Earnings Call Transcript - DEC Q1 2025

Operator, Operator

Greetings. Welcome to Diversified Energy's First Quarter 2025 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce Douglas Kris, Senior Vice President, Investor Relations and Corporate Communications. Thank you. You may begin.

Douglas Kris, Senior Vice President, Investor Relations and Corporate Communications

Good morning. And thank you all for joining us today. And welcome to our first quarter 2025 results conference call. With me today are Diversified's Founder and CEO, Rusty Hutson; and President and CFO, Brad Gray. Before we get started, I will remind everyone that the remarks on this call reflect the financial and operational outlook as of today, May 12, 2025. These outlooks entail assumptions and expectations that involve risks and uncertainties. A discussion of these risks can be found in our regulatory filings. During this call, we also reference certain non-GAAP and non-IFRS financial measures. Our disclosures regarding those items are found in our earnings materials, on our website and in our regulatory filings. Additionally, as noted in the first quarter 2025 results announcement issued this morning, all financial and operational metrics and our underlying results represent only two weeks of contribution from our recently closed Maverick Natural Resources acquisition. I will now turn the call over to Rusty.

Rusty Hutson, CEO

Thank you, Doug. And thank you all for joining the call today. Before I start my prepared remarks, I want to highlight and emphasize that we have significantly transformed and strengthened our company since the start of the year. I appreciate the tremendous efforts of our employees to deliver outstanding results and live by our culture of getting things done to help us be successful every day. This team has positioned Diversified for an exciting future. I'm confident that our presentation will reinforce my excitement. Additionally, while we recognize the current uncertainty, increased volatility and sharp market sell-offs related to tariffs and other factors, we believe it is essential to address why these items do not affect Diversified's fundamental business. Here are a couple of important, unique and differentiated factors of the Diversified business model. We are predominantly a natural gas-focused company with the commodity seeming to have a positive macro outlook and tailwind. We are the only publicly traded PDP champion with a focus on the management of mature producing assets. We are a high cash margin business with a large protective hedge book, paying a fixed rate dividend and maintaining an active share repurchase program. We have built vertical integration and economies of scale to help insulate against inflation. We have built near-adjacent businesses in coal mine methane and well retirement. We are financially sound with approximately $450 million in liquidity. Our model is to use low-cost capital to acquire and take advantage of an often-overlooked segment of the oil and gas sector that is historically highly cash generative. Bottom line, the magnitude of any tariffs' direct or indirect impact on our bottom line financial health is extremely limited. While it's sometimes a challenging environment to operate in, we know that if it's hard, there is opportunity. For those of you following along with our first quarter 2025 results slide deck, which we posted to our IR website this morning, I will cover a few slides and then turn the call over to Brad to discuss a few highlights from our financial results. After Brad, I will provide some additional thoughts on our guidance for our powerful path forward in 2025 before opening the call for your questions. Starting on Slide 3. We continue to focus the core of our capital allocation strategy around our four key pillars that are really deliverables to judge us by: systematic debt reduction, returning capital to shareholders through dividend distributions and through share repurchases and growing the company through accretive and strategic acquisitions. Last year, we checked that box and we continue to build that credibility in 2025. You can see here our progress year-to-date in 2025. Debt principal reduction totaled approximately $51 million during the first quarter of 2025. Additionally, we returned approximately $59 million to shareholders in the form of dividends and strategic share repurchases. Importantly, we believe our shares remain a compelling investment at current levels and we will continue to take advantage of the current cycle and market dislocation to opportunistically repurchase shares. And we accomplished all this while continuing to focus on our growth initiatives with approximately $2 billion in announced acquisitions, inclusive of the recently closed transformational Maverick acquisition. We maintain flexibility in our capital allocation strategy to ensure we deploy capital to the highest value opportunities. Taken together, we believe our capital allocation strategy balances investment in the business and growth initiatives while enabling a tangible shareholder return framework, all of which creates long-term value for our stakeholders. And we will remain focused on these key strategic pillars. With that, I'll turn it over to Brad to discuss our financials in additional detail.

Brad Gray, President and CFO

Thank you, Rusty. Let me share the highlights of our financial and operational results for the first quarter. We'll start with production. The average daily production exit rate for March was approximately 1.149 million cubic feet equivalent per day and our quarterly production averaged over 860 million cubic feet equivalent per day. Over 50% of our produced volumes were generated in our central region. The growth in our production base has put the company in a fantastic position to participate in both LNG exports and data center needs while continuing to supply energy to our local communities and commercial customers. Our total revenue was approximately $295 million and adjusted EBITDA was $138 million, which represents an approximate 47% adjusted EBITDA margin, which was relatively flat quarter-over-quarter despite a dramatic decline in oil prices. Notably, as we continue our integration process and improve the combined company cost structure, coupled with a recovery in liquids pricing, we anticipate margin expansion to grow above our historic 50% level. This quarter's free cash flow was $62 million, delivering an approximate 45% free cash flow conversion rate. Our net debt stood at approximately $2.56 billion. And as part of the Maverick transaction, the company's RBL capacity increased to $900 million. And today, we have the largest but most importantly, we have the strongest balance sheet we have had. With a net leverage reduction quarter-over-quarter and over $450 million in liquidity, our balance sheet strength is giving us the financial optionality and the financial flexibility to navigate and potentially take advantage of volatile markets as well as commodity price cycles. Our investment grade rated and stable longer-term ABS structures help contribute to our financial resilience. In summary, the strong execution of our strategy from all of our teams during the year delivered our positive results, enabling strong free cash flow generation and allowing us to continue to prioritize returning capital to shareholders and paying down debt. Now, we'll turn over to Slide 5. One of the main benefits of our recently closed Maverick transaction is that we have multiple drivers of cash flow growth. The combined company will benefit from our low decline production profile, commodity diversification, a continued disciplined hedging program and the potential for additional upside from anticipated operational and administrative synergies with this acquisition. As a result, the chart on the right side of the page shows that the 2025 guidance for combined free cash flow totaled $420 million, an approximate 200% uplift from Diversified standalone results in 2024. Now, we'll turn over to Slide 6. Our differentiated business model, including our low capital intensity, combined with our strong cash margins, result in a strong free cash flow conversion rate of 45% as seen on this slide. Within our natural gas peers, you can see how Diversified's business model is differentiated and we continue to be a leader in the natural gas sector, outperforming many companies with market capitalizations, enterprise values and production profiles meaningfully larger than ours, with our impressive free cash flow conversion rate of approximately three times our peer group average. Additionally, our fixed-rate investment grade debt from our ABS notes helps lower interest expense, which also benefits our free cash flow. Our ability to generate strong free cash flow allows us to direct cash towards the four pillars of our capital allocation strategy. Turning now to Slide 7. We have a proven approach and an ability to identify and achieve synergies in our acquisitions. Our stewardship operating model supported by our long-tested smarter asset management practices is all about optimizing the assets we acquire through production enhancements and expense efficiency. We use every lever at our disposal to increase cash margins, increase returns, and increase free cash flow from our investments. With this acquisition, we have already identified and achieved synergies by increasing asset density in our field operations, we've integrated processes and we're improving material contract turns, which deliver better compression and chemical cost. Additionally, we have upgraded and reduced redundancies in staffing in several areas across our organization. Anytime you have the opportunity to bring talented groups together, there is the opportunity to utilize the best from each other, whether that be professional experiences, tools, processes or procedures. Now, turning over to Slide 8. We continue to believe our share price is undervalued and has been impacted by macro headwinds that are not connected with our company's fundamentals or our consistent and compelling performance. Based on the EV to EBITDA metrics where we have historically traded and compared to multiples of our natural gas peers, we strongly believe there is a real opportunity for a re-rate in our shares. With a number of near-term catalysts on the horizon, including the integration of Maverick with meaningful identified and quantified synergies, the unlocking of additional hidden acreage value, our emerging coal mine methane opportunity and the continually consolidating landscape of North American operators, we believe that there is meaningful shareholder value to be captured from our differentiated business model. It's worth noting that one of our capital allocation pillars is strategic share repurchases. And as Rusty briefly mentioned earlier, we will continue to take advantage of the market dislocation and valuation to repurchase our shares. With that, and those comments, I'll turn the presentation back to Rusty for his additional comments.

Rusty Hutson, CEO

Thanks, Brad. Let me provide a couple of thoughts on our now combined company outlook and how we believe the combined company will look in the coming year before we take questions. On Slide 9, we continue to maintain momentum into the second quarter with the Maverick integration progressing in a way that we believe will exceed our targeted run rate synergies of $50 million. Importantly, with our targeted production of over 1 Bcf per day and more than doubling the free cash flow compared to Diversified on a standalone basis to over $420 million, the company is positioned on a path that creates a unique and compelling investment opportunity. Turning to Slide 10. As we continue to emphasize, we are a differentiated energy producer that seeks to optimize existing long life and often overlooked and undervalued US energy assets. We seek to drive shareholder returns in a unique way by minimizing traditional E&P risk, optimizing our low decline production and by being good stewards of our capital while driving meaningful and consistent cash flow. Our results reflect our continued focus on building a strategic resilient energy producer. We believe we are the champion of the PDP subsector within the upstream E&P space. We are the one and only publicly traded company executing this strategy, offering investors a vehicle to invest in a similar fashion to the private equity PDP roll-up strategy. Importantly, compared to those private entities, Diversified offers unique value creation attributes, which provide us with a competitive advantage. With our large operational scale, vertical integration and corporate infrastructure that leverages a leading technology platform, we have a proven process of integration that allows us to streamline and capture meaningful synergies. We have executed that playbook 27 times over the past seven years, and we are well on our way to accomplishing that again for the transformational Maverick Natural Resources acquisition. Every industry subsector needs a standout or go-to investment, which usually has several strategic advantages to its business model. Today, as the only publicly traded PDP focused company, we believe Diversified is that winning investment and has a distinct opportunity to grow our business and re-rate the shares. We are excited about the prospect of transforming the valuation of the business through continued execution of our strategy, and we thank our shareholders for their continued support. We remain focused on building a portfolio of assets through value-accretive transactions while simultaneously unlocking hidden value through our unique operational framework, strategic development partnerships and growing adjacent business segments, including coal mine methane. With the combination of maturing assets and M&A activity leading to growth-oriented E&Ps recycling capital through divestment of assets, in many cases, mature producing assets, there remains an ample opportunity for Diversified's continued growth. Additionally, given our industry-wide reputation and the current upstream market dynamic of E&Ps making acquisitions to backfill and expand undeveloped inventory, Diversified provides a creative and actionable solution as a PDP partner in joint acquisitions. We have been steadfast in executing our strategy since our IPO, driving strong financial and operational performance. The right company, right time mindset for the type of assets we manage delivers consistent free cash flow and returns to shareholders and serves a fundamental role in sustaining the US energy markets. Before I turn the call over to the operator for Q&A, I'd like to take a minute to recognize our employees for their outstanding achievements and contributions during the year. Without their excellent work in the field and in the corporate office, these results would not be achievable. With that, I'd like to turn it over to the operator for the Q&A portion of today's call.

Operator, Operator

Our first question is from Tim Rezvan with KeyBanc Capital Markets.

Tim Rezvan, Analyst

First one I had today, it makes sense with Maverick having just recently closed that you would leave the 2025 outlook unchanged. Obviously, gas tailwinds are at your back. But I was curious about the Permian joint development opportunity, which is sort of the biggest component of your CapEx coming from Maverick. Can you talk about how set in stone that program is? I know WTI is at 63 today but it's been weak. Just curious on how you're thinking about that CapEx should we see oil retrench back into the 50s?

Rusty Hutson, CEO

For clarification, our largest joint venture opportunity is in Cherokee and Oklahoma. We also have some smaller joint venture opportunities in the Permian, but most of our committed capital expenditures are focused on Cherokee and Oklahoma. Production from that area is evenly split among oil, natural gas liquids, and natural gas. Even with the recent downturn in oil prices, it hasn't been significantly affected compared to areas primarily producing oil, like the Permian. We continue to monitor the situation with our operator and partner. As of now, everything is proceeding as we originally expected. If both gas and oil prices decline throughout the year, we will reassess. However, at this moment, it's business as usual for that program.

Tim Rezvan, Analyst

But and then your Permian activity, do you feel pretty good about 2025?

Rusty Hutson, CEO

It's minimal compared to what we have going on in Oklahoma, to be honest. We are currently conducting a full assessment of all of our acreage in the Permian, evaluating each piece to determine where we can get the best value, whether that involves partnering with someone to drill or deciding to monetize areas we believe are not worth pursuing. For the most part, we have very little capital allocated for the Permian this year, but the funds we do have are still planned for the remainder of the year.

Tim Rezvan, Analyst

I found Brad's comments quite intriguing. It seems that even after closing the Maverick deal, you are well-prepared for potential incremental mergers and acquisitions. You mentioned being ready to seize opportunities and emphasized the strengthening balance sheet. Could you share your perspective on pursuing M&A if a suitable opportunity arises? Do you feel that despite the ongoing integration, you are in a position to engage in transactions if they come up?

Rusty Hutson, CEO

Tim, that's an excellent question regarding the integration. Over the short time we've been working on it, just a little over a month, we've discovered synergies greater than what we originally expected when we announced and finalized the deal. We believe this will continue throughout the year. The integration process has been smooth, and for two large companies, it has been quite straightforward and cooperative so far, with minimal impacts. We are making progress on everything we planned to do. The integration is proceeding well. I often mention that we cannot control when opportunities become available. We are continuously monitoring potential options and have a list of things we believe would be beneficial if they arise, and we want to be prepared for those possibilities. Fortunately, we have the ability to act if needed, though it doesn’t mean we will. We could maintain our operations month after month while achieving our synergies effectively. However, we are also alert to opportunities that could significantly enhance shareholder value in the future. Our balance sheet is in a strong position, we have considerable liquidity, and we will continue to generate free cash flow as we did in the first quarter. This gives us options to pursue opportunities that we believe will provide the most value to our shareholders. That's our current status.

Operator, Operator

Our next question is from Sam Wahab with Peel Hunt.

Sam Wahab, Analyst

It's really a follow-up to Tim's question around the JV activity in Oklahoma in particular. It's more around sort of the timing of that, what the activity looks like and what success would look like following that CapEx spend?

Rusty Hutson, CEO

I think the original schedule we had with our partner has had just minor adjustments. Honestly, we don’t see any change from what we anticipated when we announced the deal back in March. These drilling programs involve setting a schedule, and there may be some tweaks because completions don't always happen on time. However, right now, everything looks great. From our perspective, there’s no need for significant adjustments, as we have a different revenue stream from these wells compared to what we would expect in the pure Permian, which is mostly oil. These wells tend to have a bit more gas and NGLs, and the overall returns look strong. The internal rates of return are still high and definitely above our lower threshold, which indicates that we are well positioned. Therefore, we see no reason for adjustments at this point. We will continue to work closely with our operator and partner and stay on schedule; the wells are performing well.

Brad Gray, President and CFO

And I would just quickly add, Sam, that it's important to have a quality partner, and we do, that we've got a lot of confidence in. So we'll maintain good dialogue and good visibility there as to what's going on as Rusty indicated. And we're confident that we'll both be able to make good quality business decisions.

Sam Wahab, Analyst

And then just very briefly on the coal mine methane outlook and obviously, with the Summit acquisition, there was increased potential there. Has anything you've seen since that's been integrated changed your view or probably increased your outlook on that particular revenue stream?

Rusty Hutson, CEO

We were able to achieve some additional cash flow in the first quarter as a result of closing that Summit acquisition. We're confident that that increased activity will continue throughout the rest of the year. So no changes from that standpoint. We like our acreage position where we are generating these credits. And we believe there's an opportunity to continue to grow that revenue stream.

Brad Gray, President and CFO

I think we also made the comment that maybe it was back at the year-end numbers that we felt that this could be increased up to 300% from 2024 levels by the time 2026 and we're well on our way to do that.

Operator, Operator

Our next question is from Paul Diamond with Citibank.

Paul Diamond, Analyst

I just wanted to quickly touch on the kind of M&A landscape, a bit deeper than we talked about already. Given the current disconnect in markets, call it uncertainty, are you seeing more opportunities on the oil side or nat gas side and things, the bid-ask widening out? I guess, how are those conversations going, how should we think about near-term opportunities given current dislocations?

Rusty Hutson, CEO

The oil companies are not very keen on selling in the current market environment. There has been a noticeable pause on the oil side as companies try to assess the situation. Prices fluctuate significantly, moving from 55 to 62 or 63, creating challenges in pricing and valuation due to the volatility. This situation resembles what we saw with natural gas a couple of years ago, where uncertainty led to a standstill. In contrast, the natural gas market appears more active, with prices being more stable. We might see transactions in this area in the coming weeks or months. Additionally, we believe there are too many small-cap oil and gas companies and stocks, and there's potential value to be unlocked through reducing general and administrative costs over time. We are monitoring this closely, but even with market improvements, recovering these values may be difficult. Thus, the small-cap stock sector could offer value as time progresses.

Operator, Operator

Our next question is from Simon Scholes with First Berlin.

Simon Scholes, Analyst

I've just got one. Just looking at lease operating expense, unit lease operating expense in the first quarter, I mean, it's quite a way above what you had last year. I was just wondering if you could give us an indication of where you expect unit lease operating expense to be over the next couple of quarters?

Rusty Hutson, CEO

I'll let Brad provide some additional insights here. We've recently made an acquisition that features a significantly higher liquids value compared to what we've seen in the past. Last year, during the first quarter, our portfolio was comprised of 85% natural gas. This year, we're looking at a 70% exit rate for natural gas and 30% for oil and NGLs. While this transition brings a slightly higher operating expense on the liquids side, it also translates to a considerable increase in revenue. As a result, we expect margins to remain strong, similar to where they were last year. Brad, would you like to add anything?

Brad Gray, President and CFO

A few points to note. As Rusty mentioned, the liquids weighting will certainly have an impact. As the year progresses, you will begin to see more stability in our lease operating expenses as we integrate these factors. We have only had two weeks with Maverick so far, but we are also on track to achieve the synergies that Rusty has talked about a few times, and we are very excited about that. Additionally, there were some significant weather events in early January and February that affected production levels, resulting in a temporary increase in operating expenses on a per-unit basis. However, all production volumes have returned to alignment with our plans, so there was just a slight impact in the quarter due to those severe weather conditions. As I mentioned earlier, we are very confident that we will return to our historical levels of over 50% margins.

Operator, Operator

With no further questions in the queue, I would like to turn the floor back over to Rusty Hutson for closing remarks.

Rusty Hutson, CEO

Thank you all for joining today. Again, we're very excited about the first quarter and looking forward to continuing our success in our operations throughout the year. And thank you all for joining and we'll talk soon. Thank you.

Operator, Operator

Thank you. This does conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.