CNX Resources Corp Q1 FY2023 Earnings Call

Good morning, and welcome to the CNX Resources First Quarter 2023 Earnings Conference Call. I would now like to turn the conference over to Tyler Lewis, Vice President of Investor Relations. Please proceed.

Thanks, Tyler. Good morning, everybody. First, let me give you a warning at the start, this is take your kids to Workday for us. We've got over 80 kids throughout the hallways in the office at the headquarters today, and we lost containment about 45 minutes ago. So if you hear any yelling or screaming, that's what that's all about. I apologize in advance. But it is one of my favorite days, actually, of the year. First quarter of 2023 marked 13 consecutive quarters of significant free cash flow generation, going back to early 2020, and we've continued to utilize that free cash flow to reinvest into the asset base and to acquire a significant amount of our shares at prices that we believe represent a substantial discount to their intrinsic value. During the quarter, we repurchased an additional 3% of our outstanding shares, resulting in the cumulative retirement of approximately 28% of the outstanding shares of the company since 2020. As we discussed on our previous call, this magnitude and pace of buybacks has not only been bested by a very small handful of other companies across the S&P 1500 over the same period of time. You get a sense of the magnitude of our share repurchase program when you look at Slide 3 in the deck, which shows the top 30 largest gas producers, at least as measured by production. More specifically, when you look at the last 12 months cash return to shareholders, comprised of share buybacks and dividends, divided by each producer's market cap, you can see that CNX is at the top of that list. The key takeaway is that scale doesn't necessarily equate to larger shareholder returns. Despite CNX being the top of the list for largest shareholder return as a percentage of market cap, our 2022 annual gas production is ranked somewhere in the middle of this group. Returning capital to shareholders is a crucial component of our capital allocation strategy, and we're going to continue to evaluate the most efficient and effective ways to do so, ultimately driving long-term free cash flow per share growth and meaningful shareholder value creation. We've maintained a prudent financial position by keeping a strong balance sheet, managing our debt levels, and maintaining adequate liquidity to weather economic headwinds, which Alan will cover shortly. Meanwhile, our industry has faced a collapse in NYMEX prices. Beginning late fourth quarter of last year and throughout the first quarter of this year, there was an extraordinary decline in natural gas prices over a very short period of time. Specifically, we saw NYMEX natural gas prices decline by approximately 74% when comparing March 2023 to September 2022 prices. This rapid deterioration in pricing, coupled with inflationary pressures across every imaginable input, poses near-term challenges throughout the industry. CNX might be the only player in the basin that will be free cash flow positive for the remainder of 2023 at the current strip, and will likely be the only one returning significant capital to owners for the remainder of the year. Many in the industry are increasing debt leverage and outspending cash flow as we speak. We believe the industry will struggle to execute the Shale 3.0 business model of returning capital to shareholders in this phase of the commodity cycle with low prices and high costs. Conversely, CNX is well-positioned to navigate this environment as a low-cost producer in Appalachia with one of the most robust hedge books in the industry. Given our targeted activity set and integrated midstream and water infrastructure ownership, we have more flexibility than most producers to adapt our activity set. This flexibility in volatile times becomes incredibly impactful, especially when combined with how Nav and his operations team are focused on driving efficient execution and optimization throughout the natural gas manufacturing process. Operationally, we are seeing positive results across drilling and completions activities as well as all supporting activities. Assuming no adjustments to our activity set related to the broader macro environment, we expect to be around a 1.6 Bcfe per day run rate near midyear, as discussed on the last call. This position allows us to finish the year within our stated annual production guidance range. Solid, steady operational performance creates optionality to optimize per share returns, and we're starting to see that unfold as we speak. Regarding our decision points for 2024, one option is to keep activity steady at the 1 frac crew plan through 2023 and early 2024, which would result in increased production up to approximately 590 Bcfe in 2024 without increasing activity beyond the single frac crew. This scenario is reflected in our guidance for 2023 free cash flow and capital. Alternatively, we could slow some select activity in 2023 to keep 2024 production closer to flat from 2023 levels while building duck inventory to bring on at the right time, thereby creating incremental free cash flow in the nearer term. Ultimately, production is a result and not an objective within our strategy and business model, and our decision-making will focus on long-term per share value rather than short-term optics. We'll carefully monitor NYMEX fluctuations, but the key takeaway for now is that CNX's operational efficiencies have reset to a higher performance level. Regarding the core business and the new technologies group, it is delivering tangible results and developing exciting projects. One project we recently announced is a collaboration with Adams Fork Energy, which is constructing a multibillion-dollar clean ammonia manufacturing facility in Mingo County, West Virginia. CNX has entered into a strategic partnership to provide natural gas, wastewater disposal, and carbon sequestration services to that project. We're also leading engagement with the Appalachian Regional Clean Hydrogen Hub, better known as Arch 2, to hopefully attract DOE hub designation and funding for the project. This project aligns with CNX's focus on tangible, impactful, and local functional ESG solutions and supports our Appalachia First vision, which aims to catalyze a new vibrant middle class in the region, especially in underserved parts like Mingo County, West Virginia. Stay tuned for future updates on this exciting project. I’m pleased to report that the new technologies group will be firmly free cash flow positive in 2023 and will be a growing contributor to our free cash flow in 2024 and beyond. We expect to release our 2022 corporate sustainability report shortly and I encourage every owner to read this document. It is likely the single best product that reflects our company's strategy, philosophy, values, and business model. To us, it is not a compliance document but rather a summary of focused investments into everything we are doing to advance our Appalachia First vision. There are many good takeaways in the report concerning our investments in the communities we operate in and our new technologies initiatives to revolutionize the energy and transportation industries. Slide 8 highlights some of the corporate sustainability report metrics, showing that the Appalachia region has the lowest methane intensity basin in the United States, and CNX's performance is better than the Appalachian Basin average. Our methane intensity is expected to decline rapidly as we focus on driving tangible and impactful results. I want to conclude my remarks by discussing the governance aspect of ESG. If you are a shareholder of CNX, you have likely heard from the company asking you to vote in accordance with our Board of Directors' recommendations at our Annual Shareholders Meeting, which includes voting against a climate lobbying shareholder proposal. This proposal may seem immaterial but optics can be deceiving. We took a public stance asserting our commitment to owner value. We view these shareholder proposals as being promoted by activist firms seeking attention rather than working to improve the underlying business or the environment. They often seek to erode sound governance and undermine our duty to shareholders in order to appropriate value for themselves. Considering these proposals as spam-like in nature, they destroy value. We hope the industry and capital markets will follow our lead and push back against these proposals, as they are bigger issues that shareholders and proxy advisory companies need to confront. We were pleased to see Glass Lewis' recent recommendation to vote against this proposal, and we'll do our part to ensure the right outcome. With that, let me turn it over to Alan to review the details of the quarter.

Thanks, Nick, and good morning to everyone. As Nick mentioned, this quarter represents the 13th consecutive quarter of free cash flow generation through executing our sustainable business model and long-term strategic plan. In this quarter, we generated approximately $89 million of free cash flow. Since we initially laid out our free cash flow plan in the first quarter of 2020, this brings our cumulative total to approximately $1.7 billion or roughly 65% of our current market cap. Let's first turn to the capital allocation side of the business as highlighted on Slide 6. As you can see, we continued our market-leading shareholder return initiatives by repurchasing approximately 6 million shares in the quarter and another 500,000 shares after the close of the quarter through April 13. In total, we bought back approximately 3% of our shares outstanding over that timeframe. Since Q3 of 2020, we have repurchased about 28% of the outstanding shares of the company. Given the significant disconnect between the current share price and its intrinsic value, repurchasing our shares continues to be a low-risk capital allocation opportunity which will dramatically reduce our denominator and meaningfully grow our long-term free cash flow per share. On the balance sheet side, total debt levels remained essentially flat with the previous quarter, while net debt slightly increased as we used cash from the balance sheet towards share repurchases during the quarter. Our net debt to trailing 12-month EBITDA is 1.8x, and we expect it to continue to adjust throughout the year to reflect fluctuations in EBITDA driven by commodity pricing. More broadly, as part of executing our sustainable business model, we expect to continue paying down absolute debt levels over time to further bolster our balance sheet. As seen on Slide 5, the balance sheet management activities we've undertaken during the last several years have positioned us with substantial liquidity and an enviable debt maturity runway. These attributes differentiate us and enable us to confidently continue our market-leading shareholder return initiatives even during downturns in the commodity cycle. Additionally, they position us to take advantage of any valuation disconnects that might occur in either the equity or debt markets. Let's now shift to our updated 2023 outlook on Slide 7. As Nick discussed, due to mild winter weather and increased year-over-year national production levels, we have seen a rapid and remarkable natural gas price decline that started in Q1 of 2022 and continued through the first quarter of 2023. Despite having around 80% of our 2023 gas production volumes fully hedged for NYMEX and basis differentials, around 100 Bcf of natural gas volumes remain open and exposed to pricing fluctuations. Half of those open volumes were sold in Q1, and the remaining half are spread across the remaining three quarters of the year. Consequently, we are updating our annual EBITDAX range to be between $950 million and $1.05 billion, as well as our full-year free cash flow guidance to approximately $250 million. Despite the significant drop in gas prices for 2023, our operational plan and capital guidance remain unchanged, as current long-term strip prices reflect a bullish long-term gas outlook. As such, we expect annual production volumes to be between 555 and 575 Bcfe and to return to around a 1.6 Bcfe per day run rate around midyear. During the quarter, we operated two full rigs: a top full hole rig and a continuous frac crew. We expect to release the second rig towards the end of the second quarter, resulting in the cadence of capital spending reflecting that decline in activity across the third and fourth quarters. Our activity set and corresponding capital expenditures for this year represent a growth plan rather than mere maintenance. This year's capital spend includes critical investments in key long-term infrastructure projects, which maintain our basin-leading cost position and enable production growth in 2024 to approximately 590 Bcfe or roughly 5% year-over-year. Lastly, despite no changes to the current plan, should forward gas prices decline further, we have a built-in optionality and will not hesitate to reduce our capital activity set to achieve the best long-term economic results. Regarding service and commodity costs, while we see some positive indications, we are not yet experiencing a decline in costs reflective of the drop in gas prices. Should gas prices continue on their current trajectory, we would expect this situation to change in the second half of the year, as typically seen in other cycles. This potential service cost deflation in H2 2023 would benefit us, though the impact would be most significant in 2024. We expect 2023 fully burdened cash costs to be lower than in 2022, and most importantly, we continue to strive for lower cash costs moving forward as we optimize all parts of the business. In conclusion, we are confident that the sustainable business model we've created will continue to deliver value to our shareholders throughout the cycle, as evidenced by our expectation to generate free cash flow for the remainder of 2023, despite current prices. Our focus will be on safe, compliant, and efficient execution to develop our extensive natural gas asset base, accelerating free cash flow growth from our new technologies business, consistent and clinical capital allocation for long-term free cash flow per share, and ensuring our decisions reflect a long-term owner mindset. With that, I will turn it back over to Tyler for Q&A.

Thanks, Alan. And operator, if you can please open the line up for questions at this time.

Our first question comes from Zach Parham from JPMorgan.

I guess, first, just on the balance sheet. Over the past several quarters, you've been very aggressive with the buyback with less focus on debt reduction. And Nick, in your prepared remarks, you mentioned continuing to return cash to shareholders through the remainder of '23. But just how are you thinking about the balance sheet here with gas prices moving lower over the last 6 months? You're approaching 2 turns of leverage. Will you consider shifting more free cash flow back to the balance sheet later this year? Just any color there?

Yes, this is Alan. I think what you're seeing now is the cumulative effect of all our transactions in the last several years have positioned us to withstand this sort of environment. We've been clear that we are built to continue shareholder returns throughout the cycle. For the remainder of '23, given our maturity runway, ample liquidity, and our hedge book, we are comfortable that we can consistently return capital without any issues regarding debt management in the foreseeable future.

Got it. And then one just on OpEx. Operating costs were a bit higher than expected in Q1, and I noticed in the slide deck that you increased the 2023 fully burdened cash cost guidance by about $0.05 per M. Can you just give us color on what's going on there? Is that just inflation-driven? Just any thoughts on that number?

Yes, so two primary drivers. The first is the impact in Q1 from being able to sell unutilized FT; there wasn’t as much of a spread on some of our pipes as we initially forecasted. The second driver is we've added some incremental planned maintenance projects on the compressor side, so we've updated the outlook for that.

The next question comes from Leo Mariani from ROTH MKM.

I was hoping you could talk a little about these two different scenarios that you're envisaging here, where there could be some cut in activity depending on what the math tells you. I understand it's very focused on what the markets and math are going to tell you here. But I wanted to get a little sense of what you're going to be looking at. Obviously, near-term gas prices are weak, but as you look out into '24 and '25, as you mentioned, the strip is materially higher. Is it really more of a drop in that strip as we get into winter and into 2024 that may cause CNX to pull back a little on activity this year? Or is there also going to be some impact from spot prices? Just trying to get a sense of how the dynamic plays out.

Yes, a couple of things on that. From a production perspective, our variable costs are incredibly low due to our midstream ownership. We look at this opportunity in terms of when to bring wells on, considering TIL cadence and deferring completions activities. What we observed in 2020 is one approach we could take if cash prices stay weak by delaying TILs from the shoulder season to the end of the year, bringing them on in the winter. We're consistently monitoring the strip and might kick it over to Nav for insights on shut-ins.

On shutting-in existing production, we're trying to optimize over asset lifecycle valuation. Since we have integrated upstream and midstream, our focus is maximizing the deliverability of gas. We're analyzing wells based on lifecycle phases, ensuring maximizing production while minimizing costs.

Okay, that's helpful for sure here. I wanted to clarify that it sounds like, at this point, you guys reiterated the guidance. Everything is intact, so there hasn’t been any material change, and I guess we'll just have to wait and see what happens.

That's right. Currently, where the forward strips are reflects a steady state, and we're developing plans accordingly.

The '24 and '25 forwards mentioned currently align with the math of maintaining the 1 frac crew activity set. If those forwards change, this will influence the longer-term rates of return, and we can adjust as needed.

I wanted to ask about the Adams Fork deal. Can you provide more color on CNX's role? Are you going to be the exclusive gas supplier to that clean ammonia plant? Regarding carbon capture, will you manage the storage reservoir and drill injection wells?

Yes, Leo, regarding the strategic partnership with Adams Fork, we will be the gas supplier. Our gas assets are located close to this facility's construction site. Additionally, we have expertise in drilling deep wells and CO2 sequestration, allowing us to offer those services to the project.

Our next question comes from Michael Scialla from Stephens.

Alan, you mentioned you've been surprised the industry activity hasn't responded to lower gas prices yet. What are your thoughts on takeaway capacity from the basin, and how does it look with or without MVP?

There haven’t been changes to takeaway capacity depending on MVP's status. I don’t have unique insight into that project's timing. I think we all hope to see it help with national production levels. My comment on industry response related mostly to service costs; we haven’t seen those drop yet, but expect changes as schedules adjust.

Got it. To follow up on cost, you said you anticipate '23 costs, if I heard right, to be below '22. Is that based on further efficiencies on your side and assuming similar OFS costs? Or do you anticipate a decline in OFS costs as well?

Yes, last year we had about $1.20, now we’re guiding to $1.50 in the current environment. We'll try to better that, and that forms the basis of that comment.

Our next question comes from Noel Parks from Tuohy Brothers.

Going back to the Adams Fork and the ammonia plant project. I'm curious about how long discussions have been ongoing for forming this partnership and the impact of the 45Q carbon capture credit increase. Was there a possibility of a deal before it became apparent, or was it a key catalyst for making it happen?

The discussions with Adams Fork are ongoing, with many details still to be addressed. The 45Q incentives improve the project's outcome. They could provide a stable revenue stream, and we expect our technology will yield a clean stream of CO2 for sequestration. Our assets position us as ideal partners for such projects, and we anticipate that 45Q incentives will keep making initiatives like this feasible, especially in disadvantaged communities affected by energy transitions.

Regarding the macro front, with the volatility seen in gas over the past quarter, much of the industry appears to be shifting focus to LNG capacity coming online in '24, '25, and '26. Are there any insights affecting your macro thinking, especially as you look to 2024 and '25, considering your hedging policy?

Macros from a demand perspective for natural gas have been a key area of focus in our new technologies efforts. Things like LNG exports will impact national energy supply and demand, along with global markets. However, from a sequential perspective, immediate opportunities for demand creation in natural gas within the Appalachian Basin arise from integrating into transportation and manufacturing sectors. That's why projects like Adams Fork excite us. They can be deployed quickly, compressing supply chains from thousands of miles to dozens, creating immediate economic drivers that align with various policy objectives. LNG export growth will have its time but will likely follow these more immediate opportunities.

This concludes our question-and-answer session. I would like to turn the conference back over to Tyler Lewis for any closing remarks.

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

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