CNX Resources Corp Q3 FY2023 Earnings Call

Good morning. And welcome to the CNX Resources' Third Quarter 2023 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 third quarter conference call. We have in the room today, Nick DeIuliis, our President and CEO; Alan Shepard, our Chief Financial Officer; Navneet Behl, our Chief Operating Officer; and Ravi Srivastava, President of our New Technologies Group. Today, we will be discussing our second quarter results. This morning, we posted an updated slide presentation to our website. Also detailed third 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 3Q 2023 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 our previous Securities and Exchange Commission filings. We will begin our call today with prepared remarks by Nick followed by Alan, and then we will open the call for Q&A where Nav and Ravi will participate as well. With that, let me turn the call over to you, Nick.

Thanks, Tyler. Good morning, everybody. The third quarter of 2023 marks our 15th consecutive quarter of free cash flow generation, despite experiencing what I would call extremely challenging basin pricing, and our continued execution of our long-term strategy, which started back in 2020. It has generated approximately $1.8 billion in free cash flow. It's reduced outstanding debt by approximately $385 million. And it's allowed us to repurchase and retire 31% of our outstanding shares at deeply discounted prices. We remain on pace to exceed our original goals supported by our sustainable business model that has and will continue to generate significant long-term per share value for our owners. And all that might sound like a broken record, because we've been stringing out this theme for these metrics for a couple of years now, which is sort of the point. And that's the consistent execution and clinical capital allocation; these things drive the creation of meaningful share value over the long-term. During the quarter, our operations team continued to execute efficiently. In fact, the team has been successful in further improving cycle times and accelerating activity, and Alan will go into some more of those details in a minute and how it impacts our full-year production outlook and capital timing. More specifically, one thing I'd like to highlight during the quarter is that we brought online four new wells beneath the Pittsburgh International Airport's runway. These latest wells highlight our public-private partnership with the airport. We achieved this, by the way, with zero safety incidents and zero environmental impacts. These four new wells are projected to generate almost $70 million in royalty revenue for the airport through 2042, and about $20 million of that will be over the next four years. This is on top of a similar amount of royalty revenue that the airport has already received from our partnership that was created back in 2013. Our historic partnership with the Pittsburgh International Airport has created a sustainable fuel hub, utilizing locally sourced, lower-cost, lower-carbon intensity natural gas. It's a perfect example of our Appalachia-first vision driving tangible results. Let's shift now to the New Technologies Group, a very exciting part of our business. We continue to expect around $75 million, with the potential of reaching up to $100 million in free cash flow in 2024 associated with the New Technologies Group. We're just getting started with New Tech, and we think this business has the potential to be an even bigger free cash flow growth driver for the company moving forward. The near-term New Tech free cash flow growth comes from our ability to monetize environmental attributes tied to our waste methane abatement operations in Virginia. Additionally, our New Tech effort is poised to lead the charge into the hydrogen economy with the Adams Fork clean ammonia project, where we expect to provide ultra-low carbon intensity feedstock and carbon capture and sequestration services. The Department of Energy recently announced the funding of this project as part of the ARCH2 Hydrogen Hub application. While we certainly applaud the funding announcement and inclusion of ARCH2 in the award, we're also eagerly awaiting implementation guidance regarding the related hydrogen production tax credit, or the 45V provision of the IRA. That guidance will materially impact the project economics. The intent of the hydrogen production provision of the IRA, of course, was to incentivize the creation of low carbon intensity hydrogen, to reduce emissions, enhance U.S. energy security, and create jobs and economic activity in energy communities. The Adams Fork project squarely aligns with all those objectives. We're monitoring developments with the 45V guidance closely. We're hopeful that Washington will follow the intent of the law, which will help us make this important West Virginia project and others like it a reality. I’d also like to highlight that we reached our 2023 methane emission reduction target of 70,000 tons of carbon dioxide equivalent by the end of the third quarter of this year, which was an incredible accomplishment. This was completed a quarter ahead of schedule, and our team is still hard at work with regards to making further adjustments and improvements to reduce emissions further. Great accomplishment by our regulatory reporting and operations teams. By the end of this year, we expect the cumulative effects of our reduction efforts to reduce methane emissions on a carbon dioxide equivalent tonnes basis by about 49% since 2020, which is almost a 50% reduction in a very short period of time. Our methane reduction goals for 2023 were focused mostly on pneumatic devices and liquids unloading, which were the two biggest opportunity sets. We invested $7 million of capital for specific projects. The team has been hard at work; year-to-date, we have changed out over 700 pneumatic devices, coming in at a very competitive cost of $3 per CO2 equivalent tonne. We now plan to add an additional 160 devices to our plan for the rest of the year because we're ahead of schedule, due to the fantastic pace the team has set. Furthermore, the team has been working on our liquids unloading processes, which also significantly contribute to our methane emission reduction of the 70,000 tonnes of CO2 equivalent. We set difficult but achievable targets, and we do what we say we're going to do. We're not going to be in the game of setting goals that are decades away to avoid accountability. Our focus will always be on tangible and impactful local actions. Last, but certainly not least, we continue to have conviction that our shares are materially undervalued. During the quarter, we bought back an additional 1% of our shares outstanding. Our compound annual growth rate, or CAGR, for our share repurchase program over the past three years, since the peak share count around the third quarter of 2020, is approximately negative 11%. We think that's top tier across the capital markets and it compares favorably to classic, best-in-class share repurchasers like AutoZone, which has retired shares at about a negative 8% CAGR over a 25-year period. We believe that our share repurchase program presents an opportunity to create incredible value for our long-term, like-minded owners, who will benefit as their per share value continues to grow meaningfully over the coming years. Now, let's hear from Alan.

Thanks, Nick, and good morning to everyone. As Nick mentioned, this quarter represents the 15th consecutive quarter of free cash flow generation through the execution of our sustainable business model and long-term strategic plan. For the quarter, we generated approximately $19 million in free cash flow despite the challenging price environment. As we initially laid out our free cash flow plan in the first quarter of 2020, this brings our cumulative free cash flow to approximately $1.8 billion, or around 50% of our current market capitalization. Looking ahead, we expect this quarter to mark the trough of our free cash flow generation, as the confluence of lower capital expenditures, higher expected gas pricing, and growth in our New Tech cash flows solidify our confidence in achieving robust free cash flow generation in the quarters ahead. We continue to believe that our shares are trading at a significant discount to their intrinsic value; as such, during the quarter, we bought back an additional 2.4 million shares, or 1% of shares outstanding, at an average price of $19.50 per share. After the close of the quarter, through October 12, we bought back an additional 1 million shares at an average price of $22.20. Since the third quarter of 2020, we have now bought back approximately 31% of our total shares outstanding at an average price of $15.58. This is an exceptional result not just in our industry, but anywhere in the capital markets, and we believe these results will only become more impressive as we remain well positioned to take advantage of this opportunity moving forward. Turning briefly to the balance sheet, our significant maturity runway and robust hedge book continue to be key components that underpin our capital allocation flexibility. Given these two elements, combined with our low-cost position, we remain comfortable with our current leverage profile and have the luxury to remain opportunistic with respect to our debt management. Furthermore, we believe that the growth of the New Technologies Group over the next two years will result in a lower leverage ratio even before considering potential further reductions in absolute debt. Speaking of the New Technologies Group, it continues to deliver tangible results in both positive free cash flow and environmental impact. During the quarter, we recorded approximately $13 million in free cash flow primarily associated with sales and environmental attributes from our waste methane capture activities, bringing our year-to-date free cash flow from New Tech to approximately $19 million. As Nick mentioned, we continue to foresee the New Technologies Group contributing approximately $75 million to $100 million in free cash flow in 2024. As we said last quarter, free cash flow from New Tech has the potential to be meaningfully higher in the years beyond 2024. Let's now shift to the updated guidance outlook. Broadly speaking, we are reaffirming the 2023 and initial 2024 guidance that we updated last quarter. As Nick noted in his commentary, Nav and the operations team have done an outstanding job compressing cycle times and accelerating our drilling and completion activity. The accelerated operational results, particularly on the completion side, have pulled the timing of capital into Q3 and accelerated online dates for our two most recent pads. As a result of this accelerated pace, we now expect annual production and capital to trend toward the higher end of the range provided. Looking ahead to 2024, we expect to average annual production volumes of approximately 580 Bcfe. As discussed last quarter, we also anticipate total capital expenditures to fall beginning in 2024 through 2025 to around $500 million. We will provide the full 2024 guidance with our next quarterly update. To conclude, the sustainable business model that we have created is continuing to deliver value to our shareholders throughout the commodity cycle. Our focus for the remainder of 2023 will remain on safe and compliant execution to develop our extensive natural gas asset base, accelerating free cash flow growth from our New Technologies business, maintaining consistent and clinical capital allocation to grow our long-term free cash flow per share, and as always, ensuring all our decisions reflect a long-term owner mindset. With that, I'll turn it back over to Tyler for Q&A.

Thanks, Alan. Operator, if you can please open the call for questions at this time.

Hi, good morning, guys. Thanks for taking my question. On the New Tech front, would you say the $75 million to $100 million range is kind of the low hanging fruit? I know you mentioned, there's the potential for meaningfully higher free cash flow. Just wondering if you could expand on whether that next leg up requires government legislation or new partnerships or anything like that, or if the $75 million to $100 million can step up quickly to that meaningfully higher free cash flow?

Hey, Bert. This is Ravi. The $75 million to $100 million that we guided to has a good line-of-sight on what we can accomplish next year. We're not making the government legislation and all those uncertainties into that guidance for next year. However, depending on how some of these things come out, there's an opportunity to grow that beyond 2024. As we talked about our Adams Fork project, the carbon capture and storage opportunities, and low feedstock sale opportunities, all add to the meaningful growth opportunities in '25 onwards. But next year, we have a good line-of-sight on what we need to do to reach that $75 million to $100 million number.

Okay. And then could you break out maybe where you've gotten so far—the $75 million to $100 million between the three buckets that you mentioned? And whether or not that falls into the year-to-date range? Also, does some of that have macro pricing supply demand baked into it? If we saw a better environment for that, would that free cash flow range move? Or is the $75 million to $100 million more of a fixed outcome? Thanks.

To your first question, that's primarily associated with free cash flow generated over the past two quarters, which comprises the environmental attributes. They make up the bulk of that expectation for next year. The range given incorporates some subjectivity in pricing and regulatory pathways that we already have line-of-sight on to Ravi's points.

I think some of that $75 million to $100 million is contemplated based on how we see the market today. But like in any market, there is some level of fluctuation in pricing. However, we believe that $75 million to $100 million is still achievable.

Yes, thanks for taking my question. Can you give us a little more color on the trajectory of the free cash flow from New Tech going forward? Do you expect another increase in Q4? Does that get you to a '24 run-rate, or do you expect New Tech free cash flow to continue to ramp through '24? Assuming no more regulations come in, is that $75 million to $100 million a good run-rate for 2025?

Good question. I think it's easier to guide on some things annually. There are some seasonal aspects that can fluctuate. We’ll stick to annual guidance on this until there's more clarity on everything. But based on the current pathways set up, $75 million to $100 million on an annual basis is something we indeed can rely on. The team's goal will be to continue to grow that in '25 and beyond.

Yeah, just a quick follow-up on the New Tech business. Is the $75 million to $100 million of New Tech free cash flow sort of contractually underpinned? Are you selling these credits on a long-term basis? Or is this more of your internal prediction for what you're expecting next year?

It’s more of our internal production on what we expect the pricing to be. There is a mix of long-term contracts in certain areas and then other programs where pricing and volume fluctuate. It's a mixed bag of these kinds of opportunities. Our $75 million to $100 million is based on where we see the different opportunities shaking out.

Just one on the New Tech. Trying to understand the revenue generation there. Are most of the revenues generated with the alternative energy credits associated with the power plant, or are there other credits you can generate by abating methane?

The Environmental Attribute opportunities include a combination of voluntary and compliance offset programs, and there's more to that. We expect to add forestry carbon credits and wetland mitigation to it. So it’s not just coming from one source; we have pathways into multiple 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, and thank you for your interest in CNX. Please feel free to reach out if anyone has any additional questions. Thanks.

Thank you. The conference has now concluded. You may now disconnect.