Earnings Call Transcript - HESM Q1 2024

Operator, Operator

Good day, ladies and gentlemen, and welcome to the First Quarter 2024 Hess Midstream Conference Call. My name is Gigi, and I'll be your operator for today. Please be advised that today's conference is being recorded for replay purposes. I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

Jennifer Gordon, Vice President of Investor Relations

Thank you, Gigi. Good afternoon, everyone, and thank you for participating in our first quarter earnings conference call. Our earnings release was issued this morning and appears on our website. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements. These risks include those set forth in the Risk Factors section of Hess Midstream's filings with the SEC. Also, on today's conference call, we may discuss certain non-GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the earnings release. With me today are John Gatling, President and Chief Operating Officer; and Jonathan Stein, Chief Financial Officer. I'll now turn the call over to John Gatling.

John Gatling, President and Chief Operating Officer

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's First Quarter 2024 Conference Call. Today, I'll discuss our first quarter performance, which demonstrates a continued focus on the safe delivery of our strategy. I'll also review Hess Corporation's results and outlook for the Bakken. Jonathan will then review our financial results and guidance. In the first quarter, we continued to progress our 2024 business objectives in a safe and efficient manner. Throughput volumes averaged 393 million cubic feet per day for gas processing, 117,000 barrels of oil per day for crude terminal, and 116,000 barrels of water per day for water gathering. In line with our guidance, overall volumes were broadly flat compared to the fourth quarter, reflecting severe winter weather experienced in January, resulting in slightly lower oil volumes offset by strong gas capture performance. We continue to support Hess' commitment to achieving zero flaring by the end of 2025. Now turning to Hess upstream highlights. Earlier today, as reported, Bakken net production for the first quarter averaged 190,000 barrels of oil equivalent per day, which included 19,000 barrels per day of volume received from percent of proceeds contracts, which do not impact Hess Midstream throughput. First quarter net production was broadly flat compared to the fourth quarter of 2023, again, reflecting the severe winter weather experienced in January, followed by a strong recovery in February and March. Hess also reiterated their plans to continue running a 4-rig drilling program in 2024 and expect Bakken net production to average between 195,000 and 200,000 barrels of oil equivalent per day in the second quarter. Turning to Hess Midstream guidance. We're reaffirming our previously announced 2024 throughput guidance, which was included in our earnings release. For the full year 2024, we're forecasting gas processing volumes to average between 395 million and 405 million cubic feet per day, terminaling volumes to average between 120,000 and 130,000 barrels of oil per day, and water gathering volumes to average between 105,000 and 115,000 barrels of water per day. This represents an approximate 10% increase across our oil and gas systems compared to 2023, primarily driven by Hess' development activity. Now focusing on the second quarter, we expect volume growth from the first quarter across our oil and gas systems, mainly driven by Hess' planned production growth and continued focus on gas capture. In the second quarter, we're planning to conduct routine maintenance at the Tioga Gas Plant, which is in addition to our normally higher seasonal maintenance activity. Now turning to Hess Midstream's 2024 capital program. We continue to make excellent progress on our 2024 capital plans and are focused on supporting Hess and third-party development in the basin. The multiyear projects we announced in January are progressing to schedule. They include the construction of greenfield, high-pressure gas gathering pipelines and two compressor stations, which are expected to initially provide in aggregate an additional 85 million per day of gas compression capacity when brought online in 2025 and are expandable to 140 million cubic feet per day. Full year 2024 capital expenditures remain unchanged and are expected to total between $250 million and $275 million. In summary, we remain focused on executing our operational priorities and safely delivering our growth strategy, which will continue to drive sustainable cash flow generation and the potential to return additional capital to our shareholders. I'll now turn the call over to Jonathan to review our financial results and guidance.

Jonathan Stein, Chief Financial Officer

Thanks, John, and good afternoon, everyone. We continue to execute our financial strategy that prioritizes the return of capital to shareholders with a demonstrated track record of differentiated shareholder returns. Since the beginning of 2021, we have returned $1.65 billion to shareholders through accretive repurchases that have reduced our total unit count by over 20%. In addition to the combination of our 5% targeted annual distribution growth, and seven distribution level increases following each repurchase, we have increased our distribution per Class A share by approximately 45% over this period. As a result, our total shareholder return yield is one of the highest among our Midstream peers. Furthermore, our leverage of approximately 3.2 times adjusted EBITDA is one of the lowest among our peers, highlighting our differentiated ability to deliver significant shareholder returns while also maintaining balance sheet strength. In January, we announced that we expect to generate greater than $1.25 billion of financial flexibility through 2026 for incremental shareholder returns, including potential unit repurchases. Utilizing this capacity in March, we completed our first repurchase transaction in 2024 of $100 million, which was accretive on both a distributable cash flow per Class A share basis and an earnings per Class A share basis. Supported by this repurchase, we recently announced a further return of capital to our shareholders through an immediate 1.5% increase in our quarterly distribution level in addition to our targeted 5% annual distribution for Class A share increase. As we have done in the past, with the reduced share count following the repurchase, this distribution level increase maintains our distributed cash flow at approximately the same amount as before the repurchase. Following the unit repurchase, we expect to continue to have more than $1.25 billion of financial flexibility through 2026 that can be utilized for the continued execution of our return of capital framework, including potential ongoing unit repurchases. Turning to our results. For the first quarter of 2024, net income was $162 million compared to $153 million for the fourth quarter of 2023. Adjusted EBITDA for the first quarter of 2024 was $276 million compared to $264 million for the fourth quarter of 2023. Adjusted EBITDA for the first quarter increased relative to the fourth quarter of 2023, primarily driven by a significant reduction in operating costs. Total leverages, excluding pass-through revenue, decreased by approximately $3 million, primarily driven by slightly lower oil volumes due to the severe winter weather in January, offset by continued strength in gas capture as well as slightly higher tariff rates that were reset in January, as we have described at the time. As a result, segment revenue changes were as follows: Gathering revenues decreased by approximately $8 million. Terminaling revenues decreased by approximately $3 million, and processing revenues increased by approximately $8 million. With physical volumes growing as more wells come online, we expect continued growth in revenues for the rest of 2024. Total costs and expenses, excluding depreciation and amortization, pass-through costs, and net of our proportional share of LM4 earnings, decreased by approximately $15 million, primarily due to lower operating and maintenance expenses compared with the fourth quarter, where we had accelerated maintenance activity due to unseasonably favorable weather as well as lower general and administrative expenses due to seasonally high allocations in the fourth quarter, resulting in adjusted EBITDA for the first quarter of 2024 of $276 million, above the $270 million high end of our guidance range. Our gross adjusted EBITDA margin for the first quarter was maintained at approximately 80%, highlighting our continued strong operating leverage. First quarter capital expenditures were approximately $35 million. And net interest, excluding amortization of deferred finance costs, was approximately $47 million, resulting in adjusted free cash flow of approximately $194 million. We had a drawn balance of $455 million on our revolving credit facility at quarter end, which included funding of our recent $100 million unit repurchase transaction. Turning to guidance. For the second quarter of 2024, we expect net income to be approximately $155 million to $165 million, and adjusted EBITDA to be approximately $270 million to $280 million, reflecting higher volumes and revenue, offset by seasonally higher operating costs. This includes higher operating expenses from the planned maintenance work scheduled in Q2, including routine maintenance at the Tioga gas plant, as John mentioned. We also expect capital expenditures to increase in the second and third quarters, consistent with seasonally higher activity levels. For the full year 2024, we are reaffirming all previously announced guidance and expect net income of $670 million to $720 million and adjusted EBITDA of $1.125 billion to $1.175 billion, with total expected capital expenditures of $250 million to $275 million. We expect to generate adjusted free cash flow of $685 million to $735 million, with distributions for Class A shares targeted to grow at least 5% annually from the new higher distribution level. We expect excess adjusted free cash flow of approximately $115 million after fully funding our targeted growing distribution. We expect increasing volumes and revenues in each quarter through 2024 across oil, gas, and water systems with seasonally higher operating costs in the second and third quarters of the year, resulting in expected growing adjusted EBITDA through the rest of the year. As implied by the midpoint of our guidance, we anticipate adjusted EBITDA in the second half of the year to be approximately 9% higher relative to the first half. In summary, we are very pleased to have delivered additional incremental report of capital to shareholders and look forward to a visible trajectory of growth in our operational and financial metrics that underpin our unique and differentiated financial strategy with a focus on consistent and ongoing return of capital to our shareholders. This concludes my remarks. We'll be happy to answer any questions.

Douglas Irwin, Analyst

Okay. Just trying to start with the second half growth expectations. You just talked about kind of 9% relative to the first half of the year. Just wondering if you can talk about some of the main drivers there that kind of bridge that growth into the second half of the year. Just wondering how much of that is driven just by the absence of some of the one-time turnarounds and weather impacts versus organic growth on top of that. And then maybe you could just talk about some of the puts and takes that could drive the high end or the low end of the range for the rest of the year.

John Gatling, President and Chief Operating Officer

Sure. Maybe I'll take the volume, and then I'll hand it over to Jonathan to talk a little bit about the financial side. So on the volumes, obviously, we had the challenging weather in January. But I would say that the recovery from the January weather was very strong in February and March, as I mentioned in my script. As we grow into Q2, Q3, and through the end of the year, we do expect the volumes to have a strong trajectory. I mean, when you look at the growth that we had from our guidance from '23 to '24, we're expecting some strong growth there. We would anticipate that growth to be relatively stable through the rest of the year. So from our perspective, we feel like there's a lot of opportunity to continue to support the growth. Hess' performance has been very good, as you probably saw on the release earlier this morning from them as well. So, again, we're just translating that into higher throughput volumes. As far as the kind of the puts and the takes, I mean, weather is always unpredictable. We're kind of coming out of the winter weather now. We've had a very good winter with the exception of that very cold snap we had in January. And I would say that we're seeing overall delivery and throughput remaining very strong. So I don't know, Jonathan, if there's anything else you wanted to add?

Jonathan Stein, Chief Financial Officer

Yes. No, I think that was good. And let me just kind of walk through the trends that we expect for the rest of the year. So as we look into Q2, as John said, we continue to expect continued volume growth, but that will drive revenue growth. As we go into Q2, we have seasonally higher operating expenses. And then on top of that, we expect some incremental costs associated with routine maintenance at the Tioga plant, as we discussed. So that will take into our EBITDA guidance for Q2. So as we move into Q3, we expect again continued volume growth and therefore, revenue growth. Operating expenses would already be at a higher level. So really, we expect growth in EBITDA in Q3, primarily driven by volumes. And then as we move into Q4, we expect accelerated EBITDA growth again. There again, we'll have volume growth continuing, but we'll also have the benefit of seasonally lower operating expenses that we typically have in Q4, so that really gives you the trend. Your continuing revenue growing each quarter through the year and then Q2 and Q3 higher operating expenses and then expecting lower operating expenses again in Q4.

Douglas Irwin, Analyst

Okay. Got it. That's really helpful. And then just kind of touch on the contract structure here just given that the first quarter was one of the new fee mechanisms. Could you maybe just help quantify or even just directionally kind of frame up what kind of impacts the rate reset had this quarter relative to last quarter? And then as we think about just the rest of the year, are those rates stable for the rest of the year now? Or do some of those inflation escalators maybe say in throughout the year?

Jonathan Stein, Chief Financial Officer

Sure. So just as a reminder, the way we got to the fixed fee for this year was that we took the average from 2021 through 2023. Those rates are inflated to a 2023 basis and then adjusted to create a 2024 rate. That design was meant to create a smooth transition from our cost of service period. Therefore, as we move into this period, we're comparing the 2023 rate to that average. Did you have a little bit of noise as you do that comparison? But overall, as we described, rates were up across all of our systems on average. Particularly, as we mentioned in gas, you saw that rates were higher there, and you can see that in the results. Now going forward, with the rate now set, 85% of our fees are on a fixed fee basis. Therefore, they will really just be set each year, increasing with inflation based on CPI at the end of the year. That will create a steadily increasing fee structure as we go all the way through 2033, supporting continued growth in EBITDA over that period.

Jacqueline Koletas, Analyst

So you mentioned that costs were lower this quarter after the higher fourth quarter levels, and there is some seasonality there throughout the year. But should we think that this level can hold here? Or how should we think about continued changes in the business going forward?

John Gatling, President and Chief Operating Officer

Yes. Maybe I'll take the first shot at this and then hand it over to Jonathan. As Jonathan mentioned, we talked a little bit about fourth quarter being higher from a favorable weather perspective. We were able to get more done in the fourth quarter. January was a difficult month, and it caused us, as we normally expect in the first quarter, to have seasonally lower spend on the operating expense side. Then, as I mentioned in my script and Jonathan reiterated, we are planning to do some additional maintenance activities in Q2, beyond our normal seasonal increase in maintenance activities in Q2 and Q3. So we do expect to see operating expenses higher in Q2 and also relative to our normal seasonal impact in Q2 and Q3. So I don't know, Jonathan, if there's anything you wanted to add to that.

Jonathan Stein, Chief Financial Officer

Yes. The only thing I would add is we talked about the seasonality in Q2 and Q3, with higher costs and then typically Q1 and Q4 being lower. I think it's important to highlight that, if you look at our operating costs and admin G&A, excluding pass-through costs for this year, for 2024, really their forecast to be flat relative to 2023. I think that really highlights the operating leverage that we have as our ability to keep operating costs stable while our expanding system footprint continues to grow. We continue to target our 75% EBITDA margin target for 2024. Already in the first quarter, we've exceeded that. But certainly, given the seasonality, we continue to expect to meet or exceed that. So we're really in a good spot in terms of that. Obviously, I think the ability to have flat operating expense costs year-over-year highlights again that operating leverage.

Operator, Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.