we're building out the team, looking to identify and retain top talent, align with the broader organization, accelerate the transition wherever we can. Let me quickly summarize our second quarter results.

Civitas delivered free cash flow of about $190 million in the second quarter, above consensus expectations, and, and really driven by strong production, lowering expenses, and managing capital investments. On production, the team delivered higher-than-expected production of 173,000 BOE per day. For the first half of 2023, we averaged about 166,000 BOE per day, right at the midpoint or just over midpoint of our annual guidance. Our strong oil performance for the quarter was primarily driven by increased productivity we've seen from our recent 2023 TILs, including the Watkins Development area. We recently turned in line three pads with 3 mi laterals that have significantly outperformed expectations to date.

It's early, but based on that strong performance we've seen, we now expect to be around the high end of our DJ production guidance this year and continue to target an exit of 170,000 BOE per day, or 280,000 BOE per day when combined with the Permian. On the expense side, in the quarter, when we look at the foundation of our cost structure, LOE and cash G&A per BOE, we're down 10% quarter-over-quarter as we got out from under the first quarter winter and returned to normal production levels. Finally, we continue to manage our capital, and full year expectations for CapEx are unchanged. Capital investments in the second quarter, about $230 million, were consistent with the first quarter, as our activity levels remained relatively flat.

When taken together, higher production, lower expenses, and capital inside expectations, you get higher free cash flow and higher returns to our shareholders. Finally, we were recently active under our $500 million share buyback authorization and repurchased about $20 million of stock at an average price of $64.55 per share during the quarter. In total, we've now repurchased $320 million in stock year to date and have $480 million remaining under the buyback authorization through year-end 2024. In closing, let me reiterate today's key takeaways. First, our legacy DJ business is performing exceptionally well. Our teams continue to find innovative ways to address challenges and safely advance our business and deliver strong results. Second, our recent acquisitions have created a stronger, better, and more balanced Civitas.

We have options to invest capital across a portfolio of high-return assets in the DJ and Permian. We're focused on safely integrating those assets and onboarding many of the great employees from Hibernia and Taprock once we get past our TSAs. Lastly, we know the importance of a premier balance sheet. We're advancing sizable non-core asset sales and have a strong outlook for free cash flow. When combined, we expect to return to our optimal leverage ratio of less than 1x 2024. Thank you for your interest in Civitas. Operator, we're now happy to take questions.

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Neal Dingmann from Truist Securities.

Neal Dingmann (Managing Director)

Morning, guys.

Operator (participant)

Neal, go ahead.

Neal Dingmann (Managing Director)

Morning. Can you hear me all right?

Chris Doyle (CEO)

Yep, we got you, Neal.

Neal Dingmann (Managing Director)

Yes. My first question on the commodity mix. Really, can you all speak to how you're thinking of the oil cut, both in the new Permian assets in the DJ? I'm just wondering specifically, does your guide on the new assets assume, you know, much change going forward? Secondly, also on the DJ, does it assume that, you know, after that oily quarter you had last quarter, that the oil cut goes back to a more normalized level there?

Chris Doyle (CEO)

Yeah, I'll start. Thanks for the question, Neal. I'll start with the DJ. As I mentioned, the pads that came on, a couple of things going on here. One, this is in the Watkins area, which is an oilier area of our development. We love what we're seeing. Two, these were also our initial three-mile tests. Going into the year, we prudently risked both the capital and operational execution, but we also risked the performance of that third mile. What we've seen through the quarter, early on in the flowback of these pads, they came on last month of the first quarter, so we had a full quarter to look at them.

What we've seen is, the degradation that we had modeled was, was overly conservative. They beat expectations. Early in the flowback, it's oilier as well. As those wells continue to clean up, when we open them up, we'll see the gas-oil ratio increase on those pads. We've got that modeled into the back half of the year. I'll tell you, we're extremely excited about not just the continued performance of this area, where about half of our capital is allocated over the next few years, including our two caps, we're also excited about what we're seeing by extending laterals here in the DJ. We recently just rig released off our 4-mile well. Good news across the board on the DJ.

In the Permian, I would just point you to the first quarter cut was about 54%, second quarter, about 50%. Guidance indicates, you know, we'll be in that range, somewhere around 52%. You'll see a little bit of lumpiness as wells come on and off, but we're comfortable with that guidance going forward.

Neal Dingmann (Managing Director)

Great. Then just, Chris, my second, I, I think I know the answer to this, just want to double-check on that. The shareholder return plan you know, do you have any intention of changing this once I know that the intent is to, you know, get this debt paid down initially, then, you know, given the free cash we, we sell, you know, you're certainly gonna be able to do that, even somewhat early in 2024. Once, once you get this debt repaid, do you change that plan, or will it stay on that kind of, you know, 12-month sort of rolling plan?

Chris Doyle (CEO)

Yeah I'll kick this off and maybe kick it to Neal for anything, anything I miss. I, I really like the framework that was put in place here at Civitas. We've not changed the formulation. I, I like the trailing 12-month calculation. It allowed us to maintain our peer-leading dividend framework as commodity prices moderated from where they were last year. I, I see us continuing with that plan, and as we get the Permian basin's assets integrated, as we guided when we announced, we see some real strength in extending that dividend plan, but also bolstering it from where we would have been without the assets.

In terms of, just how we think about allocating between that, the dividends, the buyback, and debt paydown, we're committed to getting leverage inside that, that turn, right? We want anywhere between half a turn to a turn, depending on where we are in terms of deal cycle and commodity cycle. We're well on our way with the divestments. We think we can potentially accelerate our path to get inside of that. At the same time, and you saw it in the second quarter, as much as we are committed to getting leverage down, you see an opportunity to pick up an equity, and even in a small dose, we'll be opportunistic as those opportunities come to us. So we did that in the second quarter.

You could see us do that between now and the end of 2024, where our authorization ends.

Marianella Foskey (CFO)

Neal, I would echo Chris' comments. The balance sheet is truly gonna be the governor to everything we do. We really, really like the last four months look at the dividend because it gives some resiliency to the dividend and the shareholder return program. When you look at this plan, at $70 oil or at mid-cycle prices, there is plenty of excess free cash flow after the dividend to hit our balance sheet targets, and we're further gonna complement that with the asset sale. The asset sales are only gonna allow us to reach those balance sheet goals sooner. We really like it. We don't anticipate any changes to the plan going forward.

Phillip Johnston (Senior E&P Analyst)

Agree. We really do like that plan. Thank you all.

Chris Doyle (CEO)

Thanks, Neal.

Operator (participant)

Our next question comes from the line of Timothy Rezvan from KeyBanc. Timothy, go ahead.

John Martini (Research Analyst)

Hi, good morning. This is John Martini, on for Tim.

Chris Doyle (CEO)

Hey, John.

John Martini (Research Analyst)

As you mentioned, as you mentioned, your well results in the, in the southern area look, look strong from both in oil cuts and total BOE perspectives. How much of your drilling will be in this area before you officially start drilling in the Box Elder Cap? Do you think the recent well results here could be replicated going forward?

Chris Doyle (CEO)

We're excited about what we see. I will say it's still early days. With the Box Elder Cap and with the Lowry Cap in this immediate area, when you step back and look at, capital allocation across, or to the DJ, this is, this is an important area for us. Assuming two rigs going forward, which is, which is, really underpinning our 2024 guide, about half of that capital is gonna be directed to the south. We'll look for ways to enhance our capital allocation, whether that's within the DJ or to the Midland or to the Delaware. We like having the flexibility of moving capital around, and we're super excited about the results that we continue to see in the Watkins area.

John Martini (Research Analyst)

No, that's great.

Operator (participant)

Our next question comes to the line of Phillip Johnston from Capital One. Phillip, go ahead.

Phillip Johnston (Senior E&P Analyst)

Hey, guys. Thanks. Just to follow up on Neal's question, I think you said the Permian oil mix was 54% in Q1, and obviously fell to 50% in Q2, and then the guidance for the remainder of the year is, you know, 53%-58%. Just wondering what's moving that mix around so much. It's a pretty decent base. You know, obviously, there's some lumpiness, but it is a pretty decent base. Just curious on that.

Chris Doyle (CEO)

Yeah, I think in the, in the first quarter, with the Hibernia assets, you had some, some new wells come on, oilier, obviously. As those continued to open up and clean up, you had gas-oil ratio, coming up in the second quarter. Then you'll, you'll see that, that mix, range between those two quarters as you allocate capital and as you, deploy capital to different areas of, of both the, the Hibernia assets and, Taprock.

Phillip Johnston (Senior E&P Analyst)

Okay, thanks. You guys mentioned that you no longer expect to pay any cash taxes this year. Looking out into 2024 and beyond, I think you, you will be AMT eligible. Can you maybe help us with how we should think about cash taxes in 2024 and beyond?

Marianella Foskey (CFO)

Sure. I can address that, Philip. This is Marianella. For 2023, the, the asset sale treatment for tax, yeah, wiped what we would have otherwise expected. That, that and a little bit of lower commodity price, given the initial guidance we gave was at $80. Going forward, at mid-cycle prices, so call it $70 oil, you'll be looking at about 3%-6%, 4%-6% of EBITDA in terms of cash tax going forward. It's, it's an assumption that's obviously very sensitive based on oil price, because it's all incremental, but that, that would be a good assumption at that pricing on, on the go-forward plan.

Phillip Johnston (Senior E&P Analyst)

Okay, great. Thank you.

Chris Doyle (CEO)

Thanks, Phillip.

Operator (participant)

Our next question comes to the line of Leo Mariani from Roth MKM. Leo, go ahead.

Leo Mariani (Managing Director)

Yeah. Hi, guys. Obviously, very strong performance here, you know, in the quarter. Can you maybe give us a little bit more color in terms of what inventory is kind of in this, this Watkins area? Roughly how many wells do you kinda have left to, to drill, you know, down there?

Chris Doyle (CEO)

Yeah, if you look at, our, our Box Elder Cap and our, Lowry Cap, you're talking about a few hundred locations, in total. We have OGDPs in addition to those, to those two caps, and so it's, it's a, a large portion of, our go-forward, go-forward plan. If you look at the skyline, previous skylines, you can see sort of the split, in our southern area, which is really this Watkins area.

Leo Mariani (Managing Director)

Okay. That's helpful. Just wanted to ask, just around the asset sales. You guys are talking, you know, $300 million, kind of non-core stuff. Is that all just kind of, you know, producing assets? You know, is there also maybe some, some midstream there? Just can you provide a little bit more color around kind of what that is? Just sticking on kind of M&A, I mean, obviously, you guys have done a great job rolling up the DJ Basin over time. You're now in the Permian and, and two of the, the subbasins here.

Obviously, I think you're, you're focused on integrating these assets. Do you look to kind of employ a similar strategy that you did in the DJ, where you, you hope to kind of, you know, acquire and, and milk assets for, for more free cash flow in the Permian over time?

Chris Doyle (CEO)

Sure. Lots to unpack there, but, but thank you for the question. First, on the, on the divestment plan, we've, we've selected our bank. We are launching that process. Currently, the first wave of, of assets are, are really, as I mentioned in my remarks, areas on the right side of, of the skyline that just don't compete for capital when, when up against Watkins and our Western area and the Midland and Delaware Basins. It will include some production, as well as some inventory. You know, in terms of midstream, we would consider a partial or monetization of our midstream assets.

I think with the, with the strength in, in the commodity, we have a menu of, of options to hit our target, and position us and, and delever us, as we've laid out. We feel good where we are. We certainly are not going to cut into any muscle, and if we were to consider monetizing anything on the midstream side, we'd obviously protect our, our underlying business. I think the team has shown in the past that, that we can be creative, and that we can be on our front, front foot, to not only to hit our targets, but also surpass them. I'm excited about the, the current progress to date on the divestment plan and, and look forward to sharing more on that.

In terms of M&A, you hit it. I mean, our focus really is integrating these two assets. I think it's. We'll continue to look for ways to enhance our positions in the Midland and Delaware. You know, if this question is a year from now, it's an easier answer than, day two of integrating, Hibernia and Taprock. So, I would tell you that we'll continue to look. It would need to be accretive, on a number of metrics for our shareholders, just as we did with Hibernia and Taprock. So, I wouldn't say that we're completely on the sidelines, but it'll have to be quite compelling to have us come back onto the field.

Leo Mariani (Managing Director)

Thanks.

Operator (participant)

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad, if you'd like to ask an additional question. Our next question comes from the line of Nicholas Pope from Seaport Research Partners. Nicholas, go ahead.

Nicholas Pope (Managing Director)

Good morning, everyone.

Chris Doyle (CEO)

Morning.

Nicholas Pope (Managing Director)

Hoping you guys could talk a little bit about credit facility, I guess, credit facility utilization post the close of the deal, and how you're planning on managing that, where current rates are, post the close of this. Just trying to understand, you know, how that's gonna get paid down over the near term.

Marianella Foskey (CFO)

Sure. Hey, Nich, this is Marianella. This is something that we, as you might imagine, spent a lot of time as we were thinking of financing these acquisitions. Just where rates are, what do we want our balance sheet to look like in terms of fixed versus variable debt, among other items in the balance sheet. Where we have a slide 8 in the investor presentation.

We wanna make sure our liquidity was, was very solid, and in, in looking through that mix, because we know we want to pay down the, our outstanding quickly, we essentially, as of 6/30 pro forma for the deals, we estimate we'll be at $700 million. Again, that's not as of today, that's as of 6/30 pro forma for the transaction. If you look at the pro forma letter commitment of 1.85, that gives us very strong liquidity over $1.1 billion. To your point, given where rates are, with excess free cash flow after the dividend and with the asset sales, this will likely be the first capital or the first piece of debt that we will pay. Our goal is to get that down as quickly as possible, continue shoring up our already very strong liquidity.

As a reminder to our current, 5% senior notes, that becomes callable as well, the second half of this year, so around October. That will be given, given the rate on that, that will be lower priority as far as repayment goes, obviously, given where rates are. Hopefully that helps in terms of how we think about prepaid versus, versus fixed debt and, and order of priorities in terms of debt pay down.

Nicholas Pope (Managing Director)

That is helpful. How do you think about balancing, you know, that, that pay down, you know, with respect to the share repurchase plan, and that variable dividend? Is there any thought about considering rates? I'm assuming you're over 7% on that credit facility, about some sort of balance there, about reducing the share repurchase speed, about potentially looking at the variable component with respect to that current rate.

Marianella Foskey (CFO)

Sure. From a, from a balance sheet strength perspective, Nich, we feel very comfortable with the leverage and liquidity and where we're headed. We have put our target out there three quarters of a turn, and obviously, in looking at our profile for the next six quarters by the end of 2024, we feel very confident that we'll get under one time. That's after the dividend. In terms of the buyback, and you saw us do $20 million during the quarter, we'll continue being opportunistic. You know, when we think about what we need to get to our leverage goals, you know, we'll continue executing that prudently. When you think about what we need to get there, it's the generation of this business is so strong that even after the dividend, we will, we feel very comfortable we can get there.

You know, at this point, like you, like you mentioned, the credit facility interest is, it's up there. It's just certainly a lot higher than the 5% notes we have outstanding, so we'll be focused on paying that down as quickly as we can with excess cash flow on the asset sales.

Nicholas Pope (Managing Director)

Got it. I appreciate the time and the answers. Thank you.

Marianella Foskey (CFO)

Thank you.

Operator (participant)

Our final question comes from the line of Timothy Rezvan for KeyBanc. Timothy, go ahead.

John Martini (Research Analyst)

Hi, it's John again. If I can just squeeze another one in. You reiterated your intent to sell $300 million of non-core Permian assets with the goal of doing that by mid-2024. We're curious how you landed at that 300 figure, and how your view would change if, say, oil prices were to continue to show signs of strength here?

Chris Doyle (CEO)

Yeah. Thanks, John. Glad to, glad to have you back, back on, and want to clarify, the $300 million divestment target that, that we see currently is primarily in the DJ. These are assets that we know very well, that are either fully developed or they have inventory that, that simply just does not compete for capital over the near term. Let's say, you continue to see commodity prices strengthen. I think that's a, that's a really good day for, for a lot of folks, including Civitas. That doesn't necessarily mean that we would sell fewer assets. It could accelerate the process to delever, which is, which is great. This is not just about hitting a number and whatever it takes to get to that number.

This is more about how do you strengthen the base and the foundation of this DJ business, which is so, so strong and competitive across all other basins within North America, as evidenced by Watkins, as evidenced by our Western assets. I think what you'd see is that $300 million with some strength in the commodity price could go up. This is about paring back to a really strong foundation for the go-forward company.

John Martini (Research Analyst)

No, that's, that's great context. Thanks for that. I'll hand it back now.

Chris Doyle (CEO)

Thanks, John.

Operator (participant)

That was our final question. I will now turn the call over to Chris Doyle for closing remarks. Go ahead, Chris.

Chris Doyle (CEO)

Thanks, Erica. Thank you again for your continued interest in, in Civitas. We look forward to sharing our continued progress on upcoming calls. Have a great rest of your day, and please be safe.

Operator (participant)

Ladies and gentlemen, that concludes our call today. Thank you for joining. You may now disconnect.