Western Midstream Partners, LP (WES) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the Western Gas' Fourth Quarter 2016 Earnings 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. Please go ahead.

Thank you. I am glad you could join us today for Western Gas' Fourth Quarter and Full Year 2016 Conference Call. I'd like to remind you that today's presentation includes forward-looking statements and certain non-GAAP financial measures. Please be aware that actual results could differ materially from what we discuss 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 nights' earnings release and to the slides that we will reference on this call. I'm also pleased to inform you that the West K-1s are now available on our website and the WGP K-1s will be available in early March. With that I will turn the call over to our CEO, Ben Fink; and following his remarks, we'll open it up for Q&A with Ben and the rest of our Executive Team. Ben?

Thank you, Jon, and thanks to all of you for your calls and notes of support over the last few days. I'm excited to be in my new role as CEO and I'm truly grateful for your words of encouragement. Before we move into the discussion of our results and outlook, I want to acknowledge Don Sinclair and the success that Western Gas has enjoyed under his leadership. Over the past eight years, Don has been my boss, mentor, teacher and friend, and he has prepared me to lead Western Gas through our next stage of growth. I'm delighted that he will continue to stay on as a Senior Adviser and we will all be well-served by his wisdom and counsel. I'm also excited that Craig Collins is now our new COO as well as Head of Anadarko Midstream. Over the past seven years, Craig has played an instrumental role in the growth of our midstream business. His experience includes running both our engineering and our commercial teams and many of you have met him on past investor field trips. We are fortunate to have a COO with his experience and leadership capabilities as we enter a period of significant capital investment. Now, I'd like to take a brief moment and share my views on three aspects of our business that I believe are highly relevant today. First of all, I believe the achievement of growing our annual adjusted EBITDA to over $1 billion is a significant milestone in our development. West has now truly become blue chip name in the MLP space. Over the past eight years, we've grown adjusted EBITDA by over 10x and have almost tripled our quarterly distribution. At every step along the way, our focus has been on delivering robust growth without taking on undue commodity or financial risk. Our management team continually attempts to find the right balance between absolute growth and growth sustainability. With our run rate adjusted EBITDA now over $1 billion, the primary focus of our distribution growth policy going forward will be sustainability rather than maximizing growth in any given one year. Our decision to release two years of distribution growth guidance this year -- which I will discuss later in the call -- is an outcome of this philosophy. Secondly, I believe that one of the reasons West is exceptionally positioned at this stage, is that we have a portfolio capable of generating significant organic growth which is complemented by a safety net of drop down inventory. We all know the energy business can be volatile at times and it's unrealistic to assume that volumes will increase every year in the future The first quarter of 2016 was a perfect example of this dynamic when our execution of the Springfield dropdown at a very challenging time, set the tone for what turned out to be a very strong year. When I first started at West in 2009, dropdowns are West's primary source of growth, but today, that is not the case. West is now primarily an organic growth MLP positioned to deliver sustainable distribution growth with the added flexibility of being able to draw in a dropdown inventory if needed. Third, many of you have asked recently about our LP/GP relationship, given the recent restructurings announced by some of our peers. Every MLP has its own unique set of facts and circumstances and based upon what we know today, I'm comfortable with our current structure. MLPs often face challenges when their weighted cost of capital approaches or even exceeds their return on invested capital. This is not the case for Western Gas today. Further, certain MLPs have a one-way relationship with their general partners, meaning that the general partner receives incentive distributions, but has no means of supporting the operations of the underlying MLP. Again, this is not the case for Western Gas, but the contrary, I believe Anadarko has been the most supportive sponsor in the MLP space and is the primary owner of our IRDRs [ph], it has a strong incentive to continue to support West's objective of growing distributions over time. Now onto our results; our portfolio once again demonstrated its resilience in by delivering another year of solid performance despite periods of significant commodity price weakness. Our full-year 2016 adjusted EBITDA exceeded the high end of our guidance range. We delivered distribution growth of 10% for West and 19% for WGP, while maintaining a distribution coverage ratio of 1.29x. Our capital expenditures ended up slightly below the low end of our guidance range as we continue to allocate capital to our most attractive organic growth opportunities in the Delaware and DJ Basins. Turning to our fourth quarter results, we reported adjusted EBITDA and distributable cash flow of $268.4 million and $223.8 million respectively with a healthy coverage ratio of 1.31x. No business interruption insurance proceeds were received during the quarter. Our fourth quarter natural gas throughput was essentially flat with the prior quarter after adjusting for the Hugoton divestiture in October. We saw strong volumetric growth in the higher margin Delaware and DJ basins, offset by declines in the lower margin Marcellus and win to [ph] basins. This change in throughput mix led to a $0.03 sequential improvement in our adjusted growth margin for MCF for natural gas assets to $0.85. On the crude and NGL side, our throughput slightly decreased as growth of the Mont Belvieu fractionators was offset by declines of Springfield. Adjusted growth margin per barrel for our crude and NGL assets decreased by $0.05 when compared to the previous quarter, mostly as a result of the Mont Belvieu fractionators returning to a normalized distribution schedule. I now like to take a moment to discuss our previously announce Delaware basin transaction. In summary, West has agreed to acquire the remaining 50% non-operated interest in the assets of DB JV, in exchange for our 33.75% non-operated Marcellus interest and $155 million in cash. We expect the transaction to close in March. This is an important strategic transaction for West as it fully consolidates our ownership in DB JV and further aligns us with Anadarko's and other producers' rapidly accelerating activity in the Delaware basin. We are trading a lower growth non-operated asset with little sponsor alignment for a higher growth, operated asset with significant sponsor alignment. DB JV is supported by a cost of service contract for 2025 that will allow us to aggressively invest in the basin over the next several years while feeling comfortable in our ability to earn acceptable rates and return on invested capital. The rapid development of Delaware basin infrastructure is of paramount importance to both us and Anadarko, and as what we've said in the past, everything we're trying to do in the Delaware is an attempt to replicate the successful playbook that we utilized in the DJ basin. Key to the strategy will be integrating individual assets into a unified gathering and processing complex and this integration can now be achieved more efficiently. This transaction is therefore a critical step in further enhancing what we believe is the premier gathering and processing footprint in the Delaware basin. The near-term impact of this strategic long-term acquisition is a reduction in our forecasted 2017 adjusted EBITDA. Slide 8 attempts to quantify this impact as well as certain other items that affect the comparability of our 2016 adjusted EBITDA to the midpoint of our 2017 adjusted EBITDA guidance. The key variance drivers are as follows: first, we estimate that our 2017 adjusted EBITDA would have been $32 million higher if we have not entered into the exchange transaction. Depending on the growth rates of the exchanged assets, we believe that the EBITDA of the DB JV interest we acquired has the potential to exceed that of the non-operated Marcellus interest by 2018. Second, we recently extended the mountain gas fixed price agreements through December of 2017. The accounting treatment for this extension will be the same as that of the DJ basin extensions in 2015 and 2016. Based on our 2017 forecast, we will record approximately a $26 million capital contribution related to mountain gas that would have been treated as revenue prior to that extension. Please note that our practice is to add this capital contribution back into our calculation of distributable cash flow. Third, based on the latest forecast, our DB JV gathering will be lower in 2017 than it was in 2016. Perhaps paradoxically, a lower rate is good news because it means our volume forecast for the outer years has improved compared to last year's forecast. Had the gathering rate remained constant, we estimate that our 2017 adjusted EBITDA attributable to our 50% interest in the assets of DB JV that we owned in 2016, would have been $9 million higher than what we're projecting today. And finally, please note that the Hugoton asset that we divested at the end of October generated approximately $9 million of EBITDA for us in 2016. When adjusted for all these items, all of which are results of positive commercial developments. Our forecast reveals a base portfolio that continues to generate organic growth, fueled primarily by the Delaware and DJ basins. With respect to capital, our 2017 guidance range is $900 million to $1 billion. This is the largest capital budget in our history and we expect this substantial investment will support distribution growth for years to come. We anticipate that the Delaware and DJ basins will represent 84% and 14% respectively of this program, with 50% to 60% of our Delaware basin capital spent on expanding our gathering footprint. This program assumes the March closing of the DB JV transaction and the completion of train six at our Ramsey plant in the fourth quarter. The budget also includes capital for the construction of two new processing trains in the Delaware basin, Mentone I and Mentone II. Mentone I is scheduled to come online in the third quarter of 2018; with Mentone II scheduled for the fourth quarter of 2018. Both of these trains will have 200 million cubic feet per day of capacity and are expected to be supported by long-term volumetric commitments from Anadarko. Finally, our capital budget also includes $25 million to $30 million to finish the two produced water gathering and disposal systems that were announced last quarter. Anadarko will also be investing significant capital to develop produced water disposal systems in the Delaware basin, thus adding to the inventory of potential dropdown assets. Over 80% of this inventory's 2017 forecasted cash flow is expected to be generated by growing assets in the Delaware and DJ basins. Despite Anadarko's monetization of its Marcellus midstream assets which generated over $40 million of EBITDA in 2016, the 2017 run rate EBITDA range for the Anadarko midstream portfolio is unchanged. Even more exciting for us, Anadarko plans to invest in incremental $600 million to $700 million in its midstream business in 2017, further replenishing the midstream inventory. Anadarko's capital spend will primarily be focused on crude gathering in the Delaware and DJ basins and produced water gathering and disposal systems in the Delaware basin. I encourage you to listen to Anadarko's guidance call on March 8 for more information on their 2017 capital program. Slide 10 is a summary of our 2017 outlook and shows that we expect to spend more in maintenance capital than we ever have in our history. 2017 is a year in which we're focused on delivering sustainable growth over the longer term. As we discussed, the Delaware Marcellus asset exchange is an example of this longer term focus. We have the ability to make this type of investment, thanks to our strong 2016 distribution coverage, our low leverage and the fact we entered 2017 with over $1.5 billion of available liquidity. In addition, I'm pleased to announce that we have reached agreement with the holders of our Series A preferred units to convert them into common units in the first and second quarters of 2017. This conversion will have a significant deleveraging effect and as a result, we expect to be able to fund our 2017 capital program without the need for additional common equity assurances. Furthermore, Anadarko has elected to defer the conversion of its Class C units until March 1, 2020 which will give us additional time to reap the benefits of our Delaware basin build out. We believe these two transactions taken together will move significant potential equity over hangs in the next three years. Since the key theme of our 2017 strategy is investing for the longer term, for the first time, we are providing distribution growth guidance for the next two years. We expect West full year annual distribution growth of 7% to 9% in 2017 and 2018 and WGP growth of 12% to 18% through the same time frame. In conclusion, I would like to thank our entire midstream team for making 2016 a record-setting year and all of our investors for your continued support as we embark upon our next growth phase. I believe 2017 will be remembered as an inflection point in our history because we expect to draw upon the financial strength generated by our 2016 performance to make the strategic investments that will drive our results in years to come. With that, Operator, I'd like to open up the line for questions.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Kristina Kazarian of Deutsche Bank. Please go ahead.

Good morning, guys.

Good morning.

Ben, congrats on the promotion, and Don, it was a pleasure working with you. Exciting announcement on the new project spend, guys. Specifically thinking about the Mentone -- apologies if I'm pronouncing that wrong -- plants. But can you just talk about why selecting the asset site, how many trains the site could handle if I'm thinking longer term and then pushing you for a little more even though you just gave the biggest CapEx spend number yet. What do you see as the next set of midstream constraint on the horizon? Is it the need for more GNP? Is it residue gas take away? How are you thinking about that now that you're CEO as well?

Thanks, Kristina and thanks for your kind words. We've purchased the land for the Mentone plant and there is room there for significant expansion. As you mentioned, we have announced the first two trains. Each of those trains is probably going to cost in the 125 to 175 range when you fully load that for frontend and power et cetera. Can't really give guidance beyond '17, but if you were to see the site that we purchased, there is room for significant expansion. If you look at Anadarko's and other producers guidance, you could see the need for future expansion behind that if they deliver what they think they're going to deliver. You have also noted that there is no residue against takeaway option that we've announced. That is still a systemic need, I believe, for the basin and we're still evaluating our options. This could be an operated solution, this could be a non-operated solution, this could be helping our customers drive down the rate so low that we don't want equity in it and we're really just trying to look at all the options here. But as you mentioned, this is going to be a very robust year that maybe the first of several years to come.

And how do I think about opportunities for other midstream-related asset swaps? Maybe thinking ego [ph] further; how are you thinking about that done?

Are there swaps? As we mentioned in the prepared comments, this is a highly strategic transaction and our ability to basically own and operate virtually all of our infrastructure is a big deal for our future plans. I can't really think of a comparable scenario. If you think about the DJ or other growth area, we own all of our infrastructure there, 100%, so there's nothing really being contemplated in the near term.

Okay. And then last one for me. I know you've laid out a lot of great opportunities, biggest cap spend yet, growing APC backlog, too. How do you balance all these priorities in your mind?

Not entirely sure I understand the question. Obviously, we are trying to replicate the DJ playbook which is aggressively invest alongside the Anadarko [indiscernible], but we have a very robust third party business and we take our commitments to those third parties very, very seriously. For example, in the two new Mentone plants, we're making sure there's adequate capacity not only for Anadarko, but for the growing third parties as well.

Perfect. That's great. Thanks, Ben. Congratulations again.

Thank you.

The next question comes from Jeremy Tonet of JP Morgan. Please go ahead.

Good morning, guys. This is actually Rahul in for Jeremy. I have a couple of big questions for you. First, on the Mentone train, how much do you anticipate if you see third-party volumes there? Just curious.

I appreciate the question and I'm a bit [indiscernible] to go into the details of an Anadarko contract in advance of their Analyst Day on March 8, so I would ask that you ask them the details of that contract on that day if it's of that particular importance to you. I will just repeat my prepared comments that we anticipate those trains would be primarily granted out for usage but we are making sure that there is adequate capacity for third parties as well.

Got you. And how full is that Ramsey complex currently? And how do you see it like spending on the latter half of the year?

Well we are at 700 days capacity right now and that is ramping in line with our expectations. Perhaps, excitingly we are aware of at least one customer that's looking interruptible options in the summer because they are going to feel that we might be full before Ramsey VI comes online and they might need something for that stub period in the summer. So that tells you that we are ramping at a comfortable rate and doing everything we can to get Ramsey VI on as soon as we can.

Got you. That's helpful. And I think I saw expecting to spend worth close to $750 million on the Delaware so how do you think about the space between [indiscernible]?

Well in the prepared comments we talked about how gathering is 50% to 60% of the capital depending on how things shape out, that could even be higher. I have already mentioned the Mentone cost estimates so above and beyond that you have the finishing out of Ramsey VI.

Got you. And also one last one, can you walk me through the drivers through the drivers of the upside versus the downside of the proposed guidance range and anything which can properly know it's the higher end of the guidance, what kind of drivers should we be thinking about this?

Yes, I think its two primary drivers and that's an excellent question. One is the timing of the ramping of processing volumes in the Delaware. Faster gets you closer to the higher end, lower gets you closer to the lower end. The other is what happens in the DJ basin and to take a step back remember that Anadarko oil are just customers went all the way down to one rig last year right? And now the outlook is much better, they have announced that they will be at 6 rigs by the end of the first quarter but in 2017, you are feeling the volumetric impact of that, of going down to one rig in 2016 so the question is how do you get back on the growth train and when does that start happening at what point in the year. And that in the DJ Basin is our largest driver of cash flow, could have a significant impact of where we end out in the range. Does that make sense?

Yes that's quite helpful Ben. Thanks again and congratulations.

Thank you.

The next question is from Sharon Lou of Wells Fargo. Please go ahead.

Hi, good morning everyone. Shall we guess [indiscernible] that Anadarko has year marked about $600 million to $700 million of midstream CapEx, maybe if you can provide some detail on the types of projects that Anadarko has taken versus WES especially on the water side and if the plan is to eventually migrate all the spending to WES?

Sure, I will just disclaim a chair and tell you what I can but in advance of their own call on March 8 I might not be able to give you the level of detail that you would get on that day. As you mentioned in the prepared comments the primary drivers with the capital are the crude system in the Delaware which is still at the Anadarko level, the crude system in the DJ which is at the Anadarko level and I should mention that the crude system in the Delaware also means building a stabilizer and produce water and disposal in the Delaware. We are spending, we are building up two systems at WES which has three wells, is part of two systems. Everything above and beyond that which as you can see by the slide is over $200 million of capital is going to be at the Anadarko level. That's very exciting for us as those are a bit higher returns at gas accrued gathering according to our base gas and that will replenish the inventory even faster so that's very exciting to us. Anything above and beyond that will have to wait just a little bit longer than March 8.

Okay. And I guess just the follow up on the other question. Is the plan to eventually move all the spending to WES as our portfolio gets bigger. Like how should we think about the capital program at WES other than next couple of years? Do you have vision, you know, being at that $900 million range?

Well because so much of it is gathering Sharon that a lot of that is tied to drilling activity. I think if the producers do what they think they can do, it will be very heavy gathering CapEx or you know, the near to intermediate turn. Right now WES is spending capital associate with the assets at WES, and Anadarko is spending capital associated with the assets at Anadarko. So just as has happened over the last eight years, more assets move from Anadarko to WES, that would probably mean more capital burden on WES and as WES gets bigger and has more scale and scope, we can absorb more of a capital burden and still maintain our distribution coverage targets and our leverage etcetera.

Thanks Craig and I guess -- plans, I mean wasn't Anadarko will have pretty substantial processing in Delaware, can you maybe talk about the NGL Pigway options that you guys have signed up for and whether you think they are sufficient capacity to keep pace with the development of the region and if not, is there an opportunity at WES to maybe invest further downstream?

We will take title of those NGL's too. What I am hearing for our customers is they are in constant contact with the takeaway providers too and they are comfortable hearing about their plans to expand. There will be needs for expansion and some of that front end work is on the way and they are in constant communication and they are not concerned about a pinch point like they are with gas and long as those takeaway producers meet those commitments on how they expand those takeaway options overtime.

Okay Craig, thank you.

The next question comes from David Amass of HEA. Please go ahead.

Good morning, Ben.

Good morning.

I wanted to go back to the gathering CapEx and appreciate the detail there. Can you maybe quantify what you are building this year in terms of mileage and how in terms of rule of thumb or big picture, how we can associate that mileage or spending going forward over the next several years?

All right, I may let Craig Collins talk about mileage. What I will tell you is mostly Reeves County, if you look at our maps and footprint of where we stand today, it's more billed out to the east than it is across the river so there will be a lot of trunk line and associated compression, horsepower etcetera but in terms of miles let me let Craig talk about that.

Thanks for the question, as Ben noted we are expanding out in the Reese county area and to date our footprint is primarily in the county area with some infrastructure in Reeves but we have got a major expansion project underway in Reeves county this year. We are planning to put in approximately planning to put in approximately 210 miles of gas pipeline out in Reeves county and alongside that pipe will be oil and water pipe going on Anadarko's behalf so we are excited about the expansion, getting out into Reeves, the checker boarded position at Anadarko and so it really gives us a lot of third party opportunities going forward.

Thanks, that's really helpful and then I want to take a step back think about the Permian Delaware and mid-wind, the amount of gas that seems to be on the horizon there. At what point do you start to worry about overall gas takeaway from the region?

Great question Dave, and we are particularly focused on our area of the world which is kind of not only Delaware but the Northern Delaware. I mean we have been talking for quite some time about the need for additional takeaway capacity and we believe the solution is to eventually is to get to Waha which is about 80 miles away where you have the different interconnects, where you can go to Mexico and other places. I still needed a need for that solution just as we did late 2015 and hopefully we will have more to say about that later this year.

Okay that's helpful. Thank you.

And the next question comes from Barrett Lashky or MUFG Securities. Please go ahead.

Hey guys, quick question on the CapEx of 2017. Is it inclusive of the payment associated with the SS Swap and does it include any additional dropdowns for the year?

No, no dropdowns, no acquisitions of any kind and it does not include that $155 million payment; so it is organic CapEx.

Thank you and on Series A conversion, can you give us a little bit of a walkthrough, what you expect the coverage to look like with that? And the timings and process on those conversions?

Sure and I appreciate the question. Half the units will be converted in February and the other half in May. Just as a reminder there is approximately 700 million of these preferred's out there so as a rating agency perspective that is $350 million of debt. And so the impact of converting them from a balance sheet perspective would be the same impact if we issued 350 million of equity and pay off the debt so we are making 350 million of what's being recorded a debt, this appears with the transaction. So that's an important move and the William's deal is an important move as well in terms of setting us up for future just to be sure, alright. The impact of that is the compression and the coverage ratio and we are fortunate we ended 2016 with strong coverage that we have the ability to make transactions like this. Because those preferred units were going to get be converted in the future anyway right, you are better off converting them early than you would be issuing common and converting those preferred units later and having to deal with that additional comment. So while it's going to compress coverage ratio in 2017-2018 and beyond, it's actually a positive move. Let me stop there and make sure you are following that.

No I got it. Thank you.

Thank you.

This concludes our Question and Answer session. I would now like to turn the conference back over to the executive team for closing remarks.

Once again thank you for all your support. I look forward to talking to you in the days and weeks to come and we will see you next quarter.

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