CNX Resources Corp Q1 FY2022 Earnings Call

Good day, and welcome to the CNX Resources First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I’d now like to turn the conference over to Mr. Tyler Lewis. Mr. Lewis, please go ahead.

Thank you, and good morning, everybody. Welcome to CNX's first 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 first 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 1Q 2022 Earnings Results and Supplemental Information of CNX Resources. 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, and then we will open the call for Q&A where Don, Chad, and Olayemi will participate as well. With that, let me turn the call over to you, Nick.

Thanks, Tyler. Hi everybody. I'm going to handle the commentary today as Tyler just said, I'm going to break it into two parts. First, let's have a review of our results for the first quarter and talk about some updated guidance looking forward and then I'll wrap with a couple of comments and maybe observations—actually a better term—about our industry, the nation, and the world today. But starting first with our quarter and our outlook into the future. CNX yet again, fortunately, repetitive music sounds great for ownership. That's because like the string of recent quarters, the past few years, we had yet another clean and easy to understand quarter. I'm going to review the quarter by running down the key components of the CNX sustainable business model or the SBM as we refer to it. You can read more about our sustainable business model in our proxy and our soon-to-be-released corporate responsibility report; I encourage you to do so, of course. The sustainable business model starts with having a compelling why. What motivates us to do what we do. CNX and our employees, we bring quality of life and security to society. Without us, everything stops, and realization of our purpose or that why has grown tremendously over the past year. The world sees what happens if things like domestic natural gas are taken for granted or worse yet, if they are marginalized. And I’ll have more to say about this in a couple of minutes when we get to those observations that I spoke about. The next step of that sustainable business model is building a non-replicable and resilient, competitively advantaged business to deliver on that why. In the first quarter, we delivered another quarter of smooth, safe, and compliant operational execution across what is basically our stack pay, our upstream midstream integrated, and our low-cost—actually lowest-cost footprint in what’s become the most prolific natural gas base. You take these attributes, and couple them with our programmatic hedge book, you see CNX was able to land our production costs and margins right where we wanted them in the first quarter. The third step of the sustainable business model is to generate steady and substantial free cash flow. In the first quarter, we saw it post over $234 million in free cash flow. More importantly, we produced $1.20 of free cash flow per share in the first quarter, using the quarter-end share count, just over 195 million shares. Then the next steps of the sustainable business model start to look to astutely allocate our free cash flow to the right places, at the right times, to generate these value trading rates of return and long-term per share value. Astute capital allocation perpetuates our why. We start with investing in our most important asset, which, of course, is our team. I'm happy to report that CNX, the public company regional leader when you look at all-in average employee compensation in 2020, achieved even higher compensation for employees in 2021, with over $180,000 per team member. We have some exciting efforts in the works when it comes to human capital in 2022, so please stay tuned as the year unfolds; we have much more to say about that. Now, the next free capital allocation avenue that we consider is investing in our regional communities. CNX was very active during the first quarter on its front, the CNX Foundation is up and running with its governance. We've already committed millions of dollars to what I think are going to be hugely impactful investments across communities in need of our Appalachian footprint. The CNX Mentorship Academy is rounding the bend to conclude its first inaugural class here in early June; hard to believe. I'm beyond excited about what that is all about and how it's ready to welcome these young men and women into the local workforce, particularly the CNX workforce. Employees across the company are catching the fever to identify, personally participate in, and drive a portfolio of investments we're making across Appalachia. CNX has broken the mold and set a new standard regarding ESG performance and things like stakeholder capitalism and what it truly means to focus global. The company's success and the local region's success have always been linked, and that's the responsibility that we continue to lead on and embrace. Next, we look to pay down debt under our sustainable business model. In the first quarter, we paid down $74 million in net debt. I’d describe our balance sheet as stellar at this point; it's going to be getting even better as 2022 unfolds. The optionality that this strength creates can be a really powerful thing in an industry such as ours, which I'm also going to expand upon when I talk about those observations. The last step of the sustainable business model, but not the least, is returning capital to our owners. We've got two ways of doing that: through dividends or share repurchases. Which one we pick is going to follow the clinical math of risk-adjusted rates of return in the context of long-term per share value. That approach dictated that we continue to repurchase shares in the first quarter; we invested over $150 million of free cash flow in share repurchases, buying in over 9 million shares or just under 5% of the company in the quarter at an average price of $16.55. We are thrilled with that result. So that’s the CNX sustainable business model in action. Yet, it tends to be repetitive, but we love that kind of repetition. Before I forget, today, we also raised 2022 guidance to approximately $700 million in free cash flow, or $3.59 per share using the updated shares outstanding as of April 20. Okay, now that we've covered the quarter and our guidance outlook, let me shift and offer up a few observations about our great industry, nation, and the state of the world. These observations go to the heart of that why that I spoke about and impact not just CNX and Appalachia in profound ways, but they also deserve, I think, far more discussion than the limited time we've got today. Let's hit on a couple of these observations. I think 2022 is turning out to be quite the proving ground that’s verifying certain realities and exposing certain flawed beliefs. First, let's talk about natural gas supply and how that might grow to respond to increases in energy demand needs both domestically and in places like Europe. There's been a lot of talk about LNG and how U.S. natural gas can save the EU by replacing Russian natural gas and providing much-needed energy security during a time of crisis. At the same time, we cannot lose sight of the energy supply challenges that we still have to overcome domestically. I think the industry is doing what it can to increase supply. CNX is a great example where we expect production and capital expenditures for the year to be toward the higher end of our guidance range. Every little bit of this is going to help. However, there are some harsh realities that are quite ironic, unfortunately. The domestic natural gas, oil, and pipeline industries in the nation cannot ramp up production close to the levels that the U.S. and EU are clamoring for anytime soon. And that's not because of industry unwillingness; we are an industry of doers, and it's not because of corporate greed or profiteering, as some might allege. No, instead, it's simply and starkly because the policy has consciously and methodically looked to strangle infrastructure investments in the pipes, processing, power generation, and yes, in the LNG infrastructure—all needed to meet the world's energy demand. These policies are everywhere—global policies, such as the Paris Accord and the UN IPCC climate roadmap. You see them in national policies via a weaponized regulatory regime and the administrative state. You see it in regional policies and some of these dysfunctional regional transmission organizations that are manipulating energy and electricity markets, leading to really bad outcomes and consequences, as we've seen in Texas and California. You also see them in state and local policies, such as de facto natural gas development or transmission or end-use bans in places like New York and Boston. Unfortunately, these policies have been extremely effective in achieving exactly what they were designed to do, which is create energy scarcity, pent-up prices, and prevent the most sensible supplies of natural gas and oil from reaching the obvious demand centers. That's why Boston has to import LNG from thousands of miles away, including Russia at times, instead of taking molecules from Pennsylvania 400 miles away via the pipeline. That's why U.S. politicians plead with dictators in Venezuela and OPEC to increase output. Tragically, that's why the EU is energy dependent on Russia. For our industry to solve problems and provide solutions, it is unfortunately going to take years. The domestic energy industry has been under attack and pendant for over a decade by these policies, and now it will take nearly as long to correct that. That's assuming policymakers wake up to the reality, which is a big assumption as crazy as it sounds considering times like these where common sense tells us domestic energy has never been more vital, and the policies designed to stymie it have never been more harmful. These policy concerns lead to my second observation. Despite the clear validation of domestic energy as an attractive and deserving investment option, we believe access to the capital markets for our industry is going to continue to be more restricted. This could be something like ESG investing on the rise, or it could be the Federal Reserve climate stress tests on banks, or it could be SEC climate disclosures. To manage this risk, we believe the prudent course under our sustainable business model is to maintain a debt level, a maturity schedule, and a liquidity level whereby we never need access to debt markets. Fortunately, we reached that point; our guidance and future free cash flow generation, when coupled with our balance sheet metrics, means we have the optionality to organically delever to be independent of the debt capital markets. For our industries, the CNX way needs to become the norm until policymakers and capital markets allow themselves to be mugged by the facts. I'll wrap with my third and final observation. The topic is one of sadness. I've been around this industry and company for 32 years now. I’ve seen a lot of free-market driven, innovative, and entrepreneurial movement that disrupted the world with the shale revolution. I’ve seen the establishment of an energy powerhouse in the United States and energy independence if we choose it. I’ve seen vastly improved quality of life and the revival of the middle class in an improved environment, including lower carbon intensity for my lifelong home of Appalachia as it retorts itself to take advantage of the shale revolution. I’ve been with a company that completely transformed from exclusively coal to now best-in-breed natural gas and midstream. Working with people who care, excel, achieve, and who are compensated at the very best levels to be found in any industry, the CNX today is strong, vibrant, and secure. When you look at its future path, the opportunities are mind-boggling, from our developing and exciting emerging technologies to what we should deliver on shareholder per share value. But my emotion in 2022, I have to tell you, as I said, is sadness. Because much of what ails this nation and world did not have to be. Putin did not have to be enabled. Ukraine did not need to be destroyed. Americans didn't need their households to be robbed by what is known as inflation. And our energy security and grid reliability, whether in Texas, California, or Europe, needed not to be compromised. It all just happened and continues to run rampant, and it's going to get worse—potentially much worse. Why? Because the full potential of the American energy industry to unleash prosperity domestically and abroad has been deliberately handcuffed. Energy scarcity has been manufactured by policy design. These industries were not allowed to become victims of their own success by providing more supply of our widgets so that not only infrastructure and demand grew, but to balance supply and demand so that prices could moderate. Dictators don't have to hold the free world hostage. The current state of our energy industry and economy, our geopolitical standing, is not healthy. Until the health of those improves, we're all going to pay the price; it's just a question of what extent. This didn't have to be; how long shall we continue to tolerate it? The good news is the Appalachian region has the resources, the know-how, and the work ethic to be the fountainhead or the catalyst of the modern energy and manufacturing industries. We can be a center for skilled labor job creation to help pave a path to middle-class access for the region's underserved rural and urban communities. The only thing preventing this from happening is a collective willingness to embrace data and facts over politics and ideology. We should embrace the assets, workforce, and energy in the Appalachian region. We utilize first in this region and then far beyond. It can make western Pennsylvania or Western Virginia or West Virginia the true energy capitals of the world by developing and utilizing homegrown resources to build a local energy ecosystem that will cultivate and sustain the middle class for the next generation. These natural gas-based products are more environmentally friendly, lower cost, and will be sourced locally in the Appalachian region instead of from faraway lands, along extensive supply chains with large carbon footprints. This is a realistic and actionable solution for the Appalachian region that runs counter to other efforts championed by establishments and organizations that have ideological goals. Final thought that ties back to where we started: despite the noted challenges in my observations, we're going to continue to embrace our tangible, impactful, and local approach to ESG, which will help us execute our sustainable business model and deliver long-term per share value while advocating for our industry and region. The opportunity is now to reframe and redefine the region's energy utilization and economic strategy, and it will directly and tangibly benefit local citizens, the local environment, and the entire region. When the why of what we do is so compelling, our path forward is always clear. I'm turning it back over to Tyler now for Q&A.

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

We will now begin the question-and-answer session. Our first question comes from Michael Scialla with Stifel.

Good morning, everybody. Nick, I appreciate those observations on the industry. I guess, are there any particular things you'd be looking for in terms of policy change that would cause you to rethink the strategy of essentially no growth? And maybe, if you could extrapolate that to Appalachia as well. When do you think, if say, tomorrow the Administration started to move in the direction you think it should, is there any sense on what the timeframe for when Appalachia or CNX in particular could go back to a growth mode?

From an industry perspective, it's a great question. The most immediate issue is the policies regarding what they're doing that deters investment in more of the transportation infrastructure. As I said, to move supply to logical demand centers and settle it out in a way that allows producers to figure out what those rate of returns will be and make capital investment decisions that will span decades. That's probably the biggest impact right now regarding basin-wide or industry-wide supply responses; we basically need the plumbing to be able to move the supply of the widgets to demand centers, whether they're global, regional, or local.

Got it. I guess now with the stock over $20, you've talked a lot and in every call you've been asked about your philosophy on returning capital to shareholders. Your choices have been primarily buybacks, and I guess complemented by debt reduction. With the stock over $20 now, has that philosophy changed at all? Would you slow down on the buybacks or consider a dividend? Are you still thinking buybacks are the best form of returning capital for you at this point?

To your point, stock price is one of those important metrics and variables when we're calculating the best per share value creation avenues. The philosophy doesn't change; the equations don't change, just some of the variables. When you update share price, gas forward strips, the free cash flows that would be produced from that under our activity set that we've laid out, and consider things like free cash flow yields, and free cash flow per share—what those risk-adjusted returns are. I think at this stage, we are still comfortable following that math; share repurchases are the best avenue for shareholder returns. That can change to your point over time. We're not averse or against dividends philosophically, but we think again, looking at the math and the risk-adjusted returns, the best path continues to be share repurchases versus dividends.

Our next question comes from Leo Mariani with KeyBanc.

Wanted to delve a little bit more into one of those really, that first question. So I know historically, CNX has spoken over time that the multi-year plan was to stay in maintenance mode until there was really a shift upwards in the natural gas futures curve. Clearly, we're at the point in time where the entire gas curve you see looking out a handful of years has shifted higher. Could that potentially pave the way for a little bit of growth in 2023? Or do you think that there are too many kind of infrastructure and policy challenges to even make that a possibility at this point?

This is Chad, I'll take a shot at that. So I guess first, I want to make sure it's clear that we could grow, right. I think we've demonstrated that by growing our production by roughly 20% since 2020. But that's not necessarily the only variable we're solving for. The changes in commodity prices change the variables that are entering that optimization problem. However, various other variables are also factored. Continuation with the plan we've articulated over the past several quarters frankly, the last couple of years at this point will be ideal. We’d love to plan around it, and there are many reasons why we love that plan. It provides predictability and a line of sight on future operations. It allows our teams ample time to prepare and conduct quality control. Therefore, the steady work provides continuity of crews and equipment, minimizing the impact on our plan from the labor and equipment issues that some of our peers are experiencing. A significant third factor is that there’s only a certain amount of capacity and only a certain amount of local demand to consume the gas produced right here in Appalachia. We are fully prepared to increase our production once global demand begins to rise, or the capacity to export more molecules from Appalachia also rises along with it.

The only thing I'll add on top of that, Chad, is we look at this on a per share basis—production—just like we would free cash flow. If you look, a 5% reduction in our share count in Q1 equates to a 5% growth in our production per share. As Chad mentioned, there's two types of growth in our minds: sustainable consistent growth year after year for a decade, which needs line of sight for gas demand to support it. In the meantime, volatility will continue to be the name of the game, and there will be unpredictable price swings due to the fragility of the supply-demand balance and inventory situation that we currently have. We'll attempt to optimize and grow here in the edges and fringes year by year with hand-to-hand combat decisions, but line of sight on consistent demand growth is essential to take that approach.

I also wanted to follow up on one of the comments that Nick made. I think I heard correctly that you all said you're pointing toward the high end of CapEx in production guidance for 2022. Maybe if you could provide just a little bit more on that; I would assume maybe that the activity set hasn't changed in terms of the plan, but perhaps the wells are continuing to come in strong, which is why production would be towards the upper end, and maybe inflation is also pointing to the higher end of CapEx. Any color on that would be helpful, as well as anything about the cadence of capital spend or turn-in-lines for the year.

Yes, I'll start. I’ve said it before: the tail cadence quarter-to-quarter is not something I pay much attention to. It’s about getting these pads online, and the rate of returns are phenomenal. What's happening is that Chad and his team are getting better at efficiencies, and line of sight means we’ve been able to go faster—that’s where most of our growth has developed. If you look at the growth he talked about earlier, that's because our factories are moving faster now. If we get through one pad faster, the next pad starts sooner and vice versa. Chad calls it the accordion effect, and we have the ability to move faster, which pushes us toward the end that Nick referred to here. Ultimately, that's good for shareholders, the nation, and everyone to get more gas from the ground this year.

For more clarity on capital and production cadence: if you look at the numbers, if you consider our current guidance and the midpoint of that, divide that by four, that’s approximately where we are at on Q1 production and Q1 CapEx, plus or minus maybe 1%. This illustrates how consistent our plan is becoming. There is some chunkiness because the pads are large, so bringing a new pad on results in a surge in production, but over time, over multiple quarters and years, we’re really solving for a very consistent and predictable de-risked sustainable business model. While it’s going to be chunky and there might be bracketed quarters, we are really solving for a very consistent plan.

I just wanted to also ask on cash taxes. I noticed that in 2021, you all did not pay much on the cash tax or current tax line but saw you paid about $8.6 million in the first quarter of '22. I wanted to understand if that's more of a one-off, or do you think you're going to start paying state or federal cash taxes more materially this year or next?

As a reminder, we laid out our initial seven-year plan back in 2020 regarding reaching that $3 billion cash flow threshold. We’ve mentioned that we could be material cash taxpayers sooner since things have gained traction. Generally, as a rule of thumb, once we cross that $3 billion threshold, that’s when you can reasonably expect to be a material cash taxpayer. It also depends on how we handle free cash flow between now and then. You'll see some fluctuations, but until we pass that rule of thumb, there won't be anything substantial.

Our next question comes from Neal Dingmann of Truist.

I just want to talk about cadence a bit.

Mr. Dingmann, your line is live and open.

Let’s go to the next question, please.

Next question comes from Noel Parks of Tuohy Brothers.

I was interested to hear your comments about steering clear of the debt capital markets for the longer term. I'm curious, do you not see this as a situation with maybe two different windows ahead? Especially now with everything looking positive for natural gas fundamentals, it’s more like the old days where demand is rising. We’re seeing it in the strip against a backdrop of tight supply. This seems like a time—especially given that interest rates have gone up—where it wouldn’t be the worst time to finance with debt. In contrast to when we would be faced with declining demand trajectories for gas when alternatives become cheaper and take up more of the energy market.

Your description is accurate if you're analyzing it just based on the math. The objective assessment closely matches what you described—however, we are in a world where capital markets are not allowing objective data to prevail. Our concern is that we will continue to experience more restricted access to capital, higher rates, etc. From our perspective, as a low-cost producer and a free cash flow generator coupled with balanced sheet metrics, we suggest that from a balance sheet perspective we should manage our liquidity and maturity schedule in a manner where we never need to access debt markets. We reached that sustainable position where our business model is self-funding. I hope your description becomes the condition of our industry in the future, as that would benefit not only the industry but also the nation and the global economy. Still, we see troubling signs from various entities and regulatory bodies suggesting challenges with access to capital and cost in the debt markets.

I was also wondering, with the Ukraine and Russia situation and the shock it's causing on commodity markets, do you think that muddied the picture regarding domestic seasonal factors and consumption? In retrospect, how do you think the situation affects energy pricing seasonality moving forward?

I think the question boils down to how much exports adjust or affect seasonality of domestic natural gas prices. When looking at exports as a function of total annual consumption, approximately 10% to 15% of U.S. production is attributable to the export market. This may marginally diminish seasonality, but we remain highly susceptible to weather fluctuations, and much of the seasonality is ultimately dictated by storage availability. In past years, although natural gas consumption has grown 80%, our availability of storage and infrastructure has remained unchanged. LNG has influenced seasonality on the margin, but fundamentally, across this nation, our lack of storage and infrastructure limits our capacity to moderate seasonality driven by winter weather.

Next question comes from Neal Dingmann.

Sorry about that, guys. Just giving this another shot. I was just asking on cadence. Your plan seems pretty steady on a go-forward basis, even comparing the second half versus the first half. Can you comment on that?

I think that’s fairly accurate. I don’t think we have anything further to provide on that.

Lastly, Don, can you talk about the market mix? Do you anticipate much change there? Currently, it looks like TETCO M2 will continue to be the largest route, followed by TCO Pool. Do you foresee any sort of changes coming on the marketing side?

We really don’t expect changes in our market mix over time. Our marketing team constantly looks for short-term opportunities to move gas to different markets, providing access to various pipelines. They optimize on a daily basis, monthly basis, and weekly basis, and they do a phenomenal job down there. Moving forward, we will look at long-term firm transportation opportunities, permitting access to other markets, but justify longer-term commitments based on the anticipated market premium.

Lastly, I appreciate the breakdown of net acreage and undeveloped locations. Can you give more detail on that? How do those locations look currently versus when we were back at the $2 range?

It’s a clear way to show what we own. Development and leasing occur each year—it’s just a normal process for any Appalachian company. In total, we are responsible for around 350,000 undeveloped acres, and our consumption rate is around 6,000 to 7,000 acres a year, including some leasing. We think the current structure we maintain makes these acres better when compared to our peers who have higher gathering charges. Overall, our drilling costs present a significant advantage in all areas. They performed well at the old strip and are even better at the current structure.

This concludes our question-and-answer session. At this time, I'd like to turn it back to Mr. Lewis for any closing remarks.

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

Conference is now included. Thank you for attending today's presentation. You may now disconnect.