Mach Natural Resources - Q3 2023

Transcript

Operator (participant)

Greetings, and welcome to the Mach Natural Resources quarterly earnings call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Depending on what you require operator assistance during the call, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. At this time, I'd like to turn the call over to Daniel T. Reineke, Executive Vice President of Business Development. Thank you. You may begin.

Daniel Reineke, Jr. (EVP of Business Development)

Thank you, Daryl. Good morning, everyone. Thank you for joining our call today to discuss Mach Natural Resources' third quarter financial and operational results. During this morning's call, we will be making forward-looking statements that cannot be confirmed by reference to existing information, including statements regarding expectations, projections, future performance, and the assumptions underlying such statements. Please note, a number of factors will cause actual results to differ materially from our forward-looking statements, including the factors identified and discussed in our press release yesterday and in other SEC filings. Please recognize that except as required by law, we undertake no duty to update any forward-looking statements, and you should not place undue reliance on such statements. We may refer to some non-GAAP financial measures in today's discussion.

For reconciliation from non-GAAP financial measures to the most directly comparable GAAP measures, please reference our press release, which is available on our website, and our 10-Q will be available on our website when filed. With me on the call today, Tom Ward, CEO, and Kevin White, CFO. Tom will give an introduction and overview, and Kevin will discuss our financial results, and then we will open up the call for questions. With that, I'll turn it over to Tom.

Tom Ward (CEO)

Thank you, Daniel. Welcome to the Mach Natural Resources first earnings update. I will keep my remarks brief. However, I do want to emphasize and congratulate all the Mach employees on the successful offering of MNR. The public offering of Mach Natural Resources units is the largest upstream energy IPO since 2017. We are appreciative of the efforts of our employees and the help of Stifel and Raymond James to make the offering a success. Mach was established in 2017 with the idea that there'd be a time coming in the near future where cash flowing and producing assets would be in distress. We focused on the Anadarko Basin, since there was a significant discount to buy producing assets because of past underperformance and drilling.

Obviously, a producing asset should not carry the burden of a misguided drilling program, but that is exactly what has happened and continues today. Once capital left the area, it's been reluctant to return, thereby giving us the opportunity to acquire assets at a discount to PDP PV-10 in an area rich in hydrocarbon and midstream development with a long history of production. We did take advantage of the opportunity. With the acquisition of Paloma entities, we will have spent approximately $1.8 billion since early 2018. Our track record of accretive acquisition remains unequaled during this time period. In fact, we paid more in distributions than the total of equity invested and have been able to simultaneously keep our leverage low.

In fact, Mach has built a company from scratch to what is post Paloma, a company with nearly 85,000 BOE per day of production, more than 4,600 operated wells, and over 1 million acres of HBP land. We achieved this success by abiding by four guiding principles. Number one, maximizing cash distributions to our equity holders. This strategy is designed to ensure all decisions company-wide result in accretion to our distributions. Number two, disciplined execution with accretive-only acquisitions. We are committed to executing only acquisitions that are accretive. The assets are purchased at a discount to PDP PV-10 and have meaningful upside in undrilled locations. Number three, maintain financial strength through low leverage. We're focused on maintaining our financial strength through all commodity cycles by maintaining a low debt/EBITDA ratio of 1x or less. Disciplined reinvestment rate, that's number four.

Our disciplined reinvestment rate of less than 50% optimizes the distribution to unitholders. By following these guiding principles, we've been able to produce consistent results through all commodity cycles. Our goal is to maintain production and revenue while understanding that our distribution is variable. In other words, distributions will be better in times of higher prices than lower prices. However, we do not plan to repeat the sins of the past upstream MLPs by fixing distributions and amassing too much leverage. We also believe that properly hedging during times of having leverage closer to 1x to protect future cash flow is prudent with our business philosophy. Therefore, post Paloma, you can expect us to be hedged 50% for the next 12 months on oil and natural gas.

We also plan to hedge approximately 25% in months 13 through 24 until we pay down our debt to under 0.5 turn of leverage. We will continue to focus on making acquisitions, which are accretive to our distribution, as long as capital and opportunities are available. The Anadarko Basin remains one of the few places where both of these are available only to a small group of potential buyers. We believe we can acquire our fair share of the remaining billions of dollars of inventory that will be coming forward in the next few years while sticking to our guiding principles. If we cannot, we can lean more on our large drilling inventory for reinvestment purposes to maintain our distributions. With regard to the third quarter, MNR generated strong cash flow from better than expected production.

We controlled our costs, which resulted in a cash reinvestment of less than 50%, coupled with strong financial results. We look forward to the fourth quarter results, along with the Paloma acquisition being closed. I'll turn the call over to Kevin to discuss our financial results.

Kevin White (CFO)

... Thanks, Tom. I'd like to highlight that the results that will be included in the third quarter 10-Q include only the results of Mach Natural Resources' predecessor entity, BCE-Mach III. Since the IPO and the actual formation of Mach Natural Resources did not occur until the latter part of October, in the tables accompanying the press release, we have included the core financial statements for BCE-Mach III. However, our discussion on this call will focus on the pro forma third quarter results, as if the combination of BCE-Mach I, II, and III had already occurred.

Starting first with page nine of the release, the reported production volumes of 66,280 BOE a day were stronger than expected, as Tom mentioned, at the time we prepared the S-1, and that's stronger than expected at the time we prepared the S-1, and this beat was higher across all three product streams. Gas prices were slightly higher at $2.36 per Mcf. Oil prices at $80.88, and NGL prices at $23.47, were lower than the expectations at the time of the S-1 filing. Including the $5.2 million, largely non-cash mark-to-market hedge losses, total revenues for the pro forma entity were $217 million.

With the exception of DD&A, which came in a little bit higher, our costs were per BOE, seen on page 10, came in actually lower than expectations at the time of filing the S-1. Jumping to page 14, focusing on the right-hand column of the pro forma combined results, the EBITDA at $140 million was a little bit over 5% above, and the cash available for distribution calculation, almost 9% above the expectations included in the S-1. Pro forma cash at the end of the quarter was $93 million, and pro forma debt was $174 million, with a reminder here that we used $104 million of the proceeds from the IPO to pay down that debt number.

With that quick overview, Daryl, we will turn it back to you for opening up the call to questions.

Operator (participant)

Thank you so much. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star two, if you would 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 your questions. Our first questions come from the line of Derrick Whitfield with Stifel. Please proceed with your questions.

Derrick Whitfield (Managing Director and Senior Analyst)

Good morning, all, and congrats on your strong first public quarter.

Kevin White (CFO)

Morning.

Derrick Whitfield (Managing Director and Senior Analyst)

With the understanding that you're planning to provide full 2024 guidance in February, could you speak to the degree the Paloma acquisition will be accretive to your cash flow and dividend profile on a normalized commodity deck?

Kevin White (CFO)

Yeah, Derrick, as you said, we won't be providing specific guidance until in February, but in just at a high level, thinking about a normalized commodity price environment, we do expect, you know, really across all the quarters, for the distributions to be larger than they would have been otherwise without the Paloma acquisition. We won't be sending out all of the cash that the Paloma acquisition generates, because we will use a portion of that to service our debt.

you know, as Tom mentioned, we're gonna be anxious to get our debt paid back down to a level where we're comfortable, kind of in that 0.5 turn levered, and at a, again, not quite sure what a normalized commodity price environment you're thinking of, but, you know, thinking about the numbers we were using at the time of the S-1, we'd probably get back down to that leverage number, you know, sometime the latter part of 2025 or maybe first half of 2026.

Derrick Whitfield (Managing Director and Senior Analyst)

Terrific. And, just staying on Paloma, you just articulated the plan to get leverage back down. When you think about the transaction, does it in any way limit your ability to pursue M&A of some of the West Canada Arkoma asset packages you noted come to market?

Kevin White (CFO)

No, I don't think it limits us, Derrick. I think that as long as an acquisition meets the criteria we laid out, the four guiding principles, if you can buy PDP assets at discounts to PV-10, and if we keep our leverage under a turn. But the main point is, if it's accretive to our distributions, we would continue to look for ways to make acquisitions. And we have, we're always looking as there tends to be some type of a asset for sale at all times. And as you know, most of the things we look at we're not successful in acquiring.

Paloma was very unique in that out of the 17 acquisitions we've made, only three of them have had rigs that we're able to put to work directly and have been able to make very high rates of return. The area in Canadian County, especially Southern Canadian, is some of the best drilling in the MidCon, or I would put it up really with anywhere in the country as far as rates of return.

... So we'll be focusing on a couple of two-mile or different, a couple of different formations, really, the Woodford and the Mississippian in there, two-mile laterals. But ultimately, we'll probably start out with some one-mile laterals just to make sure the rig is up and running, our team is prepared, and then continue to move into Paloma assets. So that was, Paloma was a large acquisition for us, as you know, the largest we've made. But the upside that we're able to purchase with the PDP still below PV-10 made it very encouraging to us to move forward with it. But to answer your question directly, no, I don't think it limits what we can do.

Derrick Whitfield (Managing Director and Senior Analyst)

That's very helpful. Thanks for your color on Paloma as well.

Tom Ward (CEO)

Sure.

Operator (participant)

Thank you. Our next questions come from the line of Charles Meade with Johnson Rice. Please proceed with your question.

Charles Meade (Research Analyst)

Good morning, Tom, Kevin, and Daniel. Tom, I think this may be for you to elaborate a bit on the point you or some of the points you were just making. When I look at the Paloma assets, or really more the Paloma locations, to me, they seem to me like they're a departure from most of the drilling that Mach has done, in that, you know, these are kind of vanilla, unconventional, even though that might seem a little bit of a contradiction. They're, you know, the tight rock, big fracs, that sort of thing.

Whereas in the past, you guys, I think, have been more, you know, I just think about what you're doing in the Oswego, which is kind of a more natural, high porosity, high permeability rock. So I'm curious, my question to you is: How do you guys internally, does this feel like a new leg of the stool for you, or is this just kind of a natural extension?

Tom Ward (CEO)

I think it's fair to say it's a new leg of the stool. I feel very comfortable drilling conventional assets that have very low cost and very, very low CapEx, but can eke out a very good rate of return through saving costs. Paloma, the drilling along the deeper Anadarko, especially, I guess, in the volatile oil stage is deeper, it's expensive. These wells are gonna cost $8.5 million. We'll spend $88,000 a stage to complete them.

We have a team, though, in place that's been at several public companies, and that I've worked at, and a couple of public companies I worked at, and other companies that have had a lot of experience throughout the MidCon. So, you know, drilling ultra-deep wells, if they're vertical or drilling horizontal wells with very high pressure, and being able to frack them and stay in zone are nothing that's new to the team. It is somewhat new for us, just because our focus was on the free cash flow that came with acquisitions and not necessarily on the drilling phase. And that's still the...

I think that is still what we do, because we do lean on our free cash flow that comes from the PDP. However, with Paloma, the rates of return are just in a place that makes it hard not to move forward with a drilling program. But also, keep in mind, we only have one rig, so we're not coming out here with five rigs trying to drill out the reserves and grow them.

Charles Meade (Research Analyst)

Got it. Thank you for that, Tom. And then,

Tom Ward (CEO)

Yeah.

Charles Meade (Research Analyst)

A second question or a follow-up on the M&A landscape or the A&D landscape. You know, we've, you know, it's industry standard to talk about PV-10, but the truth is that, you know, debt is gonna cost you more than 10% right now. And so I'm curious, have you seen a kind of a softening of price expectations as you look across the Anadarko in recognition of the relatively high cost of debt right now?

Tom Ward (CEO)

Yes. I do think that in times of higher prices, we focus more on drilling. We're not as successful at making acquisitions. But especially if you have any kind of longer-term view, that gas is going to be north of whatever you want to call the strip today, $3, which I do. I think you're buying an asset that's for a very long period of time, that would be inexpensive. But we do see softening, and in terms of times, whenever prices move back like they have recently, that it really opens up opportunities for us to make acquisitions.

I'm not saying we'll be able to, because we are very focused on making sure they're accretive to our distribution, and that we want to watch our leverage. So keeping under a turn of leverage is important.

Charles Meade (Research Analyst)

That's great color. Thanks, Tom.

Tom Ward (CEO)

Thank you.

Operator (participant)

Thank you. Our next questions come from the line of Michael Scialla with Stephens. Please proceed with your questions.

Michael Scialla (Managing Director of Energy Equity Research)

Hi, good morning. You had a nice production beat on the quarter. Just wanted to see if you could talk about the reason that came in a little bit higher than anticipated, and also, as you look into the fourth quarter, do you still anticipate a production decline from the third quarter level and maybe the cadence production next year? I assume the Paloma volumes are probably expected to come down some from, I guess you'd call it an inflated sales mode level.

Kevin White (CFO)

Yes, we did have a good quarter, and this just was really due to just having better results than what we modeled in the S-1. I think as we move forward, you know, we did move from 3 rigs at the end of the third quarter into 2 rigs in the Oswego in the fourth quarter. So, our production and... But we also capture that in our modeling. So really, there's no really good reason other than we just ran across a string of good wells that produced above what we expected.

Michael Scialla (Managing Director of Energy Equity Research)

And then, Tom, as you look into next year, any help you could provide on the cadence of production there?

Tom Ward (CEO)

Yeah, Michael, on production, you know, obviously, we'll have the Paloma assets that'll be folded in at year-end. We will pick up a third rig to provide some extra production from the third rig. You know, as we look out through the balance of next year, you know, there is obviously some flush production that's coming on with the acquisition, similar- not too dissimilar from the production that we had in Q3 from running more rigs in the Oswego earlier this year.

So, you know, through the calendar year 2024 on a three-rig program, when we exit the year, we've kind of looked at that as being kind of where we will hit our stride on a normal run rate with a three-rig program.

Michael Scialla (Managing Director of Energy Equity Research)

Okay. And Daniel, would you anticipate kind of first quarter being the high watermark for production for the year? I realize you haven't given your 2024 production guidance yet. Just sort of looking for a general shape of the production profile.

Daniel Reineke, Jr. (EVP of Business Development)

Yeah, I think that's fair to say, is that the Q1 of next year will be the high water on production, just similar to Q3 being the high water without Paloma. Q3 of 2023 being the high water, it'll now be Q1 of 2024.

Michael Scialla (Managing Director of Energy Equity Research)

Great. And, Tom, you mentioned you plan to hedge 50%. I think that was for the next 12 months on average. Where do you stand in that hedging process right now?

Tom Ward (CEO)

Yeah, we're over two-thirds complete with hedging going forward. So, and you're right, it was 50% over the next 12 months and then 25% in 2013-2024. So, yes, we have been actively hedging as we after we signed the Paloma acquisition, and feel that's prudent with getting our leverage up closer to 1x.

Daniel Reineke, Jr. (EVP of Business Development)

Yeah, Michael, you'll be able to find an update on our hedging with subsequent disclosures in the 10-Q.

Michael Scialla (Managing Director of Energy Equity Research)

Great. Appreciate it, guys. Thank you.

Kevin White (CFO)

Thank you.

Operator (participant)

Thank you. Our next question has come from the line of Grant Atkins with Raymond James. Please proceed with your questions.

Grant Adkins (Senior Equity Research Associate)

Everyone, congrats on your kind of introductory quarter. So I'm gonna start on the distribution and kind of how we should view it going forward. For the fourth quarter, I guess, is it safe to assume you're gonna be near, I guess, your 100% of that distributed cash flow? And then, looking to 2024, is there some sort of, like, vague structure, at least 50% will be distributed or anything like that, or any color we could get there just to kind of judge the debt withholdings versus your payout?

Kevin White (CFO)

Yeah, of course, we are not updating guidance until February for full year 2024. So, you know what? I think we want to reemphasize here in the... Well, in the fourth quarter, yes, we will essentially distribute all of the free cash that we generate for the fourth quarter. You know, once we close Paloma, then there'll be a little bit higher debt servicing that will be required. But we do want to emphasize, too, as we go forward in 2024, it is basically a 100% variable distribution, again, based on, you know, what commodity prices turn out to be. We will obviously have a larger percentage of that hedged as we go into 2024.

But the 2024 calculations again will be variable depending on commodity prices, and then, you know, basically what the, you know, we set aside to service both the principal and interest on the new first-lien term loan.

Grant Adkins (Senior Equity Research Associate)

Okay, thank you. And then shifting gears kind of towards Paloma, how does, like, your activity levels, I suppose, change? Like, one rig on the Paloma assets as compared to one rig in the Oswego. I would presume your Oswego, you're drilling a little bit faster up there, just given the kind of depths and challenges you face up there. But any color on that would be great.

Daniel Reineke, Jr. (EVP of Business Development)

... Yeah, I think that's a fair assessment. You know, the Oswego drilling is about twice as fast, but it is less. So if you think about an Oswego rig line versus a rig line running in Paloma with different working interests and such, the rig line in both of those, on an annualized basis, will be somewhat comparable on a net CapEx basis. And again, in February, we'll give more detailed guidance on that, when we start putting locations on a map.

Grant Adkins (Senior Equity Research Associate)

Great. If I have one more, just kind of on service costs, how do y'all feel like things are trending? You've had flat rigs, I guess, in the U.S. for a little while now. Are y'all, do you all feel like that could be a tailwind moving into next year?

Tom Ward (CEO)

Well, we are down. So just using the Oswego as an example, in 2021, it only cost $1.8 million to drill a 1-mile Oswego well. That moved up to about $3.2 million by the end of 2022, into the first part of 2023, and that's back down now to $2.75-$2.8 million. We're not seeing tremendous changes lately, so it's kind of been flattening. So, I'm not able to say that we see more disinflation. It's really the could be more steel is continually moving in direction as we use up some of our inventory also.

So, I think that we're fairly comfortable with where we're projecting the costs for an Oswego well today.

Grant Adkins (Senior Equity Research Associate)

Perfect. Thank you all.

Tom Ward (CEO)

Thank you.

Operator (participant)

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Daniel T. Reineke for any closing comments.

Daniel Reineke, Jr. (EVP of Business Development)

Thanks, everyone. We appreciate everybody's time and questions this morning. Look forward to talking to you again early next year. Have a good day.

Operator (participant)

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.