Earnings Call Transcript - DEC Q2 2024

Operator, Operator

Greetings, and welcome to the Diversified Energy 2024 Interim Results Conference Call. At this time, all participants are in listen-only mode. A brief question-and-answer session will follow a formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Douglas Kris, Senior Vice President, Investor Relations and Corporate Communications. Thank you. Please go ahead.

Douglas Kris, Senior Vice President, Investor Relations

Good morning, and welcome to our interim results conference call. Joining me here today are Rusty Hutson, our CEO; and Brad Gray, our CFO. For reference, we will make notes and comments around certain non-GAAP and non-IFRS financial measures. All of our disclosures around those are found in our earnings materials or in our earnings release on our website. I will now turn the call over to Rusty Hutson, our CEO. Rusty, please go ahead.

Rusty Hutson, CEO

Thank you, Doug. Thank you, moderator, and thank you to everyone on the phone today. We're going to go through several slides here, talk a little bit about the first half of the year, discuss some key metrics in more detail, and then I'll turn it over to Brad to cover financial aspects before I wrap it up. Starting here on Slide 3, I want to recognize our employees who may be on the phone with us today or will listen later. They have truly outperformed not only in the first half of the year but over the years, and it shows in these results. A highlight of the free cash flow generation of the business is $121 million, representing a 38% free cash flow yield. This pairs with the 50% cash margins we will discuss shortly. We also made $108 million in debt principal payments on our amortizing ABS notes, which is crucial for our long-term overall strategy. We are focused on shareholder returns, having paid around $65 million in dividends and share repurchases through the first half of the year. It's important for people to understand that our business had a 0% decline essentially over the last three fiscal quarters when adjusted for the acquisition. This is a tremendous testament to the work our team does in the field in getting additional production and improving our portfolio. Since our IPO, we have returned over $850 million of capital to our shareholders over a 7.5-year period, which I think is extraordinary. For capital allocation, we are looking at our four pillars. We paid over $55 million in dividends and fixed per share dividends for the first half of the year. We bought back about $10 million worth of our shares, representing 2% of our outstanding shares over the last six months. We have also announced the Crescent Pass acquisition and closed on the Oaktree acquisition, amounting to over $516 million worth of accretive acquisitions, contributing to our future success. Moving on to Slide 6, I would like to discuss our corporate strategy. Growth is essential to us, but being capital-efficient is equally important. Our capital intensity of 10% is significantly lower than most peers, giving us an advantage due to lower CapEx needs to maintain our production profiles. This results in higher free cash flow, which we can then allocate to our four pillars. On Slide 7, we have averaged 50% cash margins over a seven-year period, which is remarkable considering the volatility in natural gas markets. This success is a testament to our ability to acquire good assets and hedge effectively. Our scale has allowed us to drive down operating costs through geographical concentration and smarter asset management processes, resulting in success over a long time period. Moving to Slide 8, our low capital intensity at 10% and strong margins of 50% translate to a high free cash flow conversion rate. We lead among our peers on the natural gas side, converting EBITDA into free cash flow at a rate of 55%. This free cash flow can then be allocated to our capital allocation pillars, translating into shareholder returns. On Page 9, I want to emphasize the significance of our undeveloped acreage. We have around 8.6 million net acres within our operating footprint, with 65% of that being undeveloped. In the first half of this year, we've sold about $15 million of undeveloped acreage, primarily in Oklahoma. This is an overlooked part of our business, and as we progress, we can generate liquidity through these acreage sales to support our growth strategy. On Page 10, we continue to see our equity value trading at a discount to both our peers and historical averages, about a 37% discount to the current peer average. However, I believe this represents a great opportunity for investment and potential multiple expansion as we develop maturity in the U.S. market and attract more investors. With that, I will turn it over to Brad for a few slides related to our financial metrics.

Brad Gray, CFO

Thank you, Rusty. As you mentioned, we are very pleased with our mid-year results. I appreciate the hard work of our diversified team members who perform at high levels in challenging markets. On Slide 11, we highlight the favorable impacts of our consistent and disciplined hedging strategy. Hedging prices of our commodities is a crucial aspect of our business model. For the second half of 2024, our average floor price is $3.34 per MMBtu, representing a 40% improvement over the corresponding period strip price, allowing us to maintain nearly 50% cash margins. Moving to Slide 12, our technology teams focus on optimization and efficiency. Since 2018, it has been imperative to integrate new assets efficiently for our growth strategy. We standardize our data, use common systems, and are 100% cloud-based. This approach allows us to manage our assets more efficiently, giving us confidence as we execute our growth strategy. On Slide 13, as Rusty mentioned, we are committed to a balanced capital allocation approach. The strong free cash flow generated by our assets allows capital returns to shareholders through dividends and share repurchases. This balanced method provides flexibility to allocate our cash flows effectively.

Rusty Hutson, CEO

Thanks, Brad. To conclude, we pride ourselves in our differentiated business model that offers investors an opportunity to invest in a less risky energy space with more predictable production. We believe we are positioned well to take advantage of current market opportunities, continue generating free cash flow, and delivering strong results for our shareholders long-term.

Operator, Operator

Thank you. The floor is now open for questions. Today's first question is coming from Bert Donnes of Truist Securities. Please go ahead.

Bertrand Donnes, Analyst

Hey. Good morning, Rusty, Brad, and the team. Thank you for the update.

Rusty Hutson, CEO

Thanks.

Brad Gray, CFO

Thanks, Bert.

Bertrand Donnes, Analyst

On the first question, the Crescent Pass acquisition screened pretty well on our estimates. Could you maybe talk about the depth of opportunities you have with similar attributes? Has volatility in the gas space helped, or are more companies looking to unload assets to improve their balance sheets, or has the bid-ask spread widened due to sharp moves in the strip?

Rusty Hutson, CEO

Regarding the strip, we are in a slight contango, which isn't extreme. The multiples on natural gas deals may look a little higher due to lower prices in the first 12 months. There will be significant asset movement in the coming months, and we believe valuations remain favorable for us. We like the Gulf Coast area and see opportunities for success.

Bertrand Donnes, Analyst

Perfect. That's a great update. On the well retirements, it looked like you had a higher percentage of non-op activity in the last quarter. Is that indicative of more demand for next-level services, or is it just a one-time data point? Any thoughts on retirement costs or profit margins for third-party work? Thanks.

Brad Gray, CFO

We've focused on plugging diversified wells ahead of schedule. The speed of federal contracts has shifted, so we will plug for third parties more in the second half of the year. We've seen good revenue generation from various activities, and costs have remained stable year-over-year.

Bertrand Donnes, Analyst

That's great. Thanks, team.

Operator, Operator

The next question is coming from Tim Hurst-Brown of Tennyson Securities. Please go ahead.

Tim Hurst-Brown, Analyst

Good afternoon or morning, gentlemen. Thanks for the call. Just a quick question about underlying production. Since Q4 last year, excluding acquisitions, production has been broadly flat versus the 8% to 10% depletion rate you had in 2023. Are there any one-off factors doing this, and what do you expect production to do in the second half of the year?

Brad Gray, CFO

We've had good production results due to optimization projects in both regions. We expect to trend back towards our engineered decline in the high single digits for the second half of the year, but maintaining three consecutive flat quarters is impressive.

Rusty Hutson, CEO

I want to add that we invested in oilier field projects, which contributed to this flat performance and helped stave off declines.

Tim Hurst-Brown, Analyst

That's great. Thanks, guys.

Operator, Operator

The next question is coming from David Round of Stifel. Please go ahead.

David Round, Analyst

Thanks for the presentation. Your hedging strategy seems to be working well. How do you maintain the right level of hedging when acquiring businesses that may come with their own hedge book? For example, the Crescent Pass acquisition.

Rusty Hutson, CEO

We have provisions in our existing RBL that allow us to hedge acquisitions prior to closing. For the Crescent Pass deal, we are already looking at hedges to lock in the value as we work through the acquisition.

David Round, Analyst

Okay. Brilliant. Appreciate it. Thanks, guys.

Operator, Operator

The next question is coming from Simon Scholes of First Berlin. Please go ahead.

Simon Scholes, Analyst

Hello. Thanks for taking my questions. I have two. On undeveloped acreage, you've raised $15 million in Oklahoma in the first half. Is there any prospect of accelerating the disposal rate? What is the average tax burden on your remaining portfolio? And on the full-year volume outcome, if you assume a return to the previous decline rate in the second half, will average volume in '24 be slightly below '23?

Rusty Hutson, CEO

Regarding acreage sales, we will absolutely work to accelerate those when there's interest. Oklahoma has been active, and our team is skilled in moving those deals forward. As for production volume, after the Oaktree and Crescent Pass acquisitions, we expect to be above the 820 million cubic feet per day mark by the end of '24.

Brad Gray, CFO

We have an advantageous tax position, so we do not expect a significant cash tax burden from upcoming land sales.

Simon Scholes, Analyst

Thanks. Very helpful.

Operator, Operator

The next question is coming from Malcolm Graham-Wood of Hydrocarbon Capital. Please go ahead.

Malcolm Graham-Wood, Analyst

Rusty and the team, good afternoon. How are you doing?

Rusty Hutson, CEO

Hey there. How are you?

Malcolm Graham-Wood, Analyst

I'm very well, thanks. I'm better off having seen a great presentation. Well done. My question is about the undeveloped acreage. I've always said since you started, that this company could go on for 10 years without doing any acquisitions based on your portfolio. What do you think the value of that slide is regarding all your acquisitions?

Rusty Hutson, CEO

While I can't put a dollar amount on it, we know there's significant value. Acreage becomes valuable as time goes on, and we have the advantage of not paying for that upside. New formations continue to emerge, enhancing the value of our portfolio over time.

Operator, Operator

Thank you. At this time, I would like to turn the floor back over to Mr. Hutson for closing comments.

Rusty Hutson, CEO

Thank you all for joining us today. We are pleased with the first half of the year and are set for success moving forward. We will continue to drive free cash flow and generate shareholder value. Thank you, and see you soon.

Operator, Operator

Ladies and gentlemen, this concludes today's event. You may disconnect your lines and log off the webcast at this time and enjoy the rest of your day.