Earnings Call Transcript - CNX Q3 2020

Operator, Operator

Welcome to the CNX Resources Third 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, VP of Investor Relations. Go ahead.

Tyler Lewis, VP of Investor Relations

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; Don Rush, our Chief Financial Officer; and Chad Griffith, our Chief Operating Officer. Today, we’ll be discussing our third quarter results. In a continued effort to simplify our message to reach a broader investor base, we have modified our earnings press release this quarter, and provided an updated investor slide presentation, which is posted to our website. This slide presentation is focused on what we believe are the metrics that matter most to our investors. 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 2020 earnings results in supplemental information of CNX Corporation. One other change this quarter is that in conjunction with the recently closed merger of CNXM, the company has changed its reportable segments to shale, coal-bed methane and other. The other segment includes nominal shallow oil and gas production, which is not significant to the company. It also includes various other items managed outside the reportable segments. More information will be available in our 10-Q, which we plan to file today. 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 materials 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 for Q&A where Chad will participate as well. With that, let me turn the call over to you, Nick.

Nick Deiuliis, President and CEO

Thanks, Tyler. Good morning, everyone. I want to start with two key themes that capture our view on CNX's future and the investment opportunities it offers. The first theme is that we prioritize doing the right thing. This means making capital allocation decisions aimed at maximizing the long-term intrinsic value per share for our shareholders. The second theme is centered on straightforward mathematics; our decision-making and investment strategy rely on basic arithmetic. I’d like to direct your attention to Slide 2 in the presentation we shared this morning. Slide 2 emphasizes the four critical metrics that distinguish us from our competitors. Starting at the top left, the inventory chart demonstrates that CNX maintains the deepest and longest-lived inventory at a gas price below $2.50, which is more than double the peer average. Our total inventory stands at 49 years, more than 3.5 times the average among our peers. This independent assessment verifies that we possess exceptional future locations. Furthermore, this extensive inventory provides the feedstock for our free cash flow-generating operations, which extend well beyond our seven-year outlook. The slide also features other important metrics, particularly three in focus. As previously mentioned, CNX has the lowest cash operating costs in the basin, with all-in cash costs nearing $1 in the fourth quarter, and we anticipate that costs will decrease even further, approaching $0.90 in 2022. Our cost structure positions us as the low-cost leader in the basin, a remarkable achievement. Additionally, we provide the highest free cash flow yield relative to our peers. We've discussed this previously. Lastly, we are strengthening one of the best balance sheets in the industry as our debt level continues to decline. In summary, these four metrics distinctly differentiate us and reveal significant potential for upside. We are a free cash flow powerhouse that delivers reliable returns for our shareholders. Moving to Slide 3, you will find a graph from the independent study I referenced earlier. This graph provides further insight into the economic inventory of each competitor at varying gas prices. As depicted, we hold the best inventory across low, medium, and high gas price scenarios. We have over a decade's worth of inventory at the $2 NYMEX price level, over 20 years at the $2.45 strip, and 50 years at $3 of gas. Our industry often focuses on transient metrics or strategies, but ultimately, three long-term considerations are critical: having inventory viable at $2.50 or lower, being a low-cost natural gas producer, and consistently generating substantial free cash flow per share. We excel in all three areas. Our multi-year hedge book ensures significant free cash flow per share through different phases of the commodity cycle. This has been a long-term endeavor, creating a clear and persuasive narrative. Our free cash flow yield is not only leading within the industry but also surpasses market indices across various industries and sectors. Consequently, we are adjusting our communication and focus to attract a wider range of investors beyond traditional exploration and production stakeholders. Now, let's address the current global landscape. This is a topic worth spending considerable time on today as it influences our perspective. We all acknowledge the challenges and uncertainties the world faces. We anticipate that these risks may escalate in the coming 90 days. Reflecting on the events of 2020, this year has been completely unpredictable with COVID-19, plummeting oil prices, economic volatility, and speculation about future gas prices. However, we acknowledge this unpredictability and have built our company not just to withstand volatility but to thrive within it. We expect to produce a substantial amount of free cash flow regardless of what unfolds in the next 90 days. Given the existing uncertainties, we plan to allocate that free cash flow in the short term to further reduce our debt. This is the sensible approach given our current situation. As we move into 2021 and the years ahead, our primary objective will remain to deleverage, with an expectation to pay down around $1 billion in debt by 2023. Assuming adjusted EBITDA stays around $1 billion per year, we will achieve a debt leverage ratio of approximately 1.5 times. If we can maintain consistent quarter-over-quarter and year-over-year free cash flow for the next seven years, we could generate approximately $3.4 billion cumulatively, which is nearly 1.5 times our current market capitalization. This has been the backbone of our strategy, and our free cash flow yield is poised to outperform peers. In summary, we are prepared to explore any opportunities that enhance shareholder value, but we are not interested in M&A activities that diminish our industry-leading metrics and financial stability. Consistent with our long-term multi-year strategy, we plan to invest our free cash flow wisely to enhance the long-term intrinsic value per share of the company. We have never been more optimistic about the opportunities ahead of us.

Don Rush, CFO

Thanks, Nick, and good morning, everyone. I would like to start on Slide 4, which highlights our quarterly results in a much simpler concise format. In the quarter, we continued to generate strong cash operating margins, delivering $121 million of free cash flow. We also expect to generate a significant amount of free cash flow in Q4 and in 2021, which results in our industry-leading free cash flow yields. Our trailing 12-month leverage ratio was 2.6 times, and we expect this to improve to approximately 2 times by year-end 2021. Year-to-date, we have fully retired approximately $900 million of our 2022 senior notes through a combination of debt refinancing and organically generated free cash flow. We were able to accomplish this while shutting in one-third of our volumes to take advantage of seasonal price contango while simultaneously increasing our projected 2020 and 2021 free cash flow throughout the course of the year. Slide 5 shows our strategic plan in action, a plan that is delivering substantial free cash flow. Year-to-date, the company has generated over $270 million in free cash flow, and we expect this positive trend to continue in Q4 and beyond with a projected annual average of approximately $515 million in the 2022 through 2026 time period, which assumes an average NYMEX commodity price of approximately $2.50. Our ability to generate substantial, consistent free cash flow at low commodity price levels is a testament to our competitive advantages. One final point to note is that our current free cash flow calculation takes into consideration working capital changes, whereas many of our peers exclude these and other items. We believe this all-in approach more accurately reflects the current funds available for potential debt repayment and shareholder returns. As we transition into 2021 and beyond, we plan to provide additional discussion around these working capital changes to help investors better compare our free cash flow generation potential with that of our industry peers. And for reference, our 2020 free cash flow would be well over $400 million if we excluded working capital changes, just for a more apples-to-apples look. Slide 6 illustrates how we have not been satisfied simply with good results. Since we started discussing our 2020 and beyond guidance in the second quarter of 2019, we have been steadily increasing our free cash flow estimates for 2020 and 2021. We believe we have built this seven-year plan with conservative assumptions and will work to continuously improve the plan. Slide 8 shows our new capital structure, which has ample liquidity with RBL recently reaffirmed at $2.5 billion across our two facilities. It's also important to note that we have significant runway regarding our maturity schedule with our first unsecured bonds not coming due until 2026. All this is even more impressive when you consider we expect to produce over $500 million in free cash flow per year, giving us the ability to control our destiny.

Chad Griffith, COO

Slide 9 is our guidance slide. For 2020, we are tightening up the guidance ranges for production and capital with one quarter to go. We expect our EBITDA to be around $900 million, the high end of our previous guidance. For 2021, we have increased our 2021 EBITDA up to approximately $960 million on improved pricing. Our main focus will continue to be increasing our free cash flow per share over this seven-year plan. We believe that our cash flow projections are low risk and even if NYMEX gas prices were to average $2.25 from now until the end of 2026, we project that the business would still generate approximately $2.9 billion in free cash flow even when holding our costs the same. This is primarily due to our best-in-class hedge book and low cost structure producing impressive returns. Not only do our 2021 metrics look strong, but our 2022 and beyond numbers look even better, even with commodity prices currently below $2.50 for the long term. To sum it up, we are excited about our future. We have ample inventory to produce for decades, and our plan will create substantial value for our shareholders, no matter what gas prices do, and without the need for M&A or to go to the capital or debt markets.

Tyler Lewis, VP of Investor Relations

Thanks, Don. Operator, if you can open the line up for Q&A at this time, please.

Operator, Operator

We will now begin the question and answer session. At this time, we will pause momentarily to assemble our roster.

Leo Mariani, Analyst

Hey, guys. Just wanted to follow up a little bit on the 2020 production guidance, looking at the range for the full year. If I'm doing the math right, it still implies maybe around 100 million a day range in Q4. If I look at the full year range, I just wanted to get a sense of what's going on there. Obviously, we've seen much wider Appalachian gas price dips of late. Is there any wiggle room for potential shut-ins or is this more just to allow for shifting activity, maybe from Q4 to Q1, if winter doesn’t 100% cooperate?

Chad Griffith, COO

Yes, this is Chad, I'll start off and maybe Don could add in on the backend if he wants to add anything. As we sort of move into the winter season, we talked previously about the shut-ins over the course of the summer. We are moving towards having basically all production online now. We're in the process of flowing back our last pad that we had shut-in, and we should be up to full rate within a couple of days. Things should be good. I think the range on the production number gives us a little bit of flexibility to optimize on the revenue line. But the biggest thing we need to focus on is the free cash flow that we continue to generate year-over-year over the seven-year plan. Little shifts in production from month-to-month or quarter-to-quarter will not change our overall free cash flow generation.

Leo Mariani, Analyst

Okay, that's helpful. And just wanted to ask a question on the inventory chart that you guys showed here. When you look at the inventory below 250, talking about 22 years, does that assume a fixed number of wells per year, over that whole period? Is that largely just comprised of Marcellus to the Utica also competitive at 250 or less? Any comments you can provide around that?

Nick Deiuliis, President and CEO

Yes, so the reports, which I encourage folks to obtain, have confirmed our inventory for a while now. The basic mechanics show that they calculate what your run rate is over the ‘22 and ‘23 timeframe, and they use that as the proportionate amount of wells you need to drill a year. And going through on a high level, it’s roughly three quarters on the Marcellus side as far as how they're considering it below $2.50.

Leo Mariani, Analyst

Okay, we're good. That's helpful. And then just lastly, regarding your buyback commentary, you've got some nice debt reduction targets over the next couple of years, but if we don’t see commensurate stock appreciation, would you consider a buyback pretty hard here? Is that something that could realistically show up in ‘21 or would you want to get the debt down before we could look at that buyback more seriously?

Nick Deiuliis, President and CEO

Frankly, as we discussed, the primary focus will continue to be debt reduction, but when you look at 2021, there is capacity and we can see a path for share buybacks. I would be surprised to get through ‘21 without some reduction in share count. How much we budget between debt reduction versus share repurchases will depend on the facts and circumstances at that time. This is a quarter-by-quarter unfolding story, but we do have the flexibility.

Don Rush, CFO

Yes, when you look at the magnitude of free cash flow the business produces each quarter of over $100 million, if you allocate that towards share repurchases, it moves toward our leverage ratio target by quarter. We have the position to control our own destiny and pay down all of our debt if we choose while still having the opportunity to conduct buybacks.

Leo Mariani, Analyst

Very helpful. Thank you, guys.

Neal Dingmann, Analyst

Good morning, Nick and Don. Just want to compliment you on the team for the new reporting format; I think it looks really good. My first question is around your second slide. You mentioned your strong inventory life. Just wondering if you believe you're being adequately rewarded for this? Is there anything you would consider to unlock some of these significant upstream assets?

Nick Deiuliis, President and CEO

Yes, we don’t feel we are getting credit for our inventory as it sits today. We've sold substantial amounts of undeveloped locations over the last five years while many of our peers have primarily been buying. If opportunities arise where we can cash in on acres that we’re not going to develop for a while, we would consider it. But we have a strong track record of appropriately managing our inventory.

Neal Dingmann, Analyst

Great. Thank you. And just one follow up on that. Given your cash flow performance, are you considering any new growth given the higher gas prices and your hedged position?

Don Rush, CFO

Yes, if you have a high gas price environment, we could pull up a little bit of completion activity to take advantage of that. We follow the math. If we see a significant shift in gas prices, we will certainly continue optimizing our cash flow but we emphasize that we do not want to overcommit to incremental activity without proper price assurance in place.

Nick Deiuliis, President and CEO

From a broader perspective, even without adding new activities, we’ve followed the math to generate significant free cash flow. The free cash flow machine will produce without the additional capital being put into place without sacrificing our existing health.

Unidentified Analyst, Analyst

First question, just clarification. Chad, based on your comments around timing, it sounds like some of the capital that was maybe originally intended for the third quarter or when in the fourth quarter was a conscious decision to take advantage of market pricing?

Nick Deiuliis, President and CEO

Yes, one part is based on timing and with respect to core planning. It's good to stretch things out when prices are low, and nothing materially slowed down our operational execution; we consistently find the right trajectory.

Leo Mariani, Analyst

Understood. And last one for me, if you look at your Slide 6 and the free cash flow projection for the seven-year plan, outside gas prices, what do you see as the biggest risk to achieving those targets?

Nick Deiuliis, President and CEO

The biggest risks are execution consistency and making sound capital allocation decisions to optimize our free cash flow while controlling variables like ownership and operational costs. We feel we have adequately addressed many of the risks we face with robust operational strategies, successful hedging, and a clear focus on driving low-cost production.

Kashy Harrison, Analyst

Good morning, everyone. Thanks for taking my questions. I appreciate your effort to transition away from industry jargon toward simple financial metrics and the emphasis on operating margins. Could you provide an update on where leading edge Marcellus and Utica well costs are trending?

Nick Deiuliis, President and CEO

Yes, the emphasis should be on economic return, not just cost per foot metrics. We look at D&C performance more holistically, and we see that we are beating our projections. We expect these efficiencies to continue as we leverage our established vendor relationships and concentrate on process optimization.

Chad Griffith, COO

Just to give you two examples of our most recent Marcellus pads brought online, we are at $7 for one and below $7 for another. These numbers represent very competitive cost structures within the Marcellus field.

Nick Deiuliis, President and CEO

Operations are strong, and values around optimization and pulling out as much cost-efficiency as we can play into our competitive advantage. We are continuously innovating to make the process cheaper and easier.

Kashy Harrison, Analyst

Got it. Thanks for that color.

Unidentified Analyst, Analyst

Hi, good morning. Just following up on Nick's earlier comments about the political environment. I'm curious to know if you see Pennsylvania as a target for regulatory scrutiny or if you see it maintaining a stable environment?

Nick Deiuliis, President and CEO

I do not see Pennsylvania as a target for losing the natural gas industry as it has grown exponentially in recent years. The public understands the benefits it brings to the economy, jobs, and energy pricing. This perception is crucial for future stability.

David [indiscernible], Analyst

You mentioned the 2.9 billion of cash flow. I’m trying to reconcile that with your market cap and EV. What do you think might be behind the market's skepticism that you guys highlighted in the 2.9 billion versus where you are today?

Chad Griffith, COO

I think it's partly due to the fact that we are one of the least covered companies among our peers, and many in the market haven't continued to track us closely. As we build credibility, I believe they’ll recognize the strength of the metrics we're presenting.

Nick Deiuliis, President and CEO

Exactly; we've been focused on substantial free cash flow generation, yet many investors may not fully understand the comparative value we present. Our strategy supports creating value over time, with solid growth in free cash flow, which investors will certainly recognize.

Operator, Operator

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

Tyler Lewis, VP of Investor Relations

Thank you, and we appreciate everyone joining us this morning. If you have any follow-up questions, please feel free to reach out. Otherwise, we look forward to speaking with everyone again next quarter. Thank you.

Operator, Operator

The conference is now concluded. Thank you for attending today's presentation.