Western Midstream Partners, LP (WES) Q2 2016 Earnings Report, Transcript and Summary

Good day, and welcome to the Western Gas Second Quarter 2016 Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Jon VandenBrand, Director of Investor Relations.

Thank you. I'm glad you could join us today for Western Gas' Second Quarter 2016 Conference Call. I'd like to remind you that today's presentation includes forward-looking statements and certain non-GAAP financial measures. Be aware that actual results could differ materially from what we discussed today. I would encourage you to read our full disclosure on forward-looking statements as well as the non-GAAP reconciliations that are attached to last night's earnings release and to the slides that we will reference on this call. With that, I'll turn the call over to our CEO, Don Sinclair, and following his remarks, we'll open it up for Q&A with Don and the rest of our executive team. Don?

Good morning, everyone. Thank you for joining us today. Last night, we announced our second quarter results for 2016. Our quarter was highlighted by the return of Ramsey III to full service and the completion of Ramsey IV. Additionally, we successfully accessed the fixed income market to lock in a very attractive cost of debt capital through our issuance of $500 million of 4.65% senior notes. As previously announced, we raised the WES quarterly distribution to $0.83 per unit, which is an 11% increase over the second quarter of last year. We also raised the WGP quarterly distribution to $0.43375 per unit, which is a 19% increase over the second quarter of last year. Turning to our quarterly results. We reported adjusted EBITDA of $250.6 million and distributable cash flow of $199.3 million, demonstrating another quarter of excellent performance. We delivered a healthy coverage ratio of 1.22x, which includes a receipt of $2.6 million of business interruption proceeds in the second quarter. If we were able to include all the expected business interruption recoveries occurred over the second quarter, our coverage ratio would have been 1.29x. To date, we estimate our total business interruption loss to be $21 million to $30 million. In addition to the $2.6 million received in the second quarter, we've received $13.7 million in July, which will be included in our third quarter adjusted EBITDA. The drivers behind WES' first quarter results were sequential natural gas throughput growth at the DJ, Delaware and Eagle Ford assets as well as our Granger straddle plant, partially offset by declines at Marcellus and Chipeta. Our growth in crude and natural gas liquid throughput was largely driven by additional volumes flowing through the Mont Belvieu fractionators. Our gross margin per Mcf for natural gas assets of $0.84 was $0.04 higher than the first quarter, primarily driven by a significant sequential increase of our DBM complex as Ramsey came back online. Our gross margin per barrel for crude/NGL assets of $2.03 was $0.04 lower than the first quarter, driven by changes in our throughput mix. I'm pleased to report that Ramsey V and the related facilities are both on schedule to be placed in service no later than the end of the third quarter. We continue to evaluate when we will start construction on Ramsey VI and now believe the earliest the plant will be online is in the first quarter of 2018. Turning to our 2016 outlook. We're increasing our full year adjusted EBITDA expectation to $930 million to $970 million as a result of our strong year-to-date performance. While there is a possibility of yet another partial business interruption payment in 2016, our updated guidance assumes no additional insurance proceeds this year beyond what we received in July. We're also raising our total capital expenditures range to $490 million to $530 million as a result of increased capital requirements associated with incremental activity in the Delaware Basin. The portfolio's excellent performance year-to-date has reduced WES' need for additional equity, and any future WES issuances in 2016 would, therefore, be strictly opportunistic. WGP's 2016 distribution growth rate will be 19% to 21%, depending on the size and timing of additional WES equity issuances, if any. Finally, as is customary during our second quarter earnings call, we will reflect back on WES' growth and successful business model. Over the past 8 years, WES has, at times, experienced economic uncertainty, operational issues, incredibly rare weather events and multiple commodity price cycles, including the one we're in now. Yet through it all, we have been able to generate results our investors expected, and we're extremely proud of this accomplishment. WES just delivered its 29th consecutive quarterly distribution increase, and our annual EBITDA has grown to almost $1 billion. This performance across multiple cycles demonstrates that WES has a unique combination of an outstanding sponsor, scale and a resilient portfolio of quality assets that continue to perform at a very high level. We truly appreciate our long-term investors' continued support. With that, operator, I'd like to open up the line for questions.

[Operator Instructions] The first question comes from Jeremy Tonet from JPMorgan.

This is Jeremy Tonet from JPMorgan. I was just wondering if you could help walk us through a little bit some of the drivers for the increased Q2 over Q1 this year. Springfield obviously was a part of the step-up but you guys really kind of beat us to the upside. So just wondering if you could break down any of the other -- the larger components to the beat.

Yes, I mean, systemically -- this is Ben, Jeremy. Systemically, it's growth in the DJ, Delaware and Eagle Ford, everything else kind of flat to declining. I mean, the real growth is obviously the Ramsey complex, right? Sequentially, you had virtually no volumes going through it in the first, and now we're back in business in the second. And what you'll see not only is the increase in volumes, but obviously, an increase in gross margin per Mcf sequentially.

That's great. Yes, that leads to next question as far as we've seen the margin per unit mix shift really kind of lift, and I'm guessing that this is due to the mix shift changing from wet to -- from dry to wet gas. And I'm just wondering, is the unit margin we saw in the quarter, is that kind of more of a steady rate? Or is there kind of more mix shift where you could get uplift quarter-over-quarter for the rate you're getting there?

Well, you are correct, Jeremy, that the biggest driver of our blended gross margin per Mcf is our throughput mix. And I will remind you that we've previously guided that we do expect declines at Springfield, and so that's a very high-margin asset that we do expect to start declining next quarter. However, keep in mind that probably the biggest driver this quarter was that increase in margin per Mcf at Ramsey. When you have virtually no volumes going through a plant and you're still incurring costs, you actually have negative margins, right? So that's one from negative to positive. And as we continue to ramp up the plant, hopefully that margin will even improve a little bit. So when you look at our 2Q versus 1Q, Ramsey is the key driver. When you go out beyond that, it's going to really be throughput mix. Hopefully, you'll see some benefit at Ramsey, but you will see declines at Springfield.

Great. And just looking up the guidance that you guys outlined there, it seems like the back half of '16 implies kind of a lower run rate than if you just annualize kind of 2Q. And I appreciate that there's going to be some declines at Springfield, as you noted. But it seems like there's a lot of action with the Ramsey ramp-up there. Just wondering, what drives kind of the lower end versus the higher end? Is there a lot of conservatism baked in here?

Well, we did try to be prudent when setting the initial range, right? When we look to this year, we were trying to predict the timing of the start-up of 2 processing plants and 2 new processing plants coming online that were damaged. And so we need to have a lot of conservatism since the timing will impact our results. And so far, knock on wood, things have been going as planned. Between now and year-end, I think you're right. Drivers are kind of timing and speed of Ramsey volumes, significance of Springfield declines. Obviously, we saw growth in Springfield this quarter as Anadarko got efficient with its capital and brought 40 wells online, which was -- which is a real benefit to us. So those are the things that I think can really drive low end versus high end of the range.

That's helpful. One very last one, if I could. I'm just wondering, with regard to all the activity in the Permian and Delaware, we keep hearing a lot about growth there with Anadarko and others. I'm just wondering if you could provide any thoughts for us as far as what that can mean on the water business opportunity set that you guys see, having kind of a leading position in the area that you operate there.

Jeremy, this is Don. Obviously, we'd look at the water business as a perfect bolt-on to our existing midstream business and gas and crude. If you think about it today, Anadarko is already in the water business. They are having to dispose the barrels from the wells they produce today. And so that business exists within APC. It's just not been started in WES. So we're in the middle of the process of putting that business model together and getting it in place where we can go out and offer an additional service to the producers that are behind our existing assets today. And as you mentioned, obviously, having APC and be able to build infrastructure on their behalf as well as third parties is a huge benefit to us.

Our next question comes from Kristina Kazarian from Deutsche Bank.

So quick question on my side. Don, I know you -- the press release talked about the CapEx increase and you mentioned increased activity associated with the Delaware. Can you maybe talk -- give a little more color around what you're seeing here? Any particulars that are soft?

Yes, I think there's a couple of things, Kristina, that should -- that at least we've looked at as far as how we've continued to expend capital in West Texas. One is, as Anadarko mentioned in our call today, they have 6 rigs standing up. And so that's an activity level that we continue to put midstream gathering and compression infrastructure in for as well as we've been successful in the third-party side of the business and signed some new contracts out there. And so along with those contracts, come CapEx. So those have really been our drivers as far as increased CapEx in West Texas so far.

And then on the third-party side, thoughts on further being able to capture this business you may be expecting more here?

Well, we hope so.

All right.

So it's not -- it's very competitive out there. We think our footprint and the quality of infrastructure we have as well as our relationships and performance even within, say, at Ramsey give us a distinct advantage. So we continue to pursue that business and continue to have a very high level of success.

Perfect. And then can you just provide an update on the status on the Delaware Basin express pipeline? Just remind me what I should be thinking here in terms of timing and general thoughts.

Well, I kind of start with how we look at a project. We still believe we collectively, I think, that's WES, Anadarko and the producers out in West Texas, that Waha is going to be a superior pricing hub and a quality market to have interconnectivity with. And so with -- I said -- as we said before, it's not if, it's when. Right now, in the short-term perspective, producers have ample capacity to move their gas, so there's no short-term issues that are driving the long-term decisions. The long-term decisions are really being driven on strategic development of the resources. So if you think about kind of the process producers go through, I think that the key is going to be when they set their 2017 budgets, and then they're going to start forecasting from there, which is going to be the first time in quite some time that they've had a higher price. We believe they have a higher price than they did the prior year. And we think that's going to start driving the activity and the decisions. In the meantime, we continue to aggressively work on the project.

Perfect. And one last quick housekeeping item for me. Can you talk about the remaining timing or the timing on the remaining payments you're expecting from the business interruption insurance? I know you gave me a July number, it looks like. But how do I think about the remainder of the third Q and if I'm expecting anything in 4Q?

Okay. This is Ben. As Don stated in his remarks, we're not putting any more payments in the guidance above and beyond what we've received in June and July. It's really hard to predict the timing of actually receiving a cash payment. I think an additional payment, whether it's a full payment or partial, is possible, most likely in the fourth. But I wouldn't be surprised if that got pushed into the first quarter either. It's almost a 50-50 call at this point. As we mentioned, our total claim to date is $21 million to $30 million, is the range. It's possible that, that might increase a little bit in the third quarter. We'll see about that. But it would be the delta between the $16.3 million we've received and whatever that final claim number is, is what we would expect at a later date.

Perfect. And nice job on volumes also, guys.

Our next question comes from Brandon Blossman from Tudor, Pickering, Holt & Co.

Let me start with a CapEx question. The $40 million of incremental CapEx, is that mostly related to the third-party contracts? Or is that kind of shared between Anadarko and third-party?

It's shared.

Okay. Related to that, Don, you suggested and others have as well that Delaware, in particular, is going to be a pretty competitive space for midstream. Are you seeing, say, per unit margin erosion? Or is it just a little bit more work to capture that incremental business?

We haven't seen the margin erosion. It's just people trying to decide if they want to go out and put infrastructure in place without contracts. And so you have that as a backdrop, but you continue to see -- producers understand that when you look at WES, we have over $3 billion invested just ourselves in West Texas. We are investment-grade, and they can see that we're -- we have a sustainable business model out there. And that really has helped us significantly in differentiating ourselves from some of the other competitors.

Okay. So that sounds like good news, and that's useful color. And then I'll just -- final question, more of an open question. So you guys operationally look like you're pretty close to nailing all of the goals for 2016. You got your Springfield drop done early or late last year, so full year '16 almost in terms of EBITDA growth there. Is there any other goals that you have on your plate for '16 that you're looking to execute against? Or are we kind of turning our attention to 2017?

Well, I think we're a little more superstitious than you, Brandon, so I'm not sure you'd ever hear us say that we've nailed it. Obviously, we're feeling very good about '16, given that we've adjusted our outlook. Around this time, we'll be in the budgeting process pretty soon, and our focus will be on next year.

Our next question comes from Selman Akyol from Stifel.

A couple of quick questions here. So in the Anadarko call this morning, they talked about record production up in the DJ. LOE expense down by 15%. So are you guys seeing an acceleration there?

Yes. What we're seeing Selman -- this is Don. We're the beneficiary of Anadarko continuing to increase their already, what we think, industry-standard performance from a high level to even a higher level. And so they're basically getting better performance out of the wells and the capital, and so we are the beneficiary of that. As far as any other forecast of increase, I think it would be dependent on what APC does. And as they said earlier, they have -- they feel like they have a clear line of sight to $60 crude market. And with that, as they generate incremental cash from divestitures in that commodity strip, it'll be deployed in the DJ and the Delaware as well as the Gulf of Mexico. So we -- we're cautiously optimistic of those events, but feel good about our position.

Okay. And then previously, when talking about Springfield, you mentioned that it's aided by Anadarko bringing on 40 wells. Can you just discuss sort of what your assumption and guidance there for the remainder of the year, what they do within the Eagle Ford?

In the guidance that we gave at the time of the drop, which was the multiple of 2016 EBITDA, 2017 EBITDA, et cetera, we've seen that they would complete a few more wells, and then activity would stop and you would start decline. And that's what's still in their model. Anything additional that they do will be upside to our forecast.

Got you. And then I know you talked about starting in the Delaware third-party to try to sign up additional third parties there. And I know they're partnered with Shell down there. Can you say if that's one of the potentials that you're dealing with down there? Or say, probably they have their own gathering and processing?

They do not. They utilize third parties, mainly ourselves. We have existing contacts with Shell. We always continue to try to improve and extend our commercial relationship with them, and now it's not any different than before.

Our next question is from John Edwards from Credit Suisse.

Just -- Don, you were talking about, in your prepared remarks, about there's a Ramsey VI on the way. So naturally, a question, given the opportunity to sort of expand, how many Ramseys do you see coming?

Well, that's hard to forecast on a good day. And here's how we kind of look at it today. As Ben stated, we've seen increased volumes since we brought Ramsey III and IV up, and we'll see increased volumes as V comes on. Our thought is relative specifically to Ramsey VI, and I mentioned it in the remarks is we're looking at it possibly Q1 '18. And a thought around that is you'll have producers starting to set their capital budgets for '17. They'll start giving us new and updated forecasts. If you remember from previous conversations, we can put that plant in service in roughly 12 months from when we start construction. And so we think, relative to the sequential line we're looking at installing plants at Ramsey, that, that will be the right time to look at it, which would bring on the incremental -- an incremental term, meaning today and the first quarter of '18. Beyond that, it really is a function of what commodity strip does and do the producers continue to see improved performance across resource development.

Okay. And then just kind of tacking back to the drivers behind the higher CapEx. I just want to kind of ask about it a little different way because you've already made some comments there. And that is that the Anadarko CapEx was actually down for Q2 toward the, I think, either at or below the low end of their guidance, and then they left the 2016 guidance unchanged but you've raised your guidance. I mean, can you just give us sort of a contextual comment regarding that against what Anadarko is doing?

Sure. I mean, in -- I don't think Anadarko is the only producer that's able to do more with less, right? So our CapEx at the WES level is driven by the volumes we get. And as we get incremental volumes relative to our forecasts, whether it's from Anadarko or third parties, that means more capital for us, booking them up and maybe additional gathering line, trunk line, et cetera. And so more volumes for us and more capital. It's that simple.

Okay, great. All right. And then just -- can you explain a little bit, I mean, you have some footnotes and things and there is -- on the accounting on the lower interest expense. I think it was down sequentially 60%. Then there was this add-back comment. Can you just kind of reenlighten us or if it's too opaque or detailed, I mean, we can take it offline. But I just thought I'd ask the question.

No, I'd rather talk about it online, and I think it's an important question, and it deserves an explanation. Big picture, interest expense would have been $28.3 million, and then we had a $15.4 million reduction to that figure, which is our revision and accretion expense. And so what does that relate to? It all relates to our early '15 drop-down of Delaware Basin joint venture assets. Where if you remember the structure that we utilized, we don't make a payment until 2020, right? And so we had an estimated payment on the books that we thought we were going to make in 2020, and the present value of that is booked as a liability today. Now our estimate is based on forecast. In case you don't remember, the -- it's based on a formula, which is 8 times the average of 2018 and 2019 EBITDA, less the aggregate CapEx you spend between early '15 and February of 2020. So all the inputs of that formula are forecast-driven. So as those variables change, that liability is going to change. And so first and most importantly, the important thing to remember is that this is going to change multiple times between now and 2020 because all forecasts change as you get new information from your customers. So what happened this time that caused the liability to go down? Very simply, the new forecast we received actually had a bigger ramp in the back half of the agreement. So we actually had steeper volumetric growth in the 2020 to 2025 range. That is 2 impacts on the formula, as I've described. One, more capital, especially in like 2018 through 2020, to get that steeper ramp. But also, two, if you're familiar with how cost of service agreements work, you'll be getting a slightly lower rate in those earlier years because you're getting more volume in those outer years, which gets you to your agreed upon return on invested capital. So when you put all that together, the net effect on our deferred purchase price allocation, that's going down. And I'll stress once again that this will not be the last time you see adjustments in that estimate because it's all forecast-driven. Was that helpful?

Yes, very, very helpful. And that reminded me, you had warned us about that and it's simply -- I'd forgotten about that. But you had warned us it was going to come. So it's -- I guess, logically then this is going to go up, this is going to go down. It just depends on the data inputs you're going to be given.

That's correct, John.

Okay, great. And just -- are there any updates on fixed price extension agreements with Anadarko? I mean, it could be nothing, but I just thought I'd ask it to be thorough here.

No, but in fairness, those decisions are always made in the quarter before they expire. So it's just normal course of business.

Okay, great. And anything on counterparty risk? Any updates there?

I think our counterparty risk is in line with what we disclosed. I believe it was last quarter or 2 quarters ago where we showed the credit party -- the credit rating breakdown of our major upstream customers. No big changes.

Our next question comes from Richard Verdi from Ladenburg.

I wanted to follow up on something here. Earlier, when addressing one of the prior calls, I think it was Ben, maybe you had mentioned that it was gross margin per Mcf was up because of the Springfield and bringing Ramsey online, where the revenues now cover the costs. But on the throughput revenue per Mcf, can you please share with me what drove that in Q2, because it meaningfully outperformed my estimate and was up nicely sequentially and year-over-year? And I'm wondering if that's sustainable moving forward for modeling purposes.

Okay. Just to be clear, you're referring to the gross margin for national -- natural gas assets of $0.84? Is that your question?

No, your throughput revenue per Mcf was $1.22. Because you talked about gross margins earlier, I'm looking at $1.22 for throughput for revenue per Mcf.

Okay. Well, revenue per Mcf, which you must calculate on your own, is driven by change of mix. You get more revenue per Mcf in wet gas areas than you do dry gas areas because you're providing more services, right? You're providing gathering and processing as opposed to just gathering. The state of the market right now is that if you have growth anywhere, it's in wet gas areas, because people are drilling for crude. And therefore, that should trend up over time, right, because you're just seeing your higher revenue assets grow such as us in the DJ and Delaware and our lower revenue per Mcf assets on decline. I would caution you that revenue can be misleading, and I would encourage you to focus on gross margin per Mcf, only because that seems to be more indicative of profitability of those Mcfs.

Okay, okay, great. That's great color, Ben. And then just one last question. It's also kind of a follow-up on one of the earlier caller's inquiries. On the water business, that can be something that's really significant. I mean, there's a lot of avenues that could be played. You can dispose of the water. You could either gather the water to treat it and then transport it back to Anadarko. I mean, could you maybe just give us a little bit of color of what you guys are thinking here that if you were to move down that -- into that field? Where would you start and would you stay there? Or would it be something that could really evolve into gathering and water-treating and then bringing it back to something bigger over the next 10 years maybe?

Richard, the water businesses is still in a very infant stage in West Texas. How we've looked at our initial steps is we are going to look at disposing our produced water. So we do not see going into the freshwater delivery business. It's going to be disposal of produced water, which will also have some treatment component to it, but it won't be significant. It really will be driven by transportation disposal. And so that will be our first step, and then we'll see where the market and the opportunities take us from there.

So would it be fair maybe, Don, if I could take that as, if that business is successful, then we're going to look to try to really build upon that and make some -- further exploit that opportunity?

You'd like to think so, Richard. It's always our objective to find commercial opportunities that we think we're pretty good at and expand on them. And so we don't see water being an exception to that rule.

Our next question is from Helen Ryoo from Barclays.

Just a couple of quick questions. Related to the -- your explanation on the DBJV, the change in sort of forecasted growth on that asset, just wondering, what's your assumption -- based on the new forecast on that asset, what do you expect to spend going forward? I think at the time of the drop-down, you did indicate some spending opportunity every year. And I wonder if that has changed quite a bit given the sort of more back-end loaded nature of that growth. So between now and, let's say, 2018, '19 time frame, what do you see into the CapEx?

I think relative to the initial forecast, Helen, remember that initial forecast was early '15. We're probably spending a little less in '16, given what happened in commodity prices earlier this year, right? But more now in kind of the '18, '19, '20. And so that aggregate CapEx over the 5 years has gone up. Right here, right now, that aggregate CapEx increase is about $100 million over the 5-year period. But I can't stress this enough, it's going to keep changing just because it's forecast-driven.

Okay. Great. So the aggregate numbers up, but in terms of the timing, it's much more closer to 2020 versus near term?

Yes, that's right.

Okay. Now Anadarko has 6 rigs running in Delaware, is that all behind your assets? And is there anything running behind DBJV at this point?

They're all behind DBJV.

Yes, they're all behind the DBJV or Haley, all 6.

Okay, so Ramsey is all third-party then?

Yes.

Yes. And there is third-party behind DBJV as well.

Okay, great. And then on the Springfield, I guess, when you announced that acquisition, the MVC was set at like 75%. Are you sort of running at that level currently? Or is it...

We're well above it, right, because we're at basically forecasted volumes, and then MVC was set at 75% of forecasted volumes. So...

Okay. Got it, got it. So that's why there's some downside, but I guess, the downside, there is a protection at some point, given the Mcf?

That's correct.

Okay, great. And then just lastly, big picture. When I think about your appetite for M&A, I guess you have some JV assets that the JV interest is owned by third parties. Is that -- when you think about a third-party asset acquisition versus buying in your JV interest, I mean, is that sort of -- do you have as much appetite in doing some of that versus just going out and buying a third-party asset?

Well, Helen, to us, every asset transaction starts by saying, "You got to have a willing seller." So we'll look for the willing seller, whether it's in a JV asset or in third-party and determine if it fits the portfolio, and if we think it's a good, solid accretive acquisition for us.

Our next question is from David Amoss from Heikkinen Energy Advisors.

I'm trying to get a feel for the ramp in EBITDA at Ramsey over the next couple of quarters, so a month of Train IV in the second quarter and then Train V coming on in the third quarter. If we look at 4Q '16 as sort of the run rate or when all of your capacity is online, can you talk about the ramp in EBITDA between 2Q and 4Q for that facility?

Just going to have to wait and see, David. I mean, the reason we have such a large range in our outlook is exactly that question, right? When you turn a plant online, you don't know the lines you're going to get until you actually get them. And so as we get closer to the date, maybe we can give you a little more color.

Okay, fair enough. And then on the Springfield asset, given that Anadarko brought on 40 wells in the second quarter, it seems like, in the guidance you did, that's a lot of the activity that you have modeled for this year. Is there a base decline in assumption that you can give us if, say that Anadarko was not to really have any more activity for the rest of the year?

I'll just refer you to the guidance we already gave. I mean, when you look at the guidance we gave in terms of multiples of 2016 and 2017 purchase price, you have a good idea of the decline.

This concludes our question-and-answer session. I would like to turn the conference back over to Don Sinclair for any closing remarks.

I'd like to thank everyone for joining us today. Also like to welcome Jon VandenBrand to the team at WES. As far as you see him, this is his first foray into WES, but he's been associated with this asset and specifically in West Texas for quite some time. We've talked about some of our commercial successes in West Texas; they are directly correlated to Jon's previous job. With that, we all look forward to seeing you again soon. Thank you.

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