Earnings Call Transcript - CNX Q2 2023

Tyler Lewis, Vice President of Investor Relations

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

Nicholas DeIuliis, President and CEO

Thanks, Tyler, and good morning, everybody. Second quarter of 2023 marks our 14th consecutive quarter of free cash flow generation and the continued execution of our long-term strategy. It also represents the halfway point on the 7-year plan that we presented back in 2020. So, 3.5 years into the plan, we've now generated approximately $1.8 billion in free cash flow. We reduced outstanding debt by almost $415 million, and we repurchased 30% of our outstanding shares. Now, there have certainly been twists and turns from the original plan as time has passed and macro events have unfolded. We are on pace to exceed our goals, and we've been unwavering in the core principles of our sustainable business model. It's going to continue to generate significant long-term value for our owners. Additionally, despite some near-term cyclical challenges that the industry is currently experiencing, the long-term outlook for CNX and for the natural gas industry has never been brighter. During the quarter, we focused on what I referenced as the three key areas of long-term value creation. The first is efficient execution and the development of our extensive asset base. Second, continued growth of our new technologies business unit. Lastly, clinically allocating that free cash flow to acquire shares at prices that we believe represent a substantial discount to their intrinsic value. Operationally, our team has built impressive momentum across effectively all fronts in 2023. Drilling and completions are firing on all cylinders in both the Marcellus and Utica horizons, establishing a new efficiency level that will impact everything from TIL timing to capital intensity. But instead of me talking about this, let's have Nav, our leader of operations, tell you directly. So I'll turn it over for a few minutes to Nav.

Navneet Behl, Chief Operating Officer

Thanks, Nick, and good morning, everyone. As Nick mentioned, the team has established a new level of operational efficiency, which is vital because it drives our foundational free cash flow generation that supports our sustainable business model. The team achieved several operational accomplishments in the quarter. One key achievement was compressing cycle times and getting a 7-well pad turned online 24 days ahead of schedule. We also accelerated the timing of four additional Marcellus wells that will come online later this year. This acceleration was primarily driven by efficiency improvements and completion activities, where we achieved a 34% increase in completed lateral feet per day compared to last quarter. We reduced completion costs per foot by 5%. Shortly after the quarter ended, the drilling team successfully completed its deepest and longest Utica well with a total vertical depth of 13,765 feet and a lateral length of over 15,000 feet. This well in the CPA Mamont area is a significant accomplishment, supporting the development of this prolific acreage in our long-term plan. We have continued to apply these lessons to our other Utica drilling operations in Southwest PA, where we successfully drilled, completed, and are currently flowing back two wells. In the SWPA area, we also drilled two long Marcellus wells with a lateral length of over 19,500 feet each. As we progress through our full-year plan with 1.5 rigs and 1 frac crew, we will be positioned to grow volumes in 2024. During the quarter, we continued to run the second horizontal rig, which was recently released. Thus, the remainder of this year's activity will primarily be one rig and one frac crew, and the capital spending cadence will decline accordingly. Moving into 2024 and beyond, we expect capital intensity to lower. The significant investments we are making this year to grow volumes put us in a position to maintain our target production levels with lower overall activity moving forward. Alan will go into more detail on the full year guidance shortly, but I want to emphasize that we are well positioned to adjust our activities to respond to any material changes in gas pricing that may unfold in the second half of the year. This flexibility is one of the key advantages of being a low-cost producer and owning our midstream assets. Our well economics remain attractive, even in lower pricing environments, and we are not beholden to high fixed-cost midstream arrangements that can lead to uneconomic decisions. Regarding our ESG initiatives, we are on target with production equipment modifications to reduce emissions by 70,000 metric tons CO2 equivalent by December 2023 compared to December 2022. In summary, the operations team's focus on continuous improvement is driving outstanding results, and I'm proud of our team's diligence and hard work in positioning CNX as an operational leader in the basin. Now let me turn it back over to Nick.

Nicholas DeIuliis, President and CEO

Thanks, Nav. That's exciting. If I may, let me pivot now to new technologies. As I mentioned during last quarter's call, we were expecting this business unit to be free cash flow positive this year, and that has started in the second quarter. Alan is going to touch on this more in his remarks, but suffice it to say, this is a very promising part of our business, likely to materially impact our free cash flow outlook moving into 2024 and beyond. Most importantly, we're just getting started here, thanks to our unique asset base that underpins our Appalachia First vision. We have a wealth of opportunity to create even more per-share value in the years ahead. One effort in our new tech unit that we are thrilled about is the Appalachian Regional Clean Hydrogen hub, referred to as ARCH2. This initiative has been in the works for some time, and we've touched on it in past calls. To refresh, our contribution to the ARCH2 hub effort centers around the Adams Fork Clean Ammonia project, located in Mingo County, West Virginia, and it's expected to be one of the largest and cleanest ammonia plants globally. It is also the anchor project of the ARCH2 hub application to the U.S. DOE. You might wonder why we're involved in something of this size in Southern West Virginia. Firstly, this project exemplifies our Appalachia First strategic vision of producing locally and using it locally. By doing so, we can enhance the status quo and provide vast economic opportunity in a region heavily affected by the energy transition. Secondly, this region contains abundant, low-cost, and as Nav pointed out, low-emission natural gas feedstock found anywhere in the world. Therefore, there is no better place to build such a project, which explains our strong focus on working with our partners to make it happen. We're eagerly awaiting guidance from D.C. regarding the Inflation Reduction Act (IRA) and the hydrogen production tax credit, which makes this project viable, along with final decisions from the DOE on hydrogen hub awards. The intent of the hydrogen production provision in the IRA was to incentivize low carbon-intensity hydrogen creation and reduce emissions while creating jobs and economic activity in energy communities. This project embodies that goal significantly. We've observed the chilling effect of discussions in Washington on investment decisions. A recent example is Constellation, which caused a $1 billion clean hydrogen project investment to be delayed pending IRA guidance. We are monitoring this closely. Of course, we hope that Washington follows the intent of the law and helps us actualize this crucial West Virginia project. Now regarding share purchases, we continued our industry-leading efforts in this area during the quarter, repurchasing an additional 2% of our outstanding shares. Since initiating our recent share buyback program in Q3 2020, we've repurchased over $1 billion in shares, or 30% of the company. This equates to approximately 75% of our current authorization, and our pace and magnitude of repurchases far exceed anything typical of peers. Actions speak louder than words, and I believe our track record of consistently returning capital to shareholders speaks for itself. We still view our shares as undervalued. Therefore, we are announcing an additional $1 billion share repurchase authorization with no expiration, reflecting our continued confidence in the long-term outlook for our business. This increase brings our total authorization to $1.28 billion, including the $280 million remaining from the prior authorization. We believe this $1 billion increase in our share repurchase program provides another opportunity to create incredible long-term value for like-minded shareholders who will benefit as their ownership grows meaningfully in the coming years. Lastly, I'd like to highlight a non-op asset sale this quarter. Broadly, all asset sales are evaluated under strict criteria, and we consider our bar to be quite high. However, when an opportunity makes economic sense, we will capture that value. In this case, we sold various non-operated producing oil and gas assets consisting of royalty and working interest primarily in the Appalachian Basin, producing approximately 33 million cubic feet per day. Through this transaction, we effectively monetized non-core assets and pulled forward value for redeployment in an accretive manner. I'd also like to highlight our corporate sustainability report released this quarter. We are proud of this product. It showcases our transparency and provides investors and stakeholders with valuable information to evaluate our value proposition while illustrating our unique approach to ESG and our Appalachia First strategic vision that prioritizes impactful local actions. One example of this is the CNX Mentorship Academy, which supports local high school students aspiring for sustainable and well-compensated careers without needing a four-year degree. This Academy connects the region's premier employers and building trades with local young emerging talent. The program has just concluded its second full year and its success demonstrates how we can achieve long-term human capital development, diversity goals, and expand inclusion in our regional economy. Our goal is to ensure that the benefits of the energy and manufacturing economy within Appalachia are accessible to young individuals in disadvantaged communities, a win for CNX, a win for our industries, and a win for the region overall. In a week or so, we will kick off our third class, which will be the largest to date—hard to believe the progress made in the past three years. With that, let me turn it over to Alan.

Alan Shepard, Chief Financial Officer

Thanks, Nick, and good morning to everyone. As Nick mentioned, this quarter represents the 14th consecutive quarter of free cash flow generation through our sustainable business model and long-term strategic plan. During this quarter, we generated approximately $135 million of free cash flow, including proceeds from the non-op sale previously announced. This brings our cumulative free cash flow to approximately $1.8 billion, roughly 60% of our current market cap. We are well on the way to executing our long-term free cash flow generation plan and believe we are positioned to benefit from any deepening valuation disconnects in equity markets. We also maintain that our shares trade at a significant discount to their intrinsic value. We'll continue to capitalize on this opportunity moving forward to drive our share count lower and free cash flow per share higher. More on that shortly. On the balance sheet, we've strategically managed our debt maturities and leveraged profiles to reduce risk and maximize capital allocation flexibility. Our goal of maintaining a low-risk balance sheet through active management remains unchanged. Our significant maturity runway and robust hedge book provide visibility into the future that supports our capital allocation flexibility. As evident over the last few quarters, we expect leverage ratios to fluctuate with underlying EBITDA and commodity prices. Absolute debt levels may also vary in the short term based on free cash flow deployment timing, but these fluctuations are merely short-term noise. Before turning to our updated guidance for 2023, I want to address three key themes that will drive our confidence in materially growing long-term free cash flow per share into 2024 and beyond. Firstly, we expect natural gas realizations to increase as the forward NYMEX strip prices rise. The strong macro backdrop supporting natural gas demand as a cornerstone of the global energy mix will significantly boost cash flows as we look beyond the near-term pricing environment. Secondly, we've previously guided for higher production levels in 2024, while capital levels decline materially moving forward, as a result of current operational successes. Starting in 2024, we expect to grow volumes over 2023 levels to approximately 580 Bcfe. Maintaining production at that level beyond 2024 will allow us to drive capital intensity below $500 million annually by 2025. This estimate assumes no change in current service cost pricing, driven instead by a lower capital intensity required to sustain our projected production levels in 2024. This would return us to maintenance capital levels consistent with those initially envisioned in our 7-year plan, albeit with slightly higher service costs and an increase of about 20 Bcfe of production annually compared to that original plan. The third key theme is that our new technologies group is now cash flow positive. As discussed in prior calls, there are three main categories the New Tech Group is pursuing. Firstly, expanding alternative fuel markets such as CNG, LNG, and hydrogen; secondly, developing oilfield services technologies that lower costs and emissions; and thirdly, securing value recognition for the environmental attributes tied to our waste methane abatement operations. The latter, currently has the most progress regarding near-term free cash flow impact. This quarter, we recorded approximately $8 million in revenue from environmental attributes. While still in early stages of developing these opportunities, we are optimistic about the New Technologies Group contributing around $75 million in free cash flow annually starting from 2024, with potential to achieve up to $100 million annually. Furthermore, we expect this annual free cash flow from the New Tech Group to increase significantly in the years following 2024. When considering these three factors, it's clear we see considerable free cash flow per share potential for the company in the coming years, supporting the decision to continue reducing our share count. The overall trend is unmistakable—unless our share price materially re-rates, we anticipate a significant shrinkage in our outstanding shares in the next several years, contributing to further growth in our free cash flow per share. Now let's shift to the updated 2023 outlook to clarify how we anticipate the remainder of the year to unfold. We have updated each of the major guidance components following the impact of the non-op sale during the quarter, adjusting our EBITDA and free cash flow outlook for the year accordingly, along with the decline in near-term commodity prices experienced during the quarter. Starting with production, the key takeaway, as Nick and Nav mentioned, is that our operational progress for 2023 is excellent. On a wellhead basis, we remain on track with our initial plan for 2023 after adjusting for the non-op sale. We're narrowing our production range to between 545 and 555 Bcfe, driven by three factors. Firstly, we've removed approximately 9 Bcfe due to the non-op sale effective April 1, with the asset producing about 33 million cubic feet equivalent per day. Secondly, we're experiencing lower expected ethane recoveries for the year, as one of our key downstream counterparties couldn’t accept the initially forecasted ethane volumes due to plant start-up challenges. The ethane has remained in the gas stream, sold for heat value. As a result, although our overall free cash flow remains unaffected due to penalty provisions in our contract with this customer, we expect our reported production equivalent volumes for 2023 to be about 9 Bcfe lower than initially planned. Lastly, operational efficiencies are expected to offset roughly 3 Bcfe of the non-op and ethane adjustments. In summary, despite the noise from the two downward adjustments, the key takeaway is that our operations are successfully on track with our plan. We are also reaffirming our production outlook for 2024 to approximately 580 Bcfe after adjusting our prior guidance, reflecting an estimated 10 Bcfe impact from the non-op sale on next year’s volumes. Now looking at capital expenditures, the second quarter included spending associated with running two rigs and one completion crew throughout the quarter. The second horizontal drilling rig has been released recently, which will cause the capital spending cadence to decrease through the remainder of the year. As for service costs, while we have seen modest downward trends in specific categories, they haven’t been substantial enough to materially affect our projected 2023 capital. Hence, we are raising the lower end of our capital range upward. Looking ahead, we remain optimistic about further reductions in service costs entering 2024, which we’ll elaborate on in future calls as that outlook becomes clearer. Importantly, our 2023 activity set and associated capital expenditures represent more than a maintenance production plan. This capital expenditure level enables us to maintain an efficient operational pace, resulting in production volume growth from 2023 to 2024. Even though we currently see no changes to the plan at this moment, should forward gas prices decline further throughout the year, we will adapt our capital activity focus in alignment with achieving optimal long-term economic outcomes. Lastly, we’ve increased our free cash flow outlook for 2023 to approximately $325 million. This update accounts for the one-time proceeds from the non-op sale, offset by roughly a $12 million decrease in free cash flow due to the non-op sale and a $35 million decrease due to continued declines in commodity prices this quarter. Despite the near-term commodity headwinds, we now project 2023 free cash flow per share to grow by 33% to around $2 per share, excluding any future share count reductions that may occur as the year progresses. In conclusion, our sustainable business model will continue to deliver value to our shareholders throughout the entire cycle. Our focus for the remainder of 2023 will concentrate on safe and compliant execution to develop our extensive natural gas asset base, accelerate free cash flow growth through our new technologies business, and maintain a consistent capital allocation strategy that simultaneously drives long-term free cash flow per share growth while ensuring that our decisions reflect a long-term owner mindset. With that, I will turn it back over to Tyler for Q&A.

Tyler Lewis, Vice President of Investor Relations

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

Benjamin Parham, Analyst, JPMorgan

First, just on the longer-term guide. You mentioned the line of sight to getting to less than $500 million of annual CapEx and $25 million plus to hold production flat at 580 Bcfe. You're at 650 this year on CapEx at the midpoint. How should I think about 2024? Should I just assume kind of the midpoint of those two numbers? Just really looking for some color on what '24 spending could look like.

Alan Shepard, Chief Financial Officer

Yes. We're not going to provide a formal guidance range at this time. But the way to think about it is, ultimately, you're able to step down from a 1.5-rig program to maybe a 1.25 or 1-rig program next year while also running fewer completions without needing a full completions crew. By the time you get to '25, you're basically down to a 1-rig program and a spot completions crew.

Benjamin Parham, Analyst, JPMorgan

Got it. And then just on the new technologies business, you talked about $75 million in free cash flow expected next year from that business. Could you give us a little more color on the different projects that are going to generate that free cash flow? And maybe some color on the expected CapEx you plan to spend on that business?

Alan Shepard, Chief Financial Officer

Yes. In the near term, as we alluded to previously, the most material driver currently is the recognition of environmental attributes from our waste mine capture projects. You should see that move sequentially higher. This quarter, we booked $8 million, and we anticipate that will increase, representing the bulk of the near-term driver in 2024.

Leo Mariani, Analyst, ROTH MKM

I want to delve into production a little bit more for 2023. Just looking at the second quarter, production was down a couple of percent versus 1Q. I think you had 13 turnarounds this quarter but production was down. Can you give us a bit of color on how the second half of '23 breaks down? Do we see significant growth in 3Q and 4Q to reach a higher exit rate that aligns more closely with the maintenance level for '24?

Alan Shepard, Chief Financial Officer

Yes. It's important to note that the second quarter's production was impacted due to the April 1 effective date of the non-op sale, meaning about 3 Bcfe was missing that we otherwise would have had. If you add that back, our sequential production is higher. As we discussed, we started the year at a low point and are ramping up to reach our desired run rate in Q3, then you should see that trend continue through Q4, reaching the 580 Bcfe target for next year.

Leo Mariani, Analyst, ROTH MKM

So just to clarify, you're forecasting a higher run rate in Q3 and then a similar run rate in Q4 heading into next year. Is that correct?

Alan Shepard, Chief Financial Officer

Yes, that's correct.

Leo Mariani, Analyst, ROTH MKM

Regarding the asset sales, I noticed your LOE was down this quarter per Mcfe. Was that impacted by the asset sale? Did you see some cost benefits from shedding older, higher-cost wells?

Alan Shepard, Chief Financial Officer

The non-op sale had little to no impact on the LOE. Most of those were lower cost working interest wells. However, we did achieve a reduction in LOE this quarter due to our team's operational success. Moving forward, we expect that trend to continue.

Bertrand Donnes, Analyst, Truist

It seems your operational efficiencies may allow you to increase your activity pace compared to earlier expectations. Could you discuss the CapEx range for this year? On your prepared remarks, it sounded like the low end was raised due to current service costs, but could activity be pulled from '24 into '23?

Alan Shepard, Chief Financial Officer

The increase in the lower end of our range is primarily because service costs haven't decreased as quickly as anticipated. While we've pulled in a few TIL this year, which will increase capital slightly, the service cost adjustments account for most of that change.

Bertrand Donnes, Analyst, Truist

And regarding your buyback strategy, I understand you continue to execute effectively. Is there a percentage of free cash flow you're targeting annually for buybacks, or is it opportunistic?

Alan Shepard, Chief Financial Officer

It's opportunistic. We always perform clinical allocation analysis, and the current share price dictates our pace of buybacks. We perceive it as being well below intrinsic value, and we seek to maximize share acquisitions.

Nicholas DeIuliis, President and CEO

It's important to note that current share repurchases are challenging to beat compared to other free cash flow options.

Michael Scialla, Analyst, Stephens

I would like to discuss the 2025 maintenance capital dropping below $500 million. What is driving that? Is it due to the decline rate continuing to shallow or overall efficiencies?

Alan Shepard, Chief Financial Officer

It's a combination. We've reset our maintenance production level here at 580, and our efficiency rate is on target. We don't require as many pads each year to sustain production.

Navneet Behl, Chief Operating Officer

All of our wells are performing at or above expectations, supporting our strategies.

Michael Scialla, Analyst, Stephens

Any concern about losing efficiencies if you're not operating a full-time crew?

Alan Shepard, Chief Financial Officer

We certainly consider that, and our operations team strives for maximum efficiency. We expect continued growth year-on-year despite not running continuous operations.

Navneet Behl, Chief Operating Officer

Our approach to efficiency involves operational procedures, planning with service providers, operational execution, design, engineering efficiencies, and optimal scheduling parameters to maintain or improve efficiency levels.

Ravi Srivastava, President of New Technologies Group

We expect guidance to be released in late 2023 from Treasury and IRS regarding investment decisions for the Clean Ammonia facility. Construction is expected to start mid-next year, with a project timeline of two to three years. We are also exploring CO2 sequestration dynamics and UIC well requirements, contingent on the region's regulatory framework.

Noel Parks, Analyst, Tuohy Brothers

Could you provide an update on the Adam Fork project's specific terms? Is there progress being made?

Ravi Srivastava, President of New Technologies Group

Some aspects are still in flux, but we control a lot of the assets necessary for this project to be successful. We're waiting on external factors for more concrete decisions in the coming months.

Nicholas DeIuliis, President and CEO

Congress’ intent is clear on how this project situates within the law's framework, but we need to ensure administrative interpretations align with that intention.

Noel Parks, Analyst, Tuohy Brothers

As for the cost environment, do you think this cycle might differ in terms of service providers' capital discipline? Are there any signs of frac costs coming down?

Alan Shepard, Chief Financial Officer

In our basin, we’ve not seen as much fluctuation in activity levels, which impacts service provider pricing. There have been modest cost improvements, but not as significant as we hoped at the beginning of the year.

Navneet Behl, Chief Operating Officer

We assess costs across multiple categories: design, operational execution, supply chain efficiency, commodity pricing, and scheduling. We've observed decreased frac costs and improved efficiencies overall.

John Abbott, Analyst, Bank of America

Regarding the 2025 CapEx at around $500 million, does that also consider discretionary spending?

Alan Shepard, Chief Financial Officer

That figure primarily refers to our legacy E&P business, with no immediate major capital expenditures affecting the new technology sector.

Ravi Srivastava, President of New Technologies Group

As with prior practices, we will conduct thorough assessments to determine our capital allocation towards new technologies as our project landscape becomes clearer.

John Abbott, Analyst, Bank of America

How do you perceive the trajectory of cash taxes considering lower potential spending?

Alan Shepard, Chief Financial Officer

We expect to reach a $3 billion mark for free cash flow generation around 2026 or 2027 before becoming a cash taxpayer again.

Unidentified Analyst, Analyst, TPH & Company

Could you share how the recent non-op deal originated and what opportunities there are for similar transactions?

Alan Shepard, Chief Financial Officer

We're constantly evaluating whether we’re maximizing value from our non-core assets. This particular asset set was non-operated, and we received favorable feedback on it, allowing us to monetize it at a strong flowing number.

Unidentified Analyst, Analyst, TPH & Company

Will the proceeds from the sell go entirely toward share buybacks?

Alan Shepard, Chief Financial Officer

We remain flexible, and if the stock price increases, we’ll reassess our capital allocation strategy.

Tyler Lewis, Vice President of Investor Relations

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 might have any additional questions. Otherwise, we look forward to speaking with everyone again next quarter. Thank you.

Operator, Operator

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