SM Energy Company (NYSE:SM) Q3 2023 Earnings Call Transcript

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SM Energy Company (NYSE:SM) Q3 2023 Earnings Call Transcript November 2, 2023

Jennifer Samuels: Good afternoon, and welcome to SM Energy’s Third Quarter 2023 Results Webcast. Before we get started on our prepared remarks, I’ll remind you that our discussion today will include forward-looking statements. I direct you to Slide 2 of the accompanying slide deck, Page 6 of the accompanying earnings release and the Risk Factors section of our most recently filed 10-K, which describe risks associated with forward-looking statements that could cause actual results to differ. We will also discuss non-GAAP measures and metrics, definitions and reconciliations of non-GAAP measures and metrics to the most directly comparable GAAP measures and discussion of forward-looking non-GAAP measures can be found in the back of the slide deck and earnings release. Today’s prepared remarks will be given by our President and CEO, Herb Vogel; and our CFO, Wade Pursell. I will now turn the call over to Herb.

Herbert Vogel : Thank you, Jennifer. Good afternoon, and thank you for your interest in SM Energy. I will start on Slide 4. We are very pleased today to discuss our third quarter and year-to-date results. You’ll see that we continue to deliver on our core strategic objectives for 2023, demonstrate the quality of our assets and position our company for an even stronger 2024. I’ll start by reviewing our progress against the objectives we set forth early in the year. First, deliver an increased return of capital to our shareholders. In the third quarter, return of capital amounted to $114 million, which is up 31% from the previous quarter. In addition to the dividend, we repurchased and retired 2.35 million shares of stock. From inception of the return of capital program in September 2022, we have now repurchased 7.7 million shares or around 6% of the shares that were outstanding as of September 2022.

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Looking ahead, I’m very pleased to announce a 20% increase in our fixed dividend policy. As we emphasize when we initiated the return of capital program, we seek to offer a sustainable dividend through the cycles in our industry. This increase is a testament to the confidence we have in our assets, capabilities, performance and outlook. Turning now to Slide 5. The second objective is to focus on operational execution. This quarter, we enjoyed continued strong well performance in both the Midland Basin and South Texas. This was complemented by faster drilling and the accelerated completion of three wells in South Texas. Also this quarter, our land team executed an asset exchange at our Sweetie Peck location. This increased our working interest from around 42% to nearly 100% in 9 15,000-foot lateral drilled but uncompleted wells which we expect to be strong performers when they are turned in line early in 2024.

Looking ahead, these wells are expected to contribute to our estimated mid-single-digit oil growth next year. Our third objective is to replace and build inventory during 2023. Year-to-date, we have increased our Midland Basin footprint by just over 29,000 acres or about 35%. We contracted a fourth rig for the Midland Basin that commenced drilling on a Howard County pad in early October. We intend to move it to our new acreage position in North Martin and South Dawson Counties in December once permits and other logistics are in place. Looking ahead, this rig is currently contracted for 6 months, and we are excited to initiate drilling in the new area, which we expect to contribute to both our high-quality inventory and 2024 oil production growth.

In short, we have exceeded expectations on all fronts this year. As we wrap up the last 2 months of 2023, we expect to remain well positioned for a positive trajectory in 2024. I’ll now turn it over to Wade to speak to some of the specifics behind these results and what to expect in the fourth quarter. Wade?

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Q&A Session

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Wade Pursell: Thanks, Herb. Good afternoon, everyone. Before I get into the details of the quarter, I’d like to step back, put some numbers behind the strategic objectives that Herb just walked through. Turning to Slide 6. Our sustainable and repeatable long-term business model is generating substantial free cash flow a 7% yield to current market cap over the last 12 months. In turn, we allocate that free cash flow with disciplined objectives to generate long-term value. We seek to: one, maintain low leverage; two, maintain and build our high-quality inventory base; and three, return to predictable yield with upside opportunity to our stockholders. Drilling down on capital allocation. On the top half of the slide at January 1, 2022, SM started the year with $333 million in cash and since then, generated $1.2 billion of adjusted free cash flow.

This has been allocated using round numbers as follows: approximately 50% to 55% to debt reduction reducing our net debt to adjusted EBITDAX from 1.5x to currently 0.7x, 10% to acquisition/inventory and 30% as a return of capital to stockholders with the cash balance increased to around $400 million. Then looking at the bottom half of the slide, we show these metrics for 2023 year-to-date. We entered 2023 with $445 million in cash and had essentially met our leverage target. This year-to-date, we have generated $353 million of adjusted free cash flow with low leverage in place, we’ve been able to lean in further on the return of capital to our stockholders while still maintaining inventory. Year-to-date, capital allocation has been approximately 65% to stockholders and 30% to acquisitions and increased acreage.

Looking ahead, I think you can assume that we will continue to maintain a thoughtful balance for long-term sustainability. Turning to Slide 7 and a quick look at the balance sheet, which remains very healthy. Net debt to adjusted EBITDAX 0.7x, liquidity of $1.65 billion, including zero drawn on the revolver with commitments of $1.25 billion. Maturities staggered ratably from 2025 through 2028, offering significant flexibility. As I’ve mentioned, we are earning over 5% on invested cash, so no rush in taking down the 2025s. So let’s turn to Slide 8 now and look at the details from the excellent third quarter results. Production of 14.1 million BOE or 153.7000 BOE per day with oil production at 44% or 67,000 barrels per day, slightly exceeded our guidance.

The beat was driven from South Texas, where faster drilling and completion accelerated 3 wells that contributed to the quarter. Strong oil production, combined with higher sequential commodity prices, supported GAAP net income of $1.88 per diluted share, adjusted EBITDAX of $476 million. Cash flow from operations adjusted for working capital changes of $436 million and adjusted free cash flow of $208 million. All of these bottom line results were up significantly sequentially and I believe, albeit consensus expectations. The financial statements are generally straightforward, although I will point out that we have earned a significant tax credit for the research and development efforts behind our optimized well performance. As we pointed out over the years, we have pioneered technology and innovation in the Permian Basin and continue research and innovation in South Texas Austin Chalk.

These efforts support a research and development tax credit. In addition to the current year benefit for periods prior to 2023, we have recognized a $77 million benefit, which will be carried forward to future years, reducing cash taxes in those years. For your modeling purpose, this is expected to reduce our cash taxes in coming years by up to 75% until the carryforward is completely used, a significant future cash tax benefit. For purposes of adjusted net income, the onetime prior period carryforward was removed. Capital expenditures adjusted for change in accruals were $228 million. This came in below guidance, but is simply due to timing so the difference gets pushed into the fourth quarter, which is a good segue to guidance on Slides 9 and 10.

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