Expand Energy Corporation (EXE) Q3 2021 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Southwestern Energy call discussing its third quarter results and the acquisition of GEP Haynesville. Management will open up the call for a question-and-answer session following prepared remarks. [Operator Instructions]. I will now turn the call over to Brittany Raiford, Southwestern Energy's Director of Investor Relations.

Thank you, Tom. Good morning, and thank you for joining today's call. Joining me today are Bill Way, President and Chief Executive Officer; Clay Carrell, Chief Operating Officer; Carl Giesler, Chief Financial Officer; and Jason Kurtz, Vice President of Marketing and Transportation. As a part of this morning's announcement, we also posted a new investor presentation to our website. Before we get started, I'd like to point out that many of the comments we make during this call are forward-looking statements that involve risks and uncertainties affecting outcomes. Many of these are beyond our control and are discussed in more detail in the risk factors and the forward-looking statement sections of our annual report and quarterly filings with the Securities and Exchange Commission and the forward-looking statement sections of the respective announcements. Although we believe the expectations expressed are based on reasonable assumptions, they are not guarantees of future performance, and actual results and developments may differ materially, and we are under no obligation to update them. We may also refer to some non-GAAP financial measures, which help facilitate comparisons across periods and with peers. For any non-GAAP measures we use, a reconciliation to the nearest corresponding GAAP measure can be found in our earnings release available on our website. I will now turn the call over to Bill Way.

Thank you, Brittany, and good morning, everyone. We really appreciate you joining us on the call today for our discussion. We delivered another strong quarter, both financially and operationally. In addition, we financed, closed and integrated the Indigo acquisition, a transformative opportunity that positions us well in the 2 premier U.S. natural gas basins. Our dedicated team has worked closely and incredibly hard over the last year to execute our strategy, many of whom are listening to this call. By way of one example, we just surpassed 4 trillion cubic feet of responsible natural gas production in our Pennsylvania asset in the Northeast Appalachia, which continues to deliver great value to the company. So to my team on this call and across the company, I congratulate you on all that you do on a job well done, and thank you. Our strategy is comprised of 4 interdependent pillars including creating sustainable value, protecting financial strength and progressing our leading operational execution. Results delivered by our teams in these first 3 pillars allow us to execute the fourth pillar, capturing the tangible benefits of scale. Our strategic intent is to be the preferred investment vehicle for institutional investors to gain exposure to responsible natural gas development. The acquisition of GEP announced earlier today directly supports that intent. It also meets all the criteria of our disciplined acquisition framework as any deal must. GEP brings large-scale core Haynesville assets with stacked pay Haynesville and Middle Bossier inventory. The 226,000 net effective acres are adjacent to SWN's newest operations in the Haynesville. The addition of GEP increases SWN's total production to 4.7 billion cubic feet a day equivalent per day. Including 1.7 Bcf per day from Haynesville, making us the largest operator in the Haynesville. It will also increase SWN's expected year-end 2021 SEC proved reserves to approximately 21 trillion cubic feet equivalent. The transaction adds 700 economic locations to our high-quality inventory. With the scale, adding acquisitions, well cost reductions, performance enhancement and commodity price improvement, the company now has approximately 6,800 economic locations across the enterprise. Given the strength and complementary nature of our portfolio, we expect to have investment activity across all of our operating areas in 2022 as part of our maintenance capital program. With the expanded exposure to the LNG corridor and the growing demand centers along the Gulf Coast, this acquisition will further improve the company's overall basis differentials and increase our margins. The access to high-value global markets will supplement our premium Appalachia outlets. As part of our leading ESG practices, we plan to implement a responsibly-sourced gas program in the Haynesville. Beyond the clear ESG sustainability benefits, we believe that responsibly-sourced gas will ultimately lead to enhanced margins and improved economics from greater access to global markets. Turning to the terms of the deal. The $1.85 billion total consideration is comprised of $1.325 billion in cash and approximately $525 million of SWN stock. The cash portion will be debt financed, and the equity portion will consist of 99 million shares of SWN stock calculated per the agreed 30-day VWAP of $5.28 per share as of November 3. We have a clear and appropriately derisked path to reach our revised lower debt and leverage targets announced in our press release, and Carl will more fully discuss this in a minute. The purchase price implies an enterprise value to projected '22 EBITDA of 2.9x, a meaningful discount to where SWN currently trades and at a discount compared to other recent natural gas consolidation transactions. Given this attractive valuation, we expect the transaction to be immediately accretive to SWN's margins, returns and key per share metrics Cash flow per share, free cash flow per share and earnings per share all increased by approximately 15%. Included in these accretion estimates are the already identified $25 million of synergies in 2022. We expect our synergy capture to increase to $50 million per year, starting in '23. The integration of GEP will be enhanced by our recent experience integrating Indigo as well as with a 6-month transition services agreement negotiated with the seller. We expect to close the deal by year-end, subject to customary closing conditions, including regulatory approvals. Now let me turn the call over to Clay Carrell, who will provide an update on the quarter and operational perspectives on the GEP acquisition.

Thanks, Bill, and good morning. Before I get to some operational details related to the acquisition, I want to touch on the third quarter results where our team hit the ground running in Haynesville and continued to deliver in Appalachia. In 3Q, which included 30 days of Haynesville, we reported total production of 310 Bcfe at the top end of our guidance range. We exited the quarter producing 4 Bcfe per day including 1 Bcf per day in Haynesville. Total production included 106,000 barrels per day of NGLs and oil, which is flat with the previous 2 quarters. During 3Q, we averaged 4 drilling rigs in Appalachia, and there were 6 rigs running in the Haynesville with 2 completion crews in each area. We have now been operating the Haynesville for 2 months. Our new employees in Houston and Louisiana have been integrated into the business, and operations have been running smoothly. Our initial focus in Haynesville has been to leverage the operational expertise that our combined teams bring to the table. In September, we brought our first 5 wells online, all of which were in the Middle Bossier with an average initial production rate of 24 million cubic feet per day and an average C-Lab of approximately 6,300 feet. These results are indicative of the quality of our existing Haynesville position. And with today's GEP acquisition announcement, we increased the scale of that high-quality position. As Bill mentioned earlier, the proximity of the GEP acreage to our existing Haynesville position will allow for operating economies, marketing synergies and contract optimization, realizing the benefit of our enhanced scale. GEP is currently running 4 rigs and 1 completion crew and expect to exit the year running 3 rigs. We will issue formal 2022 guidance early next year and maintain our commitment to maintenance capital program with investment of approximately $1.9 billion holding production flat. I'll close by acknowledging the continued high-end performance of our technical and operating teams who are driving improved performance through efficiency gains, innovation and knowledge transfer. We have established a track record of leading operational execution in Appalachia, and we expect to do the same in Haynesville as we move forward with our 2022 development plan. I'll now turn it over to Carl to discuss the financial highlights.

Thank you, Clay. During the quarter, we generated $105 million of free cash flow. We expect our free cash flow to materially increase in the fourth quarter. We ended the third quarter with $4.2 billion in total debt, reducing our leverage by 0.4x to 2.2x. Turning to today's announcement. We plan to finance the acquisition in a manner that, A, protects our financial strength while, B, minimizing equity dilution. From a debt perspective, the deal is essentially leverage-neutral with our expected year-end leverage near 2.0x. And as Bill referenced and I'll discuss further, we have a clear and appropriately derisked path to materially lower total debt and leverage ratios. From an equity perspective, the transaction should drive immediate double-digit accretion across key for share metrics. Given our increased scale with the current commodity price outlook, we would expect approximately $2.3 billion in free cash flow over the next 2 years. We intend to apply our disciplined hedging approach to the acquired production, which should go a long way to safeguarding this expected cash flow. Using this cash with debt repayment would reduce our total debt to approximately $3 billion and our leverage ratio to near 1.0x. Our debt would then be at the low end of our announced $3.0 billion to $3.5 billion target range and our leverage ratio at the lower end of our newly announced 1.0x to 1.5x target range. We added the absolute debt range to the updated leverage target range to provide better clarity to the market about how we're thinking about the right-hand side of our balance sheet. Importantly, as we approach our total debt and leverage targets, we would look to initiate a return of capital program. The company's hedging strategy remains a core part of our enterprise risk management process. We would like to clarify the execution of some aspects of our hedging approach. Given the company's improved financial strength going forward, we will target hedging at a level sufficient to cover the company's expected costs and capital program, assuming conservative pricing on unhedged production. In general, with this dynamic construct, our hedging levels will shift lower or higher inversely with commodity prices and directly with changes to our cost structure and capital investment. We believe our hedging approach protects the company's financial strength while retaining appropriate exposure to potential commodity price upside. This concludes our prepared remarks. Please open the line for questions.

[Operator Instructions]. The first question comes from Holly Stewart with Scotia Howard Weil.

Maybe first one, Clay, I think you mentioned consolidated CapEx of $1.9 billion. First, I guess, is that right? And then could you allocate out for us what GEP was expected to spend this year?

So definitely, the $1.9 billion is the correct number. We expect to have capital spend in all areas as we move into 2022. I don't have what their full year 2021 capital number was. We know that 4 rigs are running right now, and that's how they'll exit the year.

Yes. Holly, we'll put out our '22 plan in the first quarter like we usually do. And even the $1.9 billion is just directional at this point. What we will be as a maintenance capital program enterprise -- for the enterprise.

Okay. And maybe, Bill, just to follow on to that point. I believe that GEP and Williams have a JV to develop a portion of its Haynesville and have put out some pretty big growth plans associated with that. How should we reconcile maybe that with your plans on GEP's acreage?

Yes. I think -- just for clarity, and you can check with them later if you want to. But GEP acreage that you're talking about is in a separate company than what we are dealing with. It's never been a part of the acreage that we acquired. It's -- they call it GEP 2. It's a separate deal with Williams. So we're not privy to any of that because it's not something that we looked at, and that's not a change from any part of this whole acquisition that's always been carved out. It's a relatively new arrangement.

The next question comes from Jeoffrey Lambujon with Tudor, Pickering, Holt.

First one, I just wanted to ask about the puts and takes on the pro forma headline metrics for 2022 in comparison to how you're thinking about the business pre-deal. I do appreciate the per share commentary on the change in free cash flow, cash flow and EPS. But just since the last time, I think the pre-deal estimates for 2022 were run at something like $2.75 gas. I was hoping you could just give us a sense of how some of those metrics on Slide 10 for CapEx, free cash flow leverage, we're tracking, again, pre-deal for next year at $4 gas.

Yes, great question. And you pointed out, Jeff, that the metrics that are on slide, I think Slide 10, as you referenced, or $4 gas, and so definitely accretion on the free cash flow side and free cash flow on all of the per share metrics leverage neutral. So we feel really comfortable that the deal progresses our financial strength and fits right in line with our strategic framework there.

Okay. I'll just circle back on that after the call. The second question is on free cash flow use. I just wanted to kind of understand the priorities as you get kind of closer to that 1.5x level at the top end of the sustainable range that you all updated. Obviously, getting there closer to year-end 2022. As we move towards that time frame, should we think about free cash flow allocation as 100% dedicated to the balance sheet? Just curious on how that balances or where you might be on shareholder returns and when that might start to enter the discussion as you integrate the asset base.

So you correctly -- I think I interpreted and started the question out, that when we achieve the levels of debt and leverage that we've put out in our new press release, we have other options. Until we get there, we are committed to bringing that debt down. As Carl said in the past, it is appropriately risked or derisked and cleared. Once we have $3 billion to $3.5 billion of debt and 1 to 1.5x leverage, then obviously, our attention shifts to -- appropriately to can we return -- how do we return capital to shareholders. And then you open up the aperture a bit wider and you talk about dividends, you talk about share purchases, a number of different ways that we do that, and that would be our intent.

The next question comes from Doug Leggate with Bank of America.

Unfortunately, this is a pretty busy morning. This is John Abbott on for Doug Leggate. Just a couple of questions here. So you've done 2 deals, you'll provide your budget in early 2022. Just speaking from a high level, given your proximity to the Gulf Coast with your Haynesville assets, how do you -- how do we think about -- how should we think about the opportunities for potential margin expansion? You have some FT agreements up in Appalachia, but what is the ability when you think about those agreements to potentially shift activity to the Gulf Coast?

Yes. The headline for every year when we do our planning and our budgeting, as you well know, is we take our portfolio of drilling opportunities with an end game being a maintenance capital-type program across -- from an enterprise perspective. And we, again, strip, do run economics on all of those, and we force-rank them, first on economics and then on any other lever that one must deal with opportunity to improve the margin by moving a little more over here, a little more over there, staying flexible because of vertical integration where we can shift on the fly. But we have no constraints upon us, for example, insufficient transportation or extra -- a lot of extra transportation. We have no MVCs. So -- and we actually have quite large banks in front of those MVCs, so quite well protected. So we have a lot of flexibility. And we will take the changes in the commodities through the -- into winter, a lot of these other thoughts and ideas, the rate of how we want to grow midstream gathering faster. Or you don't want to create sharp bins of investment and overcapitalize a certain area at the expense of another. So we take a look at all of that. One of the things we know is that the quality of the inventory in the last 3 deals we've done are complementary such that we'll have some level of activity in each area. And the result of that, when you add it all up, it's focused on maximizing value and optimizing the generation of free cash flow while maintaining a maintenance capital level production profile.

Right. Just sort of sticking with the marketing theme here. So with GeoSouthern, I mean do they basically have firm sales agreements? Do they have any FT? And then when you sort of think about Indigo and then GeoSouthern together, could you talk about the opportunities to improve marketing along the Gulf Coast?

Yes. So this is Jason. I manage the marketing group. That's a great question. When we look at GeoSouthern, they roughly have 600,000 a day of FT on 3 different pipes. And then when you roll that in with the Indigo asset, we have probably over -- just over 2 Bcf a day of FT among the 2 companies on a pro forma basis. But really, those assets, Clay mentioned it earlier, they're very complementary from a marketing perspective. meaning that there's synergies between the downstream pipelines and the gathering system. So there's the ability to lever into multiple pipelines where we have transport from the same gathering system. So there's optionality and flexibility to continue to build out that transportation and future sales portfolio.

And so strategically, we've gained access, greater levels of access to the important Gulf Coast market, where we already have 65% of our volume able to reach there. We have rightsized and rightpriced transportation. And then the Gulf Coast market and the LNG market bring all kinds of opportunities to the table, and we'll continue to optimize those as part of those plans we'll talk about in February as well.

The next question comes from Charles Meade with Johnson Rice.

I think this first question maybe for Carl. In your prepared comments, Carl, you mentioned that you want to -- I believe I heard you say that you want to finance this deal in a way that limits equity dilution. So should we interpret that as being -- and I recognize you may not want to negotiate with yourself in public and so feel free to punt on this if there's no color you want to add. But should we interpret that as saying that there's no equity on the table for this $1.325 billion? And then secondly, is there any kind of guidance you want to give us on what -- how many tranches or what form that longer-term financing of that bridge will take?

Sure. I think our press release made clear that we had committed financing to support the $1.325 billion consideration. So we don't anticipate issuing public equity to fund that portion of the purchase price. So I'm happy to make that clear. And no, it's not negotiating against ourselves. And then I think it's easily deductible. From our commentary with the cash flow that we expect to generate over the next 2 years as a company, I would anticipate a meaningful portion of our permit financing to be prepayable. Sure, I don't need to post $1.325 billion of debt against this asset permanently.

Right, right. Well, that's where I was leaning, but thank you for the clarification, Carl. And then if I could ask a question about the assets, and I'm wondering if maybe you guys can help me and other people learn a little bit more about this play. And that you've come to this play with fresh eyes sometime over the course of '20 or '21, and you made 2 deals here. And as I look at the map that you laid out there, the first deal, the Indigo was more kind of biased to the south and west, and this deal is a little bit to the north and east. And I'm wondering if you can give us a sense of how the kind of relative strength or relative attractiveness varies across that position and with a particular mention of how the Bossier prospectivity, where it kind of terminates or start to attenuate as you move north.

Yes, I'll take that. So starting with your Bossier comment, we are talking about 700 inventory locations here, and it's close to a 50-50 split. There's a little more Haynesville, but it's close to a 50-50 split across the position, very similar to the Indigo position that we picked up. When you look at the map, the core of the GEP acreage fits pretty nicely in and around the acreage that we picked up from Indigo. When you look at the map, that southeast part of DeSoto Parish, and the corner of Natchitoches Parish is where we've been seeing the really good Haynesville well results, best in the basin, Haynesville and Middle Bossier that a lot of the industry public data has also reported on. And when you look at the color combination here, Indigo had a big grouping of acreage, and then this GeoSouthern acreage hits on either side of that, which gives us more continuity across that really prolific part of the acreage position. When you go north a little bit, that kind of fills in a whole more in central DeSoto Parish. That's very high-quality Haynesville Middle Bossier. It's next to the WIM area that we picked up in the Indigo acquisition, which is in Louisiana but closer to the western part of Louisiana, all similar performance and depths in that area. And then we're picking up a new area in the northern part of Red River Parish, which is also high quality performance, a mixture of Haynesville and Middle Bossier. And essentially, all of the position is greater than a 2 Bcf per 1,000 EUR. And then when you go down towards that Southeastern piece that both deals connect, that's even better than the 2 Bcf per 1,000 EURs. So we really like the complementary nature of the GeoSouthern acreage after already owning the Indigo position.

The next question comes from Kashy Harrison with Piper Sandler.

Congratulations on the deal between GEP, Indigo and Montage. I'm sure your team has been extraordinarily busy over the past 1.5 years.

Appreciate that.

So my questions are mainly financial-related and maybe a sprinkle of strategy as well. So I was wondering if you could provide some clarification on just pricing and risk mitigation on this deal. Carl, I know you talked about maybe the hedging philosophy is evolving a bit. But as we think about this deal specifically, there's $1.3 billion worth of debt, and so I'm wondering if you actually do intend to hedge this particular deal quite aggressively just to make sure you don't get caught in an unfavorable position if the cycle turns if we don't have weather or something else goes as unexpected.

It's a fair question. I think what we're prepared to say, we've already really said is we recognize it's a large quantum of debt. It puts our pro forma debt quite a bit higher than our target debt range. We're committed to getting that target debt range, and we have a pretty disciplined hedging strategy that's part of our overall risk mitigation framework. I'll just leave it at that.

And then I think the company's cash flow generation is at the scale we're at now is estimated to be quite robust.

Exactly.

And all of that we've earmarked, if you want to get really close or really clear, we've earmarked all of that free cash flow to go to pay down debt until we reach our target. And that discipline is a firm one. No and then if you think about enterprise risk management and the fact that our -- one of the tenets of that is managing commodity price and basis risk we will continue to do what we are known for, and that is managing the risk associated with the capital outlays we have and other costs. So yes, there will be hedges across our portfolio, and we do that on a rolling 3-year basis, and that practice will continue, and then the commodity price that is out there enables us to hedge at different bubbles.

Got you. And then maybe either for Bill or Carl. Just a quick clarification on the definition of sustainable leverage. So when you talk about getting to a specific 1 to 1.5x sustainable leverage, does that contemplate using a price beneath the strip at any given point in time? Or does that take trough cycle pricing in consideration? And really, where I'm going with this is, does it make sense to maybe go beyond the $3 billion to $3.5 billion just to make sure that, hey, if the cycle eventually turns and we're looking at $2.50 gas for whatever reason, Southwestern would be in an advantaged position to make move strategically within the down cycle?

It's a great question. I'll answer it in a couple of ways. Most directly when we talk about long term through the cycle sustainable leverage ratio range of 1 to 1.5, that's sort of where we'd like to be to maintain an appropriate balance financial safety and still have an appropriate cost of capital. We don't want to be over-equitized. And so we would look to manage our business in that leverage range, i.e., we got well below 1. We try and get back above 1 and then if we got above 1.5 and trying to get back down into that range. Now your second -- so I would think about that as an ongoing target despite commodity prices, up, down. Now the other element which is new for us to guide to is what is our target quantum of debt. And with that, that $3 billion to $3.5 billion was predicated on a level of debt that we are quite comfortable with the leverage in the low commodity price scenario. We run that depending on what strip or what prices you use, really low price is that level of debt doesn't get as -- we approach 2x, but not much more than that. And that's something that we are comfortable weathering down cycle with from a leverage perspective. So that's basically how we zeroed in on that range for total quantum of debt with this new pro forma business.

This concludes our question-and-answer session. I will now turn the conference back over to Bill Way for any closing remarks.

Well, thank you for being here today and joining us on our call. We're very excited about the progress we've made in transforming the company, and I hope the scale of the company shows through on -- as you look at our materials. The activity that we've done around growth and scale, however, is strongly supported by those other 3 pillars I talked about and making sure that we're protecting our balance sheet and, clearly, looking after our financial strength, our costs and having the shareholder in front of our mind all the time. So as we continue to take this next step, we'll keep you posted, and we look forward to having conversations on our next call. With that, thank you for joining us.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.