Crescent Energy - Q3 2023

Transcript

Operator (participant)

Ladies and gentlemen, good morning, and welcome to the Crescent Energy Third Quarter 2023 Earnings 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 and zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Le'Mar Buford, SVP of Finance and IR. Please go ahead.

Le'Mar Buford (SVP of Finance and IR)

Good morning, and thank you for joining Crescent's third quarter conference call. Prepared remarks today will come from our CEO, David Rockecharlie, and CFO, Brandi Kendall. Our Chief Accounting Officer, Todd Falk, and our Executive Vice President of Investments, Clay Rynd, will also be available during the Q&A session. Today's call may contain projections and other forward-looking statements within the meaning of federal securities laws. These statements are subject to risks and uncertainties, including commodity price volatility, global geopolitical conflicts, our business strategies, and other factors that may cause actual results to differ from those expressed or implied in these statements and our other disclosures. We have no obligation to update any forward-looking statements after today's call. In addition, today's discussion may include disclosure regarding non-GAAP financial measures.

For a reconciliation of historical non-GAAP financial measures to the most directly comparable GAAP measure, please reference our 10-Q and earnings press release, which are available on our website. With that, I will turn it over to our CEO, David.

David Rockecharlie (CEO)

Good morning, and thank you for joining us to discuss our third quarter results. Our message is simple and direct today. This was a record quarter for the business, both operationally and financially. We are doing what we said we would do, generating strong free cash flow, investing capital with disciplined great returns, delivering exceptional operating performance, including meaningful capital efficiencies and reductions in emissions, with a focus on continuous improvement of our operations, including stewardship of the environment and the communities in which we operate. We're growing through accretive, opportunistic acquisitions, including the successful integration of $850 million of total transactions this year in our core Eagle Ford operating area. We're maintaining our strong balance sheet and growing capital markets presence as we continue to scale the business significantly, and we're consistently returning capital to our investors.

This quarter's record results solidify that we have the right strategy, the right asset, and the right execution in today's market environment to create significant long-term value for our shareholders. Today, I plan to cover three key items in more detail. First, our operational performance, second, our compelling acquisitions, and third, our sustainability success. First, let's discuss operations, where the business is outperforming. We've realized substantial efficiencies on the drilling and completion side, as improving cycle times and completion speed have improved well costs by 10%. You will recall that we came into the year with a focus on flexibility, and this has worked strongly in our favor.

As a reminder, we reduced our full-year capital guidance last quarter, and with continued solid execution, not only are we able to deliver our original capital program at lower cost, but also our meaningful outperformance this year in drilling and completion has had a multiple impact. We've been able to do more with less as we are able to accelerate some activity as our drilling returns have improved while still investing less overall capital this year. These capital efficiencies are materially enhancing the returns on our development program, where we are consistently earning in excess of 2x cash-on-cash returns on a full cycle basis. Importantly, these capital efficiencies have not come at the expense of well performance. Across the Uinta, in particular, our assets have materially outperformed our predecessors due to the higher completion intensity, where we've improved oil recoveries by approximately 25% since taking over operation.

Complementing our high-returning development program, our substantial long-life producing reserve base consistently provides us with predictable performance. The cash flow stability of our low-decline balanced production base is a tremendous value proposition relative to our peers. Our unique skill set, operating both conventional and shale assets, allows us to combine stable cash flows with attractive reinvestment opportunities. Today, we are the only U.S.-focused company generating more than 150,000 barrels of oil equivalent per day of production while running only a two-three rig maintenance program, which is a direct result of the lower capital intensity required to maintain production output at Crescent. This intentional portfolio construction, coupled with continuous out-performance on production and capital spend, drives this quarter's record free cash flow, as well as our expectations for substantial free cash flow looking ahead to 2024 and beyond. Now, turning to M&A.

Since the second quarter, we have closed on two previously announced Eagle Ford acquisitions totaling $850 million. First, through our $600 million acquisition of operatorship of the Western Eagle position in July, and second, through the acquisition of incremental Western Eagle Ford working interest for $250 million in October. Together, the assets represent approximately 32,000 barrels of oil equivalent per day of liquids weighted net production, with a low 16% decline rate and more than $1 billion of proved developed PV-10 value. The two deals doubled our Eagle Ford production and inventory, and quadrupled our legacy non-operated interest in the Western Eagle Ford to a current operated working interest of 63%.

Furthermore, we now operate greater than 90% of our interest in the Eagle Ford, adding scale and operational control in a core region for Crescent. To simplify our M&A growth strategy, when evaluating opportunities, we have two key objectives. First, to buy assets we understand at attractive value, targeting cash-on-cash returns in excess of 2x our money. Second, to make those assets better to drive incremental return to shareholders. Regarding this first objective, in our view, the entry prices of our recent acquisitions are highly compelling for three key reasons. First, it's nice to buy more of what you already own at a great price. We acquired over $1 billion of proved developed PV-10 value of $850 million during this summer's pullback in commodity prices. These assets we know well through our six years as a non-operated partner.

Second, the assets provide us with a significant backlog of high-returning, Lower Eagle Ford inventory, as well as Upper Eagle Ford and Austin Chalk upside. As outlined on page 10 of our investor deck, this is a compelling resource base, with the Lower Eagle Ford EURs on this asset having outperformed the basin average. That provides us the ability to compound our invested capital and earn in excess of 2 times our money on low-risk development. In many other recent industry transactions, buyers have had to ascribe material purchase price value to undeveloped resource, which is part of full cycle returns. We think our disciplined and opportunistic approach to M&A gives us a leg up on full cycle economics.

Third, the assets are highly complementary to our existing business, adding low decline production, driving financial accretion, and providing tangible operational synergies, which will deliver a return in excess of our underwriting expectations. Turning to the second M&A objective of our growth through acquisition strategy, we seek to bring improved operational execution to the assets we acquire. Following the closing of the Western Eagle Ford acquisition, we fully integrated the assets ahead of schedule and immediately began to realize synergies, starting with a 20% reduction in well costs relative to the previous operator. These cost savings are driven by the same improved cycle times and completions efficiencies, driving down costs across our existing Central Eagle Ford operations.

The speed with which we have incorporated the assets into our portfolio and have improved on legacy well performance is a testament to both the quality of our people as well as the unique benefits of acquiring assets we know well. To summarize, the Western Eagle Ford acquisitions reflect our strategy in action, adding to our successful track record of buying assets at attractive value and making those assets better. Looking ahead, we will continue to execute on our growth strategy. We see a huge opportunity for continued accretive acquisitions and firmly believe we have the ability to become an investment-grade company over time. To us, that means adding size and scale with financial discipline. As we pursue our disciplined growth strategy, we anticipate we will be highly active in the M&A market over the next 12-24 months.

We expect to be an active participant in the ongoing wave of consolidation in the sector, particularly across our core operating areas in Texas and the Rockies. Furthermore, we also believe that we are uniquely positioned to participate on the front and back side of energy sector consolidation activity, leveraging our broader investment and operational expertise to acquire attractive assets that may be less core to pro forma companies following large cap merger and acquisition activity. Now, before handing the call back over to Brandi, I'd like to discuss sustainability, an area that's core to our long-term business strategy. Yesterday, we published our annual sustainability report. We made substantial progress on our emissions last year, reducing our absolute Scope 1 emissions by 27%.

We monitor and evaluate all of our assets, identify opportunities for improvement, and our 2022 progress was primarily achieved through a carbon sequestration project in Wyoming and the replacement of pneumatic devices. In Wyoming, we are now capturing and sequestering carbon dioxide that was previously vented, and selling those volumes to an unrelated party for use in enhanced oil recovery. In addition to materially emissions, the project our existing carbon capture footprint with current operations, capture, inject, and transport CO2 volumes. While it's still early, we continue to progress opportunities in our portfolio to increase cash flow from our carbon dioxide businesses. Within our portfolio, we remain particularly focused on methane emissions and further improving our measurement capabilities. As one of the first U.S. companies to join OGMP 2.0 in early 2022, our measurement efforts have increased tremendously.

Last year, we implemented biannual flyovers across nearly all of our assets... allow us to both expedite and enhance our emissions measurement and detection capabilities. As a company focused on growth through acquisitions, that inherently means acquiring more emissions, but our organization-wide emphasis of proper stewardship ensures we will remain committed to reducing the emissions profile of the assets we own and acquire. With that, I'll turn the call over to Brandi to provide more detail on the quarter and our recent capital markets activity. Brandi?

Brandi Kendall (CFO)

As David mentioned, we achieved record production and cash flow this quarter, averaging 157 MBOE per day, generating $290 million of adjusted EBITDA and $160 million in levered free cash flow. Importantly, this quarter's results were only inclusive of the impact of the first of our two Western Eagle Ford acquisitions, the latter of which will be reflected in the fourth quarter. On capital, we spent $94 million, which will be our lightest quarter of the year due to timing of wells turned to sales. During the quarter, we brought online 10 gross operated wells in the Eagle Ford, which are posting strong early time results and are expected to generate in excess of 2x our capital invested at current commodity prices.

In Q4, we expect both production and capital to increase, bringing our full year results near the midpoint of our capital guidance range, despite the increase in activity for the year. While we are still finalizing our outlook for 2024, as David mentioned, the capital efficiencies we've achieved to date sets us up well as we expect preliminary production of 155-160 MBOE per day and consistent capital spend to this year, which equates to a two-three rig program. Maintaining capital spend at today's levels, despite a 20% increase in year-over-year production, highlights that our business requires less reinvestment to maintain our current output, which is a testament to our capital efficiencies we've realized to date and the quality of our asset base.

At these levels, we expect to generate substantial free cash flow for the remainder of 2023 into 2024 and beyond. As highlighted on pages 15 and 16 of our investor presentation, Crescent's peer-leading decline rate and capital efficiency result in significant free cash flow generation and a compelling valuation based on cash flow metrics. Our levered free cash flow over the next five years is greater than our current market cap, which is reflected in our approximate 25% free cash flow yield, nearly 50% higher than our peers. With that free cash flow, we expect to maintain our rigorous commitment to cash flow priorities 1A and 1B, shareholder returns in the balance sheet, while continuing to grow the business opportunistically through accretive acquisitions.

Alongside earnings, we announced a quarterly dividend payment of $0.12 per share, consistent with our publicly stated expectations for 2023, and generating an attractive 4% yield based on recent trading levels. From a balance sheet and capital markets perspective, we have had the same success in raising capital to support our M&A strategy while maintaining our financial strength. We exited the quarter with leverage of 1.4x and $1.1 billion of liquidity, both well within our targets. Pro forma for closing the first Western Eagle Ford acquisition, our bank syndicate reaffirmed our $2 billion borrowing base and $1.3 billion ECA. We feel great about where we sit from a balance sheet perspective, and we'll continue to use excess free cash flow in the near term to reduce absolute leverage.

In the capital markets, we successfully raised $600 million of debt and equity in the third quarter to finance the Western Eagle Ford acquisitions. In September, we priced a $155 million primary equity offering, including the overallotment. The offering represented Crescent's inaugural primary issuance and was extremely well-received, as we were able to up-size the transaction 10%, strong investor demand. The offering demonstrated increased access to capital markets for accretive transactions. Our stock trading up 8%-9% in the days following, and the greenshoe option exercised less than a week after the shares priced. In addition, we raised $450 million of incremental 2028 senior notes during the quarter across two separate transactions, further enhancing our liquidity profile and in line with our stated preference for longer duration capital in lieu of the bank market.

The offerings continued our momentum in the bond market, and the strong demand is reflective of the benefit from our recent upgrade to a BB credit. In summary, we are pleased with our efforts to efficiently access the capital markets to facilitate accretive growth through M&A and advance our strategic goals. Finally, to provide a brief update on our hedging activity. In line with our strategy of preserving returns on capital, we layered on additional hedges alongside the signing of the two recent acquisitions. As we look into 2024, we are less than 50% hedged through a mix of fixed swaps and collars. We continue to like our long-term commodity exposure, particularly given the low decline, long-duration nature of production base. With that, I'll turn the call back over to David.

David Rockecharlie (CEO)

Thank you, Brandi. There are three things we hope you take away from today's call. First, our third quarter performance was exceptional. Record production, record cash flow. We are demonstrating operational efficiencies that will make us stronger and more profitable in 2024 and beyond. Second, we have proven our ability to grow accretively. We have captured high-value transactions and financed them in a fashion that maintains a strong balance sheet, highlighted by long-term capital, strong liquidity and credit metrics, rating agency upgrades, and inclusion in the BB bond. We've created scale, doubling our business in less than three years, and are well equipped to continue to do so. Lastly, we have a simple value proposition. We believe Crescent is the best risk-adjusted stock to own for long-term exposure to oil and gas prices....

We have a lot of ambition and a lot of work ahead, but we are pleased with what we have accomplished to date, and we intend to continue to do exactly what we say we're going to do. With that, I'll open it up for Q&A. Operator?

Operator (participant)

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. If you would like to ask a question, please press star and one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 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 star. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question is from Michael Scialla with Stephens Inc. Please go ahead.

Michael Scialla (Managing Director, Head of Energy Equity Research)

Good morning, everybody. It sounds like you have a lot of visibility on free cash flow over the next few years. As you look at 2024, say, absent any additional M&A, is it fair to think that vast majority of that goes to the balance sheet, and then beyond 2024, you can think about returning more cash to shareholders, or are you thinking about it differently?

David Rockecharlie (CEO)

Yeah. Hey, thanks for the question. It's David. I would say, number one, thanks for raising it. We're all about generating free cash flow. You know, that's the investment proposition for the business. As you've probably heard us say, our number one capital allocation priority is return of capital to investors. And as you said, that to us means taking care of the balance sheet, so certainly debt reduction and also paying a cash dividend. We're sticking with the capital framework we have today. So yeah, I'd guide just sort of more of the same.

Just sticking with the same strategy and the free cash flow, certainly take care of the debt, but we are committed to making sure we maintain a dividend strategy that's appropriate for the market and the investors.

Michael Scialla (Managing Director, Head of Energy Equity Research)

Okay. And then, pretty impressive reduction in your Eagle Ford well cost, of immediate 20% reduction there. Is there any color you can add? I, I know you have a slide in your deck, talking about, some of the improved efficiencies. Was any of that contractual or any major changes in well designs made there?

David Rockecharlie (CEO)

Yeah, I'd say the good news is, that's pretty straightforward. We've been active in the Eagle Ford for a long time. We think we're good at what we do, and this is a great example of taking over an asset we know well and just continuing to execute the way we were on our own assets. So we've seen improvement in our business this year, and we were able to apply those improvements further to this acquisition. So I think operating really well, nothing specific other than just great execution. But also a really good example of what we're trying to do with the M&A strategy, which is get a great acquisition and value, and then enhance that value by doing what we know how to do well.

Nothing unusual there other than just doing a good job.

Michael Scialla (Managing Director, Head of Energy Equity Research)

Okay. Thank you, David.

Operator (participant)

Thank you. Our next question is from Neal Dingmann with Truist Securities. Please go ahead.

Neal Dingmann (Managing Director)

Morning all. Nice quarter, as you said, David. My first question's on your reinvestment rate. What I want to ask is, it seems to me that your solid reinvestment rate often gets overlooked as, you know, driven by that low base decline and, you know, the efficiencies you all talk about. I'm just wondering, David, could you talk about sort of maybe your future expected reinvestment rate and how this will ultimately drive the production, free cash flow, and shareholder return?

David Rockecharlie (CEO)

Yeah, I'll start it, and then if Brandi wants to add to it, that'd be great too. But really good question. I would say that generating free cash flow, maintaining a low reinvestment rate relative to peers is just core to what we do. We've done it for 10 years. We've historically been in about a 40% of EBITDA reinvestment rate. It's ticked a little higher recently, mostly with the what I would call the price run-up for you know the last couple of years. And it gets masked by our hedge program. As those hedges are rolling off, one I think more cash flow for investors, but secondly, it puts the reinvestment rate more in context. So we've still maintained a 40%-50% reinvestment rate typically.

But I would expect in a levelized world, we're gonna outperform peers on that just by the nature of our strategy and commitment to it. But I think thinking about us in a 40%-50% range is reasonable.

Brandi, you got anything you want to add to this, the question we dealt?

Brandi Kendall (CFO)

Yeah. No, I think David answered it well. I mean, that 20% decline rate that we have is purely declining, that translates to a really a capital-efficient business that's just much less intense relative to the broader market. It's... I know we've talked about before, Neal, I mean, we're running a two-three rig maintenance program, and that's relative to roughly 155-160 a day go-forward basis, which I think is pretty unique relative to the broader market.

Yeah, I would agree. And then, just a quick second one on capital allocation, then maybe another shot at capital allocation. David, well, I appreciate that debt quarterly dividend focus and the leverage on debt and the quarterly dividend. I guess my question is: Do you think it makes any sense to try to buy back any shares, given the sort of notably low valuation, you know, despite, you know, the limited float on the shares?

David Rockecharlie (CEO)

Yeah, good, good question. Happy to drill down a little more there. The fundamental response, and I'll let Brandi give you some more detail, is we absolutely do consider what I would call share buybacks as part of a solid return of capital program. As you know, we've still got an Up-C structure with Class B shares, and so that's a place where we've historically done that. But I definitely would highlight that we do think of dividends, taking care of the balance sheet, you know, debt reduction and opportunity buyback is something that is part of a well-rounded program. But Brandi, you may want to just address the buyback a little more directly.

Brandi Kendall (CFO)

Yeah. Neal, I think we've been consistent with how we've talked about our capital markets priority since we went public almost two years ago now, which really was to increase our float and trading liquidity, being one of those kind of key objectives. I think we've made a lot of progress with half the company now being floated, trading liquidity up, you know, nearly 200%, but still aren't necessarily where we want to be from a liquidity standpoint relative to peers, which likely makes a Class A buyback a little less actionable in the immediate term. We obviously can still buy back our Class B private shares, which we've done in the past and would expect to do so in the future, which accomplishes the same objective of reducing the total number of shares outstanding.

Neal Dingmann (Managing Director)

Great details. Thank you all.

Brandi Kendall (CFO)

Thanks, Neal.

Operator (participant)

Thank you. Our next question is from Roger Read with Wells Fargo. Please go ahead.

Roger Read (Managing Director and Senior Energy Analyst)

Yeah, thanks. Good morning. Maybe follow up on your comments, David, in the opening on the ability to continue to do acquisitions. Maybe just give us an idea of what, what the market looks like out there. I mean, something similar to what you've been doing, a step out into a different area as a possibility. And then as an addition to that, higher interest rates than what you faced in the first couple of years of this strategy, how does that factor in how you think about funding transactions, or are you seeing valuations adjust to a higher interest rate environment?

David Rockecharlie (CEO)

Yeah. No, great, great questions, and, again, thanks for joining us, Roger. I'll start, and Brandi and Clay are here with me as well and very actively involved in that part of the business and can contribute after I finish. A couple of things. We still see a very active market. It's consistently been a $50-$100 billion a year market, my whole career, and we still see that. And frankly, activity by others tends to create more activity. And so one of the things we did try to highlight this time is large cap consolidation is likely to be good for us.

We feel very good, so I think we have a good pipeline of opportunities looking forward, and we do like where the macro is as well. Turning to operationally and your comments around portfolio and focus, I think we're very good and getting better in our core areas, and there's a lot still to do there. So I think you can assume we'll continue to do what we have shown we would do, which is look to expand our core areas. We are value-driven, and so if we are good at something, have the skills to do it, and we can find great value, you know, we certainly think that we have the broadest ability in the sector in terms of scope of what we look at.

But I wouldn't take that as a hint that we're going to get distracted. I think we like what we're doing. And then lastly, I'd say a couple of things on the financial markets. We believe as long as you're patient, that valuations both on the equity and debt side, will translate into the M&A market, and they typically do relatively swiftly. We're starting to see that happen. And I'd say one of the great things about the way we're positioned today, we've proven our ability to access the public markets. We've grown our presence there. And while the cost of debt has gone up, you know, we're a BB company now, and we've been able to push our relative cost of capital down over the time period as a public company.

I think you should just expect that we're continuing to try to do all of those things. The only reason we will transact is because we think it will create significant value enhancement for the shareholders.

Roger Read (Managing Director and Senior Energy Analyst)

Great. Thank you.

Operator (participant)

Thank you. Our next question is from the line of John Abbott with Bank of America. Please go ahead.

John Abbott (Research Analyst)

Hey, good morning, and thank you for taking our question. Our two questions are really about 2024. So, you know, in terms of your sort of production outlook. So, you know, based off your results during this quarter and for your 2023 guidance, and you're pulling activity, some activity in from 2024, and Brandi, you gave us a range of 155,000-160,000 BOE per day for 2024. Just given the acceleration of activity into 2023, why wouldn't we think that you shouldn't be at the high end of that production range?

Brandi Kendall (CFO)

For 2023?

David Rockecharlie (CEO)

2024.

John Abbott (Research Analyst)

Into 2024. A lot of earnings out there, so, yeah.... You have accelerated activity into 2023, and your guidance range for 2024 is 155,000-160,000 BOE per day. Was the accelerated activity, why wouldn't you be at the high end of that production range?

Brandi Kendall (CFO)

Hey, John, it's Brandi. So I think, as David hit on, right, we've had great operational execution all year from a drilling and completion standpoint. I think that sets us up incredibly well as we look into 2024. So I mean, I think it's, we feel comfortable just given where we sit, with our preliminary budget, that the 155-160 makes sense, relative to a capital program of roughly $600 million, which is in line with what we spent this year, despite the base production is higher. So I think that's still a fair range. I think if you end up somewhere in that range, that's good. But yeah, I think there's a chance that we could be at the top end of the range.

But we'll look to provide more formal guidance in the next couple of months on 2024.

John Abbott (Research Analyst)

Okay. Maybe I'm reaching a little bit here, but for 2024, any... You know, it looks like, okay, so you're going to end up, looks like you're going to end as in a high point in terms of production and for Q23. So any sort of color on the trajectory of production in 2024?

Brandi Kendall (CFO)

Yeah, I would expect it to be relatively consistent, both from a production and capital standpoint over the course of next year. Ultimately, it'll be impacted on when wells are coming online. But I think for now, if you modeled it, fairly consistent throughout the year, I think that's a good assumption.

John Abbott (Research Analyst)

All right. Thank you very much for taking our question.

Brandi Kendall (CFO)

Thanks, John.

Operator (participant)

Thank you. As for the question, the conference of Crescent Energy has now concluded. Thank you for your participation. You may now disconnect your line.