DT Midstream, Inc. Q2 FY2023 Earnings Call

Good morning, and welcome, everyone. Before we get started, I would like to remind you to read the safe harbor on Page 2 of the presentation, including the reference to forward-looking statements. Our presentation also includes references to non-GAAP financial measures. Please refer to the reconciliations to GAAP containing these. Joining me this morning are David Slater, President and CEO, and Jeff Jewell, Executive Vice President and CFO. I'll now turn it over to David to start the call.

Thanks, Todd, and good morning, everyone, and thank you for joining. During today's call, I'll touch on our financial results and provide an update on our growth projects, including our CCS project in Louisiana. I'll then close with some commentary on the current market fundamentals before turning it over to Jeff to review our financial performance. So, with that, we had another strong quarter and the business continues to perform in line with our full year plan, giving us confidence in our full year adjusted EBITDA for 2023 and early outlook for 2024. As a reminder, we expect growth to be weighted towards the second half of the year as we bring new projects online. I am very excited to announce that we made a final investment decision on a new greenfield gathering opportunity in the Ohio Utica. This opportunity originated from an acreage dedication we held with a small private producer. That acreage has since been acquired by a large cap investment grade producer, who is committed to developing this area. This opportunity has always been in our plan for 2024. And now with the development schedule finalized and a restructured commercial agreement in place, we are shifting approximately $100 million of committed capital forward a few months from early 2024 into the second half of 2023. The initial backbone build-out of this natural gas gathering system will provide over 200 million cubic feet a day of capacity and go into service in the first half of 2024. The gathering system will transport associated gas from new wells being drilled in the rich window of the Utica. These wells are highly economic under current market prices, and our investment is supported by a long-term contract with minimum volume commitments that fully protect project returns. As is typical with any new resource development, there will be a production ramp-up expected to occur over an 18- to 24-month time period as the acreage is delineated. As such, we don't expect a meaningful EBITDA contribution until 2025. Longer term, we expect a larger scale build-out across a customer's sizable acreage position, integrated with downstream assets, such as NEXUS. So in summary, this opportunity checks all the boxes for DTM: accretive organic growth, highly economic resource, long-term contract with a strong producer that diversifies our customer mix, and significant follow-on opportunities for our existing assets. In our emerging energy transition platform, we continue to progress our CCS opportunity in Louisiana. Our initial 3D seismic survey data indicates the geology we are targeting is favorable for permanent CO2 sequestration. During the quarter, we filed our Class V characterization well permit application, which we expect to drill in the fourth quarter of this year. We plan to spend approximately $15 million this year for these activities. Assuming the characterization well results are favorable, we would then plan to finalize the project in the first half of 2024. Overall, we continue to make great progress advancing organic opportunities across our portfolio in both our conventional business lines and our emerging energy transition business platform. Turning now to our projects currently under construction, I am happy to report that all projects remain on budget and on schedule. We have made excellent progress on our LEAP Phase 1 expansion, and I'd like to acknowledge and thank our dedicated team in Louisiana for doing exceptional work on this project. Pipeline expansion is currently running ahead of schedule, and we expect an early Q4 2023 in-service date with the potential to pull that forward into late Q3 if we maintain our current pace. Finally, I want to take a moment to address the natural gas market fundamentals and producer activity across our assets. We are observing moderating production levels and some short-term deferral of activity in both basins, as producers continue to operate in a disciplined manner given the near-term weak prices. This is all fully reflected in our guidance. On a positive note, over the past few weeks, we have seen rig reductions stabilize. With extreme hot weather occurring across large portions of the country, this is driving strong power demand for natural gas. LNG feed gas deliveries have returned to high levels following summer maintenance. And all of this is beginning to reduce the current storage surplus that has created the near-term price weakness, resulting in some price improvements. For gas prices, we look favorable in 2024 and 2025, projected in the $3.50 to $4 range as the market anticipates the next wave of LNG demand. Our assets are well positioned to participate in this growth. I'll now pass it over to Jeff to walk you through our quarterly financials and outlook.

Thanks, David, and good morning, everyone. In the second quarter, we delivered overall adjusted EBITDA of $224 million, which is in line with our full year plan. Our Pipeline segment results were $2 million below the first quarter, reflecting the impact of lower winter-related revenues from our pipeline joint ventures. Gathering segment results were in line with the first quarter and consistent with our plan for the year. Operationally, total gathering volumes across both the Haynesville and Northeast averaged approximately 2.9 billion cubic feet a day in the second quarter. In the Northeast, second quarter volumes were up compared to the first quarter due to higher volumes on Appalachia gathering. In the Haynesville, second quarter volumes were down compared to the first quarter due to a planned treating outage in April and a weather-related outage in May. Haynesville's volumes have normalized subsequent to these outages, with July volumes averaging approximately 1.6 Bcf per day. As David previously mentioned, we are accelerating a portion of our 2024 committed capital into 2023 for our new Ohio Utica opportunity and initial investment in our CCS project. As a result, we are increasing our 2023 growth CapEx guidance to $700 million to $750 million, and lowering our 2024 committed growth CapEx by $100 million. Our committed capital over 2023 and 2024 of approximately $800 million remains unchanged. We have increased our 2023 growth CapEx guidance, which solely reflects an acceleration of timing driven by our customers' development plan. This accelerated CapEx timing fits within our longer-term investment plan, and we are maintaining our five-year $1.7 billion to $2.2 billion growth CapEx range. Following the completion of the heavier CapEx spend in 2023, we expect to fund our growth investments within cash flow after dividends. The strength of our balance sheet and our policy of a 4x long-term leverage ratio ceiling is a continual focus for us. Our leverage ratio ceiling now includes our proportionate share of debt at our equity method investees. We expect to end 2023 at approximately 4.2x, temporarily exceeding our long-term ceiling. As we complete our heavier organic capital investment program this year, our on-balance sheet leverage is expected to end the year around 3.8x. Also in the quarter, funds from the NEXUS financing were distributed and received, which were used to pay down our revolving credit facility. This further bolsters our liquidity, which remains very strong at approximately $900 million. Today, we also announced the declaration of our dividend, which is unchanged at $0.69 per share, and we remain committed to growing the dividend in line with cash flows. I'll now pass it back over to David for closing remarks.

Thanks, Jeff. So in summary, we are feeling good about our full year guidance for 2023 and early outlook range for 2024. Our key growth investments are on track, and we continue to advance new organic opportunities. We are excited about our new growth platform in the Utica as it further diversifies our customer base and integrates into our regional assets. Our energy transition platform is also nicely developing, anchored by our CCS project in Louisiana and our hydrogen development partnership with Mitsubishi. We will grow this business in a disciplined and thoughtful manner, leveraging our core competencies and existing business platforms. We can now open up the line for questions.

This is Ratan Reddy on for Jeremy. For my first question, I just wanted to talk about the CCS project. Wondering if you could walk us through the economics there as well as any details around the capital cost to develop the system?

Sure. This is David. We laid out a development schedule on our CCS project in our presentation. So, I'd maybe point you there. As we've said historically, this project has two strategic drivers for us. One, it significantly reduces our direct CO2 emissions for the company, making it a significant contributor to our march towards Net Zero. However, with the existing tax credits, it's also a very economic project for investors. In terms of providing more detailed disclosures around the capital, we plan to do that when we finalize the project, and we'll provide more refined information on schedule and capital. But based on where we're at in the development cycle, I think the disclosures that we've laid out in the presentation are the current disclosures we're providing.

Okay. Great. And then for my second question, I wanted to touch on leverage, which you discussed earlier in the call. Could you walk us through your thoughts on staying at or below the 4x leverage with CCS or any LEAP expansion CapEx in 2024?

Yes, this is Jeff. Yes, that's what our plan is. Again, we've been pretty clear. Our ceiling is at 4x long-term as part of the plan. As we get into 2024, we feel confident that we'll be at or below the 4x in 2024. Remember, that's at the proportional level where we are. And on a balance sheet basis, we expect to end the year at about 3.8x. So again, we're very comfortable with where we are from a leverage standpoint.

I just wanted to ask about the Ohio Utica investment. Just to confirm that the minimum volume commitments you’ll be receiving will not cover you to get to the 5x investment multiple you cited. I'm assuming you're going to need a certain amount of volume to get to that and when do you think you will hit that?

Actually, Michael, that minimum volume commitment will protect our threshold returns for the segment that will deliver that 5x EBITDA multiple. So, it's a very solid investment in this market environment.

Got it. But just to clarify, you're saying that the impact on cash flows will really show up in 2025 and not really in 2024?

That's correct. We'll construct here late in '23, and then their development schedule will start bringing volumes on in '24. They've got an 18- to 24-month ramp period as they start to develop the resource, and will ramp in volume. But there are minimum volume commitments that ramp along with the producer activity that will help us achieve that higher run rate. Yes, 2025 is when you should see a full year's higher level run rate impact on our EBITDA.

Okay, perfect. And then just wanted to ask about the CCS project. The $800 million of CapEx committed for '24 and '23, does that include— is that inclusive of the CCS project, or if you finalize the project in early '24, would that be additive?

Yes, I think the only thing that we're including right now is the $15 million that we have detailed. So, that's what I'll call pre-development capital to derisk the project. Again, like I said earlier, when we finalize the project, we'll provide a lot more granular disclosure on total CapEx budget and timing.

First question is on CapEx. The sequential decline on CapEx into '24 from '23 looks a bit more sizable now. So just curious how you're thinking about the plans to backfill with other projects from here now it sounds like funding within cash flow is a hard stop for you. The most I could assume right now is that any excess cash flow beyond the dividend is allocated toward leverage. Or could we see some other uses?

Yes. Let me start, and then I'll pass it over to Jeff. But I think you're understanding it correctly. The Ohio project was included in the 2024 committed capital. With our customer, there was a modest timing shift, which benefited us by moving us out of winter construction, reducing the risk of execution on this project. As a result, moving forward a few months into the '23 window. So, you are right; it takes a big chunk of committed capital out of 2024. The '23 free cash flow run rate is known to you all. Yes, there's a bunch of uncommitted capital free cash flow sitting in '24. And Jeff, maybe I'll pass it over to you here for thoughts about uncommitted free cash flow.

Yes, as David mentioned, our cash flow remains highly contracted, and I believe it will be relatively stable over the years. We have a significant amount of potential organic backlog that we are currently assessing, and we will share updates about additional projects either in the third quarter or at the end of the year. However, we will ensure that our cash flow stays within the leverage targets we have outlined.

The key thing is that we expect to be back to four or less on a proportional basis, which is a higher threshold than when we spun the company, because that floor was originally measured on a balance sheet basis. I expect there will be a combination of incremental organic opportunities that emerge before year-end, but I also expect they will contribute towards the balance sheet as well.

Got it. Helpful color. Second question, quickly just related to natural gas storage. I've seen a lot of your peers kind of lean into that more aggressively, as economics there have been improving. Curious about your ability to expand on that front? And if that's something that is already considered inside your long-term capital plan?

Yes. Storage has been a bright spot in our portfolio for the last six months. We leaned on that pretty good in the second quarter and formed up at attractive rates. Some of the capacity is rolling from year to year in the portfolio, so that was step number one. Step number two is looking for expansion opportunities, which our team is assessing right now. More updates to come, as we get a better sense of the market and potential expansion opportunities.

First, maybe I could start with the Haynesville. Just any high-level commentary on where you see volumes directionally on your system over the next year? Is it up meaningfully? Is it flattish? And any color on what producers are saying about how they're approaching activity with the forward curve strengthening and some of the LNG facilities coming on?

Sure. We're looking at volume growth and expecting it towards the end of the year. That should kick in post expansion. We have a series of LEAP expansions coming over the next 12 months. We also are in flight on a series of gathering expansions that support each other. We fully expect our volumes to ramp as those projects complete and come online. What we’re observing in Haynesville is rational behavior from our producers. With current low cash prices, we are seeing a pause or short-term deferral of activity, especially when considering the forward curve with a significant price ramp heading into winter. Producers have rationally adjusted their activities to align with market indicators suggesting the necessity to ramp production in '24 and '25. We see levels of drilling being maintained, but DUC inventory is growing, positioning them to react quickly to the market demands.

Great. Second question, maybe just a basic one on the CCS project. Can you talk to the timeline? You're planning to finalize it by the first half of next year, and you're expecting the Class VI well permit approval later in 2024. Can you discuss confidence in getting full permitting for the project and plans if permitting takes longer than expected?

Great question. Permitting is probably the biggest question mark for any CCS project right now. We're having regular dialogue with both the EPA and the Louisiana DNR. As you know, there's an expectation that Louisiana will receive primacy, but there isn't clarity on the timing of when that may occur, so we’re running this parallel track and keeping both agencies fully informed. We're focused on derisking the project, starting with the seismic shoot, which is key to validating the geological formation we want to sequester. One, the Class V well permit will be crucial as we prepare for the next significant derisking activity. If we succeed in that, we plan to finalize the project early next year. Our best view on the timing for the Class VI well authorization is outlined in our presentation. While we are hopeful for acceleration, especially if primacy shifts to Louisiana, all this remains to be determined as we work with regulatory agencies. We'll be committed to keeping everyone apprised as we receive more information impacting our schedule.

Just wondering if I could get your latest thoughts on a potential NEXUS expansion. Do you still consider permitting reform to be the gating item? And do you view the Utica project as a way to feed any future expansion?

Yes. We are very supportive of the progress made to date through the IRA and ongoing discussions in Washington regarding additional permitting reform. We're optimistic as more clarity on permitting and scheduling is needed to streamline projects from concept to completion. Regarding the Utica project, we believe it will strategically position us to interconnect with NEXUS. NEXUS offers a direct route to lucrative markets in the upper Midwest and through to Eastern Canada. This strategic value makes our investment in the Utica project promising. We're also closely examining the hydraulics of the NEXUS system after several years of service to maximize utilization and capacity. This past winter, NEXUS operated at very high capacity, showing its potential.

Great. That's helpful. I think you mentioned earlier that the commercial agreement underpinning the Utica project was restructured, allowing you to advance it to '23. Could you clarify if that simply involved modifying the construction schedule, or were there concessions made to incentivize your customers to accelerate production?

What happened there was the ownership shifted from a smaller independent producer to a large cap investment grade producer. Their development schedule changed after the acquisition, and part of restructuring the contract involved readdressing development plans to ensure alignment in terms of activity and economics. The features of that agreement reflect the current market conditions, and there are significant minimum volume commitments in this agreement essential to protect the capital we're deploying into this acreage and resource development. Thank you very much for joining us today. We certainly appreciate all the support and your interest in DT Midstream, and hope your day goes well. Thank you very much.

And this does conclude today's conference call. Thank you for your participation. You may now disconnect.