CNX Resources Corp Q4 FY2020 Earnings Call

Good morning, and welcome to the CNX Resources Fourth Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Tyler Lewis, Vice President of Investor Relations. Please go ahead.

Thank you, and good morning to everybody. Welcome to CNX's fourth quarter conference call. We have in the room today, Nick DeIuliis, our President and CEO; Don Rush, our Chief Financial Officer; Chad Griffith, our Chief Operating Officer; and Yemi Akinkugbe, our Chief Excellence Officer. Today, we will be discussing our fourth quarter results. This morning, we’ve posted an updated slide presentation to our website. Also detailed fourth quarter earnings release data such as quarterly E&P data, financial statements, and non-GAAP reconciliations are posted to our website in a document titled 4Q 2020 Earnings Results & Supplemental Information of CNX Corporation. As a reminder, any forward-looking statements we make or comments about future expectations are subject to business risks, which we have laid out for you in our press release today, as well as in our previous Securities and Exchange Commission filings. We will begin our call today with prepared remarks by Nick followed by Don. And then we will open the call up for Q&A, where Chad and Yemi will participate as well. With that, let me turn the call over to you, Nick.

Thanks, Tyler. Good morning, everybody. I want to emphasize four points in my brief remarks before I turn it over to our CFO, Don Rush. First off, 2020 marked the most successful year we've seen as an E&P and frankly, as a public company, going back to the late 1990s as measured by free cash flow. Better yet, this bar-setting level of free cash flow and free cash flow per share, steadily and substantially grew as 2020 unfolded. Our original guidance for 2020 free cash flow was around $135 million, compared to over the $356 million or approximately $1.60 per share that we actually posted. It's been an awesome year based on our simplest yet most crucial metrics, our debt and share count both declined in the quarter as we allocated that free cash flow to the benefit of our owners and execution allowed us to strengthen our balance sheet and return capital to shareholders—all in the middle of one of the most challenging years in decades. The second point I want to make is that we expect 2021 to be materially better than 2020 as measured by free cash flow. We expect to deliver approximately $425 million of free cash flow in 2021. This builds upon and exceeds what we accomplished in a very successful 2020 and that's at the current strip pricing, not consensus pricing. The third point is we built a free cash flow generating machine that should deliver on average $500 million free cash flow per year between 2022 and 2026. This is a marked improvement from our 2021 target of $425 million. This creates a positioning for free cash flow level setting when you run through 2020, 2021, and 2022. This also assumes the incremental interest expense for our bond issuance that we executed last year. Our seven-year, $3-plus billion free cash flow plan that we unveiled last April remains in place and the first year is now successfully in the books. Lastly, we expect a generation of $500 million per year of free cash flow to continue for many years beyond 2026. Our basin-leading cash costs, which were just $0.01 over $1 all-in for the fourth quarter, remain a huge differentiator for the capital markets, and I think they're just starting to wake up to that fact. Extensive swaths of our acreage footprint and inventory work quite well at the forward strip because of our cost structure that powers the free cash flow machine that creates a sizable free cash flow stream for years measured in decades. Free cash flow informs our execution focus, our strategy, our capital allocation, incentive compensation, our investment thesis, and our M&A screening process. We secure the drivers of it, like low costs and midstream integration. We execute to generate it, and then we smartly allocate it by applying clinical math. It’s a simple yet powerful concept. Now, before turning things over to Don Rush, I want to highlight that our approach is unique compared to the industry. The management team and board of CNX didn’t come from classic E&P backgrounds. What we've accomplished to date illustrates that. We started as a 150-year-old coal company and transformed it into the premier manufacturer of natural gas and free cash flow per share, as well as being a leader in tangible and impactful ESG performance in our space. We took a different approach to discipline capital allocation that has created per share value during tumultuous times. This strategy sets us up to be a position of strength moving forward. This is the team that investors and stakeholders seek to steward their capital wisely. With that, I'm turning it over to Don Rush, our CFO.

Thanks, Nick, and good morning, everyone. I'm going to start on Slide 3, which highlights some of the key metrics to differentiate CNX. As you can see in the top left chart, CNX has one of the largest net sale acreage positions in the basin. This acreage position is even more impressive when looked at from a relative standpoint. Since our production is less than our peers and our base P/E declines are shallow, we need to consume less of our current acreage each year to maintain the production profile. We have the deck, meaning that if you look at the next 10 to 20 years, we will only need to develop a fraction of our acreage. If we continue to stay in a maintenance production plan, this is a key fact often overlooked; the bigger you are, the more acres you must consume each year to maintain your business model. Our lean and highly profitable approach allows for a much longer runway and less risky next few decades relative to our bigger peers, which need to consume two to three times the amount of acres we do each year. This is a significant difference, especially when you consider that our plan not only consumes fewer acres but generates approximately $500 million per year of free cash flow on average. This outsized profitability on less production is due to our superior margins driven by our best-in-class cost structure that you can see on the top right. This cost advantage allows us to generate significant free cash flow, and based on where we are currently trading, creates a very attractive free cash flow yield on our equity. We remain on track to continue to strengthen our balance sheet over the next several years. As you can see in the bottom right, when you view all of these metrics together, it is clear we have positioned the company to grow intrinsic value per share going forward. Slide 4 digs deeper into the cost structure. As you can see, our Q4 costs came in around $1.01, which was slightly under the $1.04 we guided during our Q3 call. Our fully burdened cash cost finished at $1.17 per Mcfe for the full year 2020. We expect 2021 costs to be in line with our Q4 numbers and to average approximately $1.05 per Mcfe. Year-over-year, this equates to a 10% expected cost reduction. Assuming that future free cash flow is allocated towards debt repayments, we would expect fully burdened costs to decrease even further to around $0.90 per Mcfe in years beyond. When you combine our low-cost position alongside the steady execution we've seen throughout 2020, the result is four quarters of consistent free cash flow generation shown on Slide 5. In Q4, we produced approximately $85 million of free cash flow and $356 million for the full year 2020, which was modestly above our previous guidance. Last quarter, we discussed that if CNX shares continued to trade at a high free cash flow yield, we would have the wherewithal to repurchase shares in conjunction with paying down debt. That is exactly what we did, with $43 million worth of shares bought back at an average price of $10.43 per share, with $6 million of that cash settling in the first few days of January 2021. Slide 6 illustrates that our best-in-class cost structure not only drives our annual free cash flow generation under the current strip but also allows us to develop wells more economically than our peers. Out of the key variables in well economics, excluding price, OpEx has the largest overall impact on the economics of the new well. For clarification, we used a hypothetical Southwest PA dry well with a 2.6 Bcfe per 1,000-foot type curve and the other assumptions footnoted below. We looked at how changing major variables affects the internal rate of return for that well. The deltas shown on this slide are nominal rate of return enhancements for that well. For instance, if the base well had a 30% IRR and you lowered the OpEx of that well by $0.50, the well would improve to a 68% IRR. Operating expense has the largest impact on well profitability. Also, the CapEx or D&C per foot of a well has a much smaller impact compared to OpEx. This holds true if you want to assess NPVs instead of IRRs. This does not imply that EURs and D&C costs are not important; we continue to focus on reducing capital costs and improving capital efficiency and well performance. We expect this trend to continue as we become more efficient, thus maintaining our competitiveness. Finally, Slide 7 provides an update: we have closed on a $500 million senior notes offering, which creates additional financial flexibility over the next several years. We've worked hard to get the balance sheet to where it is today. As you can see, we've not only paid down debt in 2020 but have also increased our maturity runway significantly, with our closest bond maturity now five years away in 2026. Slide 8 provides an updated look for 2021 guidance. We have incorporated modest ranges with this updated disclosure. The summary indicates based on the midpoint of the 2021 guidance ranges, production and EBITDA are up slightly from our previous guidance, while CapEx is also up slightly due to timing from an $80 million CapEx beat last quarter, based on the midpoint of 2020 guidance. Most importantly, we are reaffirming our 2021 free cash flow at approximately $425 million, with our free cash flow per share guidance increasing due to our share buybacks in Q4. On the pricing front, our guidance is based on the forward strip as of January 7, 2021 for natural gas prices, utilizing a conservative forecast for NGL realized price per barrel of $15. Q1 NGL prices are currently running higher than that, and we will continue to monitor this as the year progresses. Quarter-to-quarter guidance can be challenging to ensure accuracy since a few weeks one way or the other on a new pad can make a big difference for the quarter, but not for overall pad economics. For some color, we expect quarterly production volumes to be relatively consistent throughout 2021, with capital projected to be modestly heavier in the first half of the year versus the second half. Slide 9 is a reminder that CNX continues to screen very well compared to both our E&P peers and the market indices highlighted on this slide. As such, we feel that we present a great investment opportunity. Our focus remains on executing what has become a straightforward story: generating significant amounts of free cash flow each year and allocating that free cash flow to create substantial value for our shareholders. We believe that this will drive the intrinsic value per share of the company higher over time and continue to provide meaningful opportunities to reward our shareholders. With that, I'll turn it back over to Tyler for Q&A.

Great, thanks. Operator, if you can open the line for Q&A at this time, please.

Certainly. And the first question will come from Zach Quan with JP Morgan. Please go ahead.

Hey guys. Thanks for taking my question. I just wanted to ask your thoughts on the buyback going forward. You utilized roughly half of the Q4 free cash flow to buy back shares. Is that a preview of what we should expect in 2021? And I guess just more generally your thoughts on buying back shares versus reducing debt with the free cash flow you generate.

Yes, no. Thank you for that. I’ll start, and Nick can add in anything I miss here. If you rewind back to our Q3 call, we were consistent in our conviction about the free cash flow plan not only for closing out 2020, but also what we're projecting for 2021 at $500 million on average from 2022 to 2026. We made it clear that our balance sheet was in good shape, and our cash flow generation relative to our debt and maturities was a very stable, manageable scenario. We aim for leverage ratio targets around 1.5 times leverage with a $1 billion EBITDA runway and roughly $1.5 billion of debt to achieve that leverage. We had the capacity, as we cited, to spend $1 billion on debt and have plenty of room to utilize that extra $500 million for other things along the way. As you look forward, the answer is to follow the math, adjusting decision-making based on how the variables move around us. We have the flexibility to balance between paying down debt and returning capital to shareholders; good news, both are feasible for CNX and its shareholders.

Yes, Zach. I’d add that the most critical factor is our conviction that our cost structure, coupled with our water midstream integration and inventory, will be substantial in generating free cash flow. 2020 was remarkably successful in generating cash flow, and our guidance for 2021 backs that up. If we execute as planned, I foresee significant free cash flow generation. We’ll focus on efficiently allocating that free cash flow, and the two most attractive opportunities right now are reducing debt and opportunistically buying back shares. This share count reduction will be opportunistic based on variables, and while I wouldn't read too much into individual quarters or years, the metrics we care about will guide our decision-making process.

Yes, I forgot to mention that our hedge book provides comfort and confidence regarding future cash flows. For instance, we are approximately 90% hedged in 2021, and we already have a considerable position in 2022. Looking into 2023 and 2024, we are close to being half hedged, assuming flat production. We recognize our structural advantages coupled with the clarity in cash flow generation allows us to be thoughtful as we look toward the next quarters and years.

Thanks, guys. That’s a follow-up question; we’ve seen bases widen out a bit. Since we are mostly hedged on bases in 2021 but less so in the out years, can you discuss what you can do to mitigate widening bases and just your general outlook on bases over the next few years in Appalachia, given some concerns about potential delays with new pipelines?

Yeah, Zach. This is Chad Griffith. I'm glad you asked, as it's a point I wanted to address today. We've proactively hedged against risk and are over 90% hedged on in-basin exposure for 2021 through 2024, which isolates us from the volatility you're highlighting and potential risks associated with pipeline projects. We have demonstrated foresight, having sought to eliminate our invasive pricing exposure by putting these hedges in place at attractive levels. Details are available in the supplemental materials we provided.

To add to Chad, regarding basis and index pricing, there are nuances between the two, since basis reflects the difference between Henry Hub and local marginal dispatch costs to produce in-basin. We monitor these continuously; the industry has advanced its gas production capabilities, and when looking at supply and demand fundamentals, they are tightening, suggesting volatility in the market. Using the forward strip to inform our decision-making allows us the flexibility to lock in economics before spending capital, which positions us advantageously regardless of potential short-term fluctuations or changes.

Thanks, guys. That’s all for me. I appreciate the color.

The next question will come from Neal Dingmann with SunTrust. Please go ahead.

Good morning, all. My first question is for Nick or Don, given your current free cash flow capabilities, could you discuss your thought process around free cash flow allocation? You touched on debt repayment and equity repurchase, but I’m curious about how you consider these alongside growth and potential dividends in the future.

Certainly, Neal. From a macro perspective, lower debt typically indicates less volatility in our industry, while also presenting opportunities during uncertain times. Therefore, managing leverage ratios, absolute debt levels, and continuing the allocation of free cash flow toward debt reduction will always be a priority for us. The industry appears challenged, specifically in securing capital, and those able to be free cash flow generators will thrive. Our plans for free cash flow generation remain critical. Hence, share count reduction and dividends will become more pertinent when the yields align with our performance metrics. For now, reducing share counts is our primary focus.

We have a predictable structure that allows us flexibility. The balance sheet allows us thoughtful, risk-adjusted cash flow opportunities. Regarding capital, our capital efficiency in production will enhance our overall ability to pivot in response to market demands, ensuring decisions hinge on measurable financial optimization and not speculation. In 2021, we are incorporating a higher blend of wet gas as production profiles dictate changes regarding pricing fluctuations. This blend allows us to maintain production efficiency and cater to current NGL price environments, aligning with our long-term objectives.

Adding to Don's comment, our midstream ownership provides us flexibility in our asset base. As NGL prices have rallied, we’ve strategically moved damp production towards processing to maximize value, essentially allowing us to optimize profits based on market dynamics. We are assessing additional well performance to ensure we make informed production management decisions.

I have a last follow-up for you, Chad, or Don. Would you consider monetizing the midstream asset, or is it too critical for your overarching strategy?

We have demonstrated a history of making sound economic decisions. The midstream asset plays a significant role in shaping the company’s cash flows and mitigating risk, allowing us to differentiate ourselves from peers. That said, we continuously evaluate our options based on a risk-adjusted cash flow basis, but our position currently offers us significant advantages.

Thank you, great details and tremendous free cash flow, guys.

Thank you. The next question will be from Holly Stewart with Scotia Howard Weil. Please go ahead.

Good morning, gentlemen. Maybe I’ll start with a couple of questions on the production numbers. Could you provide the overall shut-ins in 2020 and any guidance on potential shut-ins for 2021?

While I don’t currently have the total shut-ins for 2020 at hand, I’d be happy to follow up with you. As for 2021, we’re not planning any shut-ins; however, we’ll continue to monitor the situation. If opportunities arise that allow us to better maximize our asset value by timing production differently, we will take advantage of that opportunity.

Great, can you provide the exit rate for the year for 2020?

Yes, we’re looking at about 1.7 Bcf per day.

Perfect. And Don, I saw the slide on total cash cost guidance for 2021. Can you provide more granularity on Q4 material costs being considerably lower than expected? Is that a good level to consider moving through 2021?

We expect some fluctuations as we roll into 2021, along with production optimization strategies. The overall margin in cash flow remains an objective across quarters as we focus on efficiency, and costs may vary somewhat as we make operational decisions to adapt to those factors.

How are you thinking about the CNXM credit facility? Does that remain in place?

Currently, the facility remains as we structured it. Our financials continue to be reported to the holders. The eventual decision of whether to consolidate or maintain both structures will depend on market conditions and what makes the most sense strategically as we move forward.

I would like to emphasize that regardless of if we keep separate facilities or consolidate, our cost of capital should reflect advantages inherent in our asset array compared to the average upstream Appalachian peer.

Appreciate all the color. Thank you.

The next question will be from Michael Scialla with Stifel. Please go ahead.

Yes, thanks. Good morning, guys. It looks like you’re going to be able to pay off your debt and revolver quickly with free cash flow. I want to understand how and when you're planning to retire your fixed debt in your seven-year plan. Do you accumulate cash until the debt becomes due, or can you call any debt early?

Flexibility is key here. We have a robust structure with the RBL, along with our CSG bonds, which have efficient structures and encourage us to prioritize debt reduction. Our free cash flow will allow significant debt servicing alongside investments in shareholder returns, creating a solid financial foundation moving forward.

Okay, good. So, there’s no need to park cash on the balance sheet for an extended period? Thank you.

Exactly, we have flexibility and will allocate cash according to the best opportunities as they arise. Slide 6 showed our cost structure advantage on operating costs relative to competitors. If you look at that same chart compared to yourself today versus 12 to 18 months from now, can you identify the biggest controllable driver of your returns? Our forward-looking assumptions are conservative, and the cost components will roll off as contracts expire. Our D&C initiatives are aimed at continually improving our efficiency. While OpEx is a key focus, it constitutes a smaller part of the overall cost structure. We recognize this dichotomy and plan to maintain our frontline awareness here.

OpEx advantages are our long-term strategic benefits, allowing us an edge over peers. The reliable, forward-looking framework implemented has yielded operational advantages, and our workforce is well-prepared to adapt to ensure success.

The next question will be from Nitin Kumar with Wells Fargo. Please go ahead.

Good morning, gentlemen. I want to shift gears and discuss your macro view on gas right now. Your own plan calls for steady production, but I’m curious about the landscape among your peers and your perspective on gas prices.

We’ve been cautious about the 2021 strip for some time, keeping a close eye on the winter weather, which has been a bit disappointing. The strips have traded off as a result. Despite lower production, demand and exports are increasing, thus reflecting the degree of structural under-supply. Everyone is transitioning to a 'next winter' bull thesis. Continued volatility in gas prices seems likely, and we’ll keep hedging as best we can to minimize risks to free cash flow.

A perfect crystal ball doesn't exist, and we've learned that small shifts can render predictive models inaccurate. Hedging statistically outperforms not hedging; we all aim for sustainability in our approach, as it’d be undesirable to push toward higher gas prices while managing supply.

I can appreciate your focus on free cash flow, and I'm curious if there are strategic opportunities to participate in green revenue streams?

We've actively focused on ESG practices, and our historical efforts show our commitment. We're emergent in our position concerning natural gas and are reviewing opportunities to enhance our ESG endeavors to align profitability with positive community impacts.

ESG focus and responsible practices align with our operational ethic. We will continue seeking avenues to utilize our products sustainably and enhance our strategies. Past partnerships for carbon credit generation reflect our long-term commitment to responsible growth.

To summarize, sustainability and ESG initiatives come down to transparency, tangible metrics, and aligning our actions accordingly. We advocate a responsible, measurable sustainability approach that speaks to our commitment going forward.

I appreciate that approach and your commitment.

Thank you. The next question will be from Leo Mariani with KeyBanc. Please go ahead.

Hi, guys. I was hoping for more clarity on the production. You talked about a 1.7 Bcf per day exit rate, and I understand you had wells come on later in the quarter, boosting that number. However, your guidance for 2021 shows just over 1.5 Bcf a day, which is lower than the exit rate. Can you help me bridge that gap?

The exit rate reflects the surge from new pads brought online while managing production effectively to optimize cash flow. The strategic choice to manage production yield throughout the year allows for variability while sustaining overall free cash flow targets. While production may fluctuate, the focus remains on cash generation and yield optimization.

As we roll into Q1 and Q2, we anticipate seasonal adjustments. Our plans are consistent, albeit with the lumpy nature of operations as we balance cash flow opportunities.

Can you give the number of wells planned for completion in 2021? How do those break down between Marcellus and Utica?

While the bulk of our planned wells will be Marcellus, we have two Utica wells scheduled. The overall number for 2021 will be around 37 wells. We may see a higher number than our previously stated maintenance plan.

In 2020, we drilled around 46 or 47 wells, and while our maintenance plan targets 25 wells annually, we aim to operate within a range that accommodates flexibility while achieving operational efficiency.

Appreciate the insights, thanks.

The next question will be from Noel Parks with Tuohy Brothers. Please go ahead.

Good morning. I have a question on your share buyback plan. Given the current stock price, what's your appetite for taking risks on continuing to buy more shares?

Predicting stock prices accurately is inherently difficult. We remain focused on assessing free cash flow per share as our primary metric. Timing is essential, and we will make optimal allocation decisions based on value and opportunities as they arise throughout the year.

Our allocation strategies will be driven by future performance metrics, free cash flow, and market conditions, ensuring the decisions strengthen our long-term value proposition.

Just one last one; I’m curious about crude pricing stability and its implications for associated gas supply. What are your thoughts?

Crude price stability, particularly in the low $50 range, suggests potential constraints on associated gas supply. However, uncertainty remains regarding OPEC's intentions and U.S. production responses. Our focus remains firmly on our operations and hedging strategies to navigate potential fluctuations and optimize margins.

Ladies and gentlemen, this concludes our question-and-answer session. I’d like to turn the conference back over to Tyler Lewis for any closing remarks.

Great, thank you, Chad, and thank you everyone for joining us. If you have any additional questions, please feel free to reach out to the company. Thank you for attending.

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