CNX Resources Corp Q4 FY2021 Earnings Call

Good morning and welcome to the CNX Resources Fourth Quarter 2021 Earnings Conference Call. All participants will be in listen-only mode. 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, 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 Olayemi Akinkugbe, our Chief Excellence Officer. Today, we will be discussing our fourth quarter results. This morning we 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 2021 earnings results and 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 Olayemi will participate as well. With that, let me turn the call over to you, Nick.

Thank you, Tyler. Good morning. Like a string of recent quarters over the past couple of years, we had yet another clean, easy-to-understand quarter. And just allow me to spend a couple of minutes on a few highlights. In the fourth quarter of '21, approximately 80% of our free cash flow was returned to shareholders. And that was in the form of buybacks at very discounted prices. While taking advantage of bringing in shares at those attractive free cash flow yields, we also put the remaining 20% of free cash flow towards debt management, which in the fourth quarter meant really three things. First, we paid call premiums and fees for a positive rate of return bond deal where we issued $400 million of 4.75% notes that are due in 2030. We used those proceeds to retire $400 million of 6.5% notes that were due in 2025. The second thing we did was pay the fees to extend both of our upstream and midstream RBLs to October of '26. And then third and finally, we reduced our net debt. In fact, we paid down over half a billion, specifically $508 million of debt over the last eight quarters of two years. Now all three balance sheet strengthening moves seen in the fourth quarter, coupled with the cumulative free cash flow allocations for debt reduction, were recognized by another upgrade in our credit rating by Fitch, placing us one notch below investment grade. This year, we expect a market improvement in free cash flow generation relative to what was effectively a stellar 2021, and we issued 2022 guidance of approximately $600 million in free cash flow. That's about $3 a share. Given the current share count of just over 200 million shares, the past two years have been the most challenging for many companies, industries, and individuals over the decades. It really tested and proved CNX's brand of a sustainable business model in action. So what did we do? We invested heavily in our people and our regional communities to set the best team possible on the field of play. We were steady, safe, and compliant in our execution, and the team was able to deliver. In the region where we operated and manufactured our significant free cash flow, we generated that allowed for capital allocation opportunities that strengthened our balance sheet through debt reduction or maturity extensions and reduced our share count through the acquisition of our discounted shares. So those moves, they deliver impressive free cash flow per share, compounded growth rates, and intrinsic per share value growth—two things that we're absolutely focused on. In 2022, our path continues to be pinned to optimizing intrinsic per share value through long-termism and methodical execution by de-risking, and of course, by astute capital allocation. So again, going back to sort of the cliff notes for the fourth quarter of 2021, free cash flow per share was up, net debt was reduced, maturities were materially extended, share count was reduced at deep discount pricing, and we beat our 2021 free cash flow guidance. We're going to keep clinically following the math when allocating free cash flow. Rest assured our actions will continue to match our words as we shoot for 2022 and beyond. So let's hear from Don.

Thanks, Nick, and good morning, everyone. I'm going to start on slide 3. This chart highlights our steady execution and continuing commitment to our free cash flow plan. The fourth quarter of 2021 marks the eighth consecutive quarter of generating significant free cash flow, with the expectation of adding four more strong quarters in 2022. Slides 4 and 5 highlight our significant undrawn revolver capacity and our extended maturity runway that provide us considerable flexibility in the allocation of our free cash flow. As you can see, our focus has been on balancing shareholder returns and improving our balance sheet by reducing net debt and extending our RBLs to October of 2026. We also refinanced near-term debt with longer-term debt and lower interest rates. This quarter, we allocated more of our free cash flow towards share buybacks as we repurchased 8.6 million shares and another 1.3 million shares after the close of the quarter. On the debt side for this quarter, call premiums and transaction fees associated with the two major balance sheet-enhancing transactions executed late in the third quarter were cash settled early in the fourth quarter. The remaining free cash flow for the period reduced a modest amount of debt. Looking at the bigger picture, though, across all of 2021 and 2022, we have generated approximately $860 million of free cash flow, of which we used $540 million for debt management and $320 million for shareholder returns. This shows a prudent risk-adjusted blend over an extended time period. As we have previously stated, we remain committed to reducing our net debt to get our leverage ratio down to 1.5x. As you can see on slide 2, achieving that target is not a difficult task, as one year of our free cash flow gets us there. As a reminder, free cash flow is mostly protected by our hedge book and peer-leading cost structure due to owning our midstream systems. These facts give us the capacity to achieve both goals over the next several years. While we are not providing guidance on this topic, we will continue to follow the math and ensure we have a low-risk balance sheet. In other words, we will manage both materially over the next several years. Let's shift to slide 6. In the beginning of 2020, we put out a seven-year free cash flow plan. This slide highlights our outperformance again across several key metrics for the first two years of that plan. On the left side of the page, you can see that we have exceeded our original production guidance by a total of 41 Bcfe. Our CapEx during that same period was lower than our guidance by $67 million. On the right side of the page, you can see that our combined 2020 and 2021 free cash flow finished above guidance by $162 million, which is approximately 23% higher than expected. After seeing how we handily beat 2020 and 2021 guidance, and witnessing the increase in free cash flow guidance for 2022 from $500 million previously to approximately $600 million as it stands today. Let's wrap up by discussing the fundamental reset we've experienced within the company. Our operating efficiencies in the field, from drilling rates to completion efficiencies, have improved so much in the past two years that the old way of thinking about the map and the free cash flow that accompanies it are now considered obsolete— in a good way. Our efficiency step-change improvements have now placed us at a 590 Bcf run rate starting point in 2022, not the old 560 guidance from the initial plan. Notably, our 2021 production was closer to 590. This fundamentally changes how we utilize our one rig, one frac crew that we used to run for maintenance of production, now grows production without adding any new crews. That's materially better than how we envisioned the typical model back in 2020. As we always say, we will follow the math and strive to maintain high efficiencies. Today, you see our 2022 guidance on slide 7, culminating in a free cash flow target of $600 million or about $3 per share, based on the current share count. Looking beyond 2022, while we are not issuing new guidance today, we can indicate that our old plan was based on a different world—from low gas prices to different efficiencies—and is now somewhat irrelevant to how we think about the future. Instead, we anticipate low single-digit production growth at a one rig, one frac crew kind of pace. Free cash flow should be closer to a $600 million level, with opportunities for improvement assuming gas and NGL prices remain healthy, and of course, this boosts free cash flow per share. We should see impressive growth, depending on future free cash flow allocations. With that, I will turn it over to Tyler for questions.

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

Our first question is from Neal Dingmann with Truist.

Good morning, all. I think my first question for you, Don, is just about hedging. You guys continue to have a very strong balance sheet, obviously with great free cash flow behind that. So my question is—what drives your hedging strategy? Is it influenced by the balance sheet now that free cash flow has tremendously improved?

Yes, Neal, this is Nick. I think our programmatic hedging approach does not change moving forward. It's really premised on being able to derisk the top line and create a better level of certainty with the free cash flow generation and lock in those rates of return that are quite attractive when coupled with our cost structure. So I think during the different twists and turns that the commodity cycles inevitably take, we will continue to programmatically hedge out into the future. So I think that's a safe assumption to keep in place if you're looking to model us out into 2022 and beyond.

Okay, and then maybe a question for you or Chad. You guys have ample locations out there, and I wonder if given that, do you think you're getting credit for that full inventory with your stock price?

Yes, I'll approach that from three sub-answers. I don’t think we're getting proper credit for our free cash flow generation and the corresponding runway. To break it down into three sections: one, absolutely zero inventory concerns from my perspective. Two, monetization efforts of non-core assets, which has been part of our guidance numbers for years, will be included in the $600 million free cash flow number for ’22. Last year, we executed over 300 individual monetization efforts, which include both surface and different types of assets. This will be a regular course of business. Finally, what we should focus on moving forward is the free cash flow generation level, particularly free cash flow per share, and the annuitization of that. This showcases our ability to efficiently operate year in and year out and generate a growing trajectory of free cash flow per share, depending on capital allocation, which should be correctly valued in the market.

The next question is from Leo Mariani with KeyBanc.

Hey, guys, a couple things for you. So, I’d like to discuss the production trajectory for 2022. Is the expectation for volumes to decline in the first half, stabilizing thereafter?

Yes, generally speaking, I will start and then pass it to Chad for a quick follow-up. I don't think much about the quarter-to-quarter production variations. My focus is more on the free cash flow generation over an extended period. Looking back at 2020 and 2021, we made conscious decisions to curtail production based on rate of returns, and then in 2021 we accelerated production, which we could do due to our efficiencies. I expect similar flexibility in 2022 and beyond according to how we optimize for free cash flow. Overall, I foresee modest production growth, being low single digits over time.

In 2022, our quarter-to-quarter expectations based on our one rig, one frac crew schedule is roughly flat. There's a small variance, but it should average steadily with some timing included for production to maximize value. We recognize this makes it challenging to model, and we apologize for that, but our main objective is value creation.

Our new pads are so productive that the production we gain from a new pad does not significantly impact the overall business whether it comes on earlier or later. Over long durations, that can shift things from one quarter to another but balances out overall.

Understood. Based on your earlier commentary, I noticed you executed a pad acceleration from early '22 into 4Q '21. Will your TILs planned for '22 come on later in the year?

We can follow up on this after the call, but generally, we are at a new base production level of about a 590 Bcf rate. Without significant disconnects in the commodity curve, we anticipate low single-digit production growth moving forward, with our free cash flow tracking around $600 million a year. That's what I'm primarily focused on.

If a pad gets turned on the first week of January instead of the last week of December, it doesn't matter long-term, but it may impact which year the TILs fall under. It's a consistent program, but variables will change marginally, shifting some TILs from one quarter to another.

I understand you’re increasing your multiyear production forecasts from 560 to 590. Regarding your capital, I see '22 CapEx is projected around $485 million. Will that go down after '22?

The previous multiyear plan anticipated $300 million CapEx for a production level of 560—those figures are now obsolete due to our operational efficiencies. The currently guided CapEx for '22 does include some water and pipe infrastructure to set us up for our new operational efficiency level, with anticipated free cash flow generation around $600 million.

There are two main drivers for '22 capital: inflation impacting the DNC capital and some incremental activity for water and pipe infrastructure projects, which may not be evenly smooth over time. Overall, we're prepared for a bit of chunkiness in '22 in that category.

We previously mentioned an average across '22 to '26, suggesting that as our base decline rate lowers in outer years, less capital will be needed. Hence, despite '22 being higher, we expect lower capital needs as we approach 2026.

Could you quantify the expected extra water and pipe CapEx for '22?

There aren’t new projects, just moving them up, so the anticipated percentage of our total capital in the non-DNC bucket should be closer to 30% by the end of '22.

Hi, good morning, guys. You've been persistent with buybacks. Why not introduce a dividend with almost $3 of free cash flow per share?

This is a significant capital allocation topic that we spend considerable time analyzing. We have a clear desire to strengthen the balance sheet, which correlates to reducing the absolute level of debt. While we executed opportunistic moves like refinancing, our top priority is methodically reducing debt and taking advantage of discounted shares with strong free cash flow yields. Currently, given the compelling returns of buybacks, dividends are not the most efficient way to provide capital returns to shareholders. We pride ourselves on taking a unique approach, and as of now, our focus remains on debt reduction and share count reduction.

Dividends could also help market recognition of your cash flow generation. I also wanted to ask about inflation—what areas are you seeing that come through?

Inflation is affecting us across various fronts. We have incorporated that into the guidance for '22 specifically for CapEx. In terms of the specific components, Chad will elaborate on areas impacted by inflation.

Most inflation we've seen has been related to materials, particularly steel-related materials. About half of the inflation we included in our '22 forecast came from that, with the rest being spread across various materials we use in our operations.

What percentage inflation did you account for in DNC?

It is roughly 5% to 10% year-over-year.

Good morning. Chad, we'd like to get your thoughts on the basis. The divergence we saw in Q4 was a bit wider than expected; what do you see for 2022?

We assess spot exposure versus first month's exposure weekly, based on several variables including existing hedging positions, weather forecasts, and volatility expectations. The current volatility pattern is largely driven by weather fluctuations. We monitor this closely and rely on our financial hedge positioning while making monthly assessments.

Our in-basin production profiles are predominantly hedged through 2025. While we cannot predict prices, we can always protect our cash flows through basis hedges to optimize economic value.

You made minimal hedge additions into '23 and beyond; any updates you can provide on your hedging philosophy?

Our programmatic hedging approach will continue as before. Expect that around 80% of front-year production is hedged, with gradual reductions in subsequent years. This method balances our eagerness to derive free cash flow while ensuring certainty around revenue generation.

We leverage the forward strip to inform our decisions and protect the returns we're achieving. If conditions aren't optimal, we won't pursue spending.

Have you plans for RSG goals or achievements?

Our primary focus is methane monitoring, particularly autonomous methane monitoring. We're working with partners and setting up infrastructure for effective methane monitoring across our fields right now.

If it makes sense to get certified, we will, as it could be a profitable move. However, we want to manage this internally to ensure we understand it thoroughly before outsourcing.

Considering the 5% to 10% inflation in your '22 plans, did you factor in additional efficiency gains to offset inflation?

Inflation is indeed accounted for through operational efficiencies in our forecasting. The ultimate culmination is expected in our free cash flow as we increase our generation levels from $500 million to $600 million.

Our internal team is fantastic at discovering efficiencies, and we actively encourage them to do so across all areas of operations. We're confident we can achieve greater efficiencies moving forward.

Regarding your fourth quarter report, I noticed a $13 million expiration expense. Can you share what that was about?

A portion of that expense was connected to the abandonment of a well we drilled a few years back but ultimately chose not to complete due to various issues. It had a significant impact on the quarter.

Indeed, we take safety and compliance seriously, and if we see any issues with casing or other problems, we will act decisively to mitigate risks.

Lastly, on basis and related factors, how do you perceive private activity? Are there any concerns about potential constraints in Appalachia?

We closely monitor takeaway capacity, particularly regarding the MVP pipeline's status. While our plans account for current capacity, it's noteworthy that policy changes may influence supply-demand dynamics and lead to challenges during peak demand periods.

We're constantly evaluating our options to derisk the business and grow cash flow while remaining alert to changes in the market, focusing on effectively managing all variables.

The next question is from Kashy Harrison with Piper Sandler.

Good morning, everyone. Thank you for taking my question. Looking at the broader U.S. natural gas market, what are your thoughts on supply and demand trends for 2022 and 2023?

As we moved into December, U.S. natural gas supply began trending toward all-time highs. However, we lost about four to five Bcf a day of that supply due to freeze-offs and various related curtailments as we entered January, causing uncertainty in the market regarding the missing volumes and their return. On the new supply side, rig counts and frac crew counts are on the rise, indicating that the industry is responding positively to price signals. I expect continued supply response as we progress through 2022.

From a demand perspective, there will be increased consumption of natural gas nationally and globally due to limitations on renewable energy scalability. This will drive an ongoing need for natural gas, particularly as we transition away from coal. Additionally, geopolitical stability promotes energy security, emphasizing the critical role of natural gas amid fluctuating global energy markets.

With the anticipated supply increases from Haynesville and others, should we be worried about potential oversupply in the next couple of years?

Yes, we are mindful of every risk in this tight market environment, as even a small swing in supply could alter dynamics significantly. However, we continue to derisk our business through effective asset management and operational strategies.

The next question is from John Abbott with Bank of America.

What are your latest thoughts on acquisitions and M&A in this environment?

Our focus remains on selective capital allocation options, including potential M&A activity, but it is currently a low priority compared to meaningful debt reduction and share buybacks due to risk-adjusted returns. M&A doesn’t compete with those options at this time.

Lastly, how are you thinking about average lateral lengths and costs moving forward?

In '22, we’ve observed average lateral footage increasing from the previously planned 12,000 feet to around 12,700 feet. Our goal is to minimize costs while boosting drilling efficiencies, and we're optimistic about improvements in cost per lateral foot as we progress.

We expect to enhance our operational efficiency further this year, delivering more robust performance metrics.

The industry is setting new records on operations, which bodes well for all participants.

Great. Thank you, everyone, for joining us this morning. Please feel free to reach out if anyone has additional questions. Otherwise, we look forward to speaking with everyone again next quarter. Thank you.

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