Earnings Call Transcript - HESM Q2 2020

Operator, Operator

Good day, everyone, and welcome to the Second Quarter 2020 Hess Midstream Conference Call. My name is Andrew, and I will be your operator for today. 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, Andrew. Good afternoon, everyone, and thank you for participating in our second quarter earnings conference call. Our earnings release was issued this morning and appears on our website, www.hessmidstream.com. 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 Factor 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. In compliance with social distancing protocols as a result of COVID-19, we are conducting the call remotely, so please bear with us. In case there are audio issues, we will be posting transcripts of each speaker's prepared remarks on www.hessmidstream.com following their presentation. 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 Second Quarter 2020 Conference Call. Today, I'll review our operating performance and highlights as we continue to execute our strategy, provide additional details regarding our 2020 plans, and discuss Hess Corporation's latest results and outlook for the Bakken. Jonathan will then review our financial results. I'd like to begin with our results for the second quarter 2020. Despite a volatile environment, today we're announcing that we exceeded our second-quarter earnings guidance, lowered expenses, and raised our 2020 operational and financial guidance. Additionally, we're reaffirming our 2021 guidance, including adjusted EBITDA growth of 25% compared to full year 2020 and a targeted annual distribution growth per share of 5%. Our second-quarter results reflect strong Bakken performance led by Hess Corporation, which drove our throughputs above expectations and contributed to Hess Midstream exceeding second quarter adjusted EBITDA guidance. For the second quarter of 2020, gas processing volumes averaged 289 million cubic feet per day, a decrease of 10% compared to the first quarter, and crude terminaling volumes were 144,000 barrels of oil per day, a 12% decrease compared to the first quarter. Both decreases were primarily driven by lower third-party throughputs, which were in line with our expectations and guidance. Water gathering volumes averaged 66,000 barrels of water per day in the second quarter 2020, a 22% increase compared to the first quarter, as we continue to capture incremental trucked water into our expanding gathering system. Third parties contributed approximately 11% of our gas and 8% of our oil volumes in the second quarter, consistent with our guidance and expectations at the midpoint of the range. Now turning to Hess upstream highlights. Earlier today, Hess reported strong second quarter production results capitalizing on the success of the plug-and-perf completion design and mild weather conditions. Second quarter Bakken net production averaged 194,000 barrels of oil equivalent per day, an increase of 39% from the year-ago quarter and above guidance of approximately 185,000 barrels of oil equivalent per day. Additionally, Hess was able to avoid production curtailments in the first half of 2020 by leveraging Hess Midstream's pipeline and rail terminal system which provides significant export capacity and optionality, north and south of the Missouri River to key markets throughout the United States, including deliveries to load Hess chartered very large crude carriers. For the full year 2020, Hess now forecasts Bakken production to average approximately 185,000 barrels of oil equivalent per day, up from previous guidance of 175,000 barrels of oil equivalent per day. Turning to Hess Midstream guidance. As announced earlier this month, the safety of our workforce and the communities where we operate is our top priority. And as such, the planned maintenance turnaround for the Tioga Gas Plant, originally scheduled for the third quarter of 2020, will be deferred until 2021 to ensure safe and timely execution in light of the COVID-19 pandemic. The turnaround preparation activities undertaken to date position us well to complete the work in 2021. We continue to progress the expansion of the Tioga Gas Plant with the project now well advanced and facility construction expected to be completed as previously announced by the end of 2020. Incremental gas processing capacity is expected to be available in 2021 upon completion of the turnaround during which time the expanded plant and residue and natural gas liquids takeaway pipelines will be tied in. As a result of the turnaround deferral, which removes previously planned downtime from our forecast, we have updated our full year gas throughput guidance. We now expect gas processing volumes to average 275 million to 285 million cubic feet per day for the full year 2020, an increase of 12% at the midpoint compared to previous guidance. Our complete financial and operational guidance is available on our earnings release that was distributed this morning. For the balance of 2020, we continue to expect the majority of our systems to operate close to or below MVC levels. The low end of our updated full year volume guidance continues to reflect a conservative assumption that Hess Midstream will effectively receive zero third-party volumes for the remainder of 2020. While we do not anticipate this being the most likely outcome, this downside scenario demonstrates the strength of our contract structure with Hess Corporation, which allows us to continue to deliver our targeted 5% annual distribution per share growth in 2020 with a coverage of approximately 1.2x. For the third quarter, we expect lower throughputs relative to the second quarter as Hess volumes declined due to the reduction in operated rig count and lower third-party volumes as producer curtailments persist. Consistent with the midpoint of our third quarter financial guidance, we expect gas processing volumes to be approximately 10% lower than the second quarter, with both crude and oil terminaling and water gathering volumes expected to be approximately 5% lower compared to the second quarter. Again, with all systems operating close to or below MVC levels, minimizing further throughput downside. Turning to Hess Midstream's capital program. We've updated our full year capital guidance to $260 million, a reduction of $15 million from previous guidance, primarily to reflect the deferral of the turnaround and final tie-in work on the Tioga Gas Plant expansion project. Full year 2020 expansion capital is expected to be $250 million comprising approximately $135 million in gas processing, $20 million in gas compression, and $95 million in gathering and well pad interconnects. Maintenance capital has been reduced to approximately $10 million as a result of the TGP turnaround deferral. In summary, we're well positioned to meet the challenges of 2020 and beyond. We continue to deliver a level of visibility and certainty as a result of our contract structure, which provides MVCs for approximately 97% of projected revenues for the second half of the year. This underpins our updated 2020 adjusted EBITDA guidance range of $690 million to $710 million, which has been narrowed and increased. Additionally, looking forward to 2021, we expect to grow adjusted EBITDA by 25% relative to full year 2020, with approximately 95% MVC protection, demonstrating Hess Midstream's resilience to weather current market conditions and continue to deliver strong operational and financial performance in 2020 and for the long term. Finally, we want to again emphasize our continued commitment to operating safely and reliably during this unprecedented pandemic. The safety of our workforce and the communities where we operate remain our top priority. I'll now turn the call over to Jonathan to review our financial results.

Jonathan Stein, Chief Financial Officer

Thanks, John, and good afternoon, everyone. As John described, we are pleased with the progress we have made in the first half of 2020, continuing to deliver strong results against the backdrop of an uncertain macro environment, and further emphasizing how both our contract structure and financial strength differentiate our business model. Our second quarter results again beat our quarterly guidance. And in combination with lower-than-anticipated costs this year due to the deferral of the TGP turnaround, have allowed us to raise our full year 2020 financial guidance. We are increasing our full year 2020 net income guidance to be in the range of $425 million to $445 million. Adjusted EBITDA is expected to be in the range of $690 million to $710 million, representing approximately 25% growth compared to full year 2019 results. We still expect to maintain approximately 75% EBITDA margin in 2020, consistent with our historical margin. Maintenance capital and cash interest are projected to total approximately $100 million for the full year 2020, and distributable cash flow is expected to be in the range of $590 million to $610 million, resulting in expected distribution coverage of approximately 1.2x. We expect to end the year with leverage at or below our conservative 3x adjusted EBITDA leverage target. Our 2020 adjusted EBITDA guidance includes approximately 97% of our revenues protected by MVCs in the second half of the year, highlighting our stability. The lower end of our 2020 guidance conservatively assumes zero third-party volumes for the balance of 2020, while still providing distribution coverage of approximately 1.2x. Our strong contract structure and financial strength enable us to provide visibility and stability to our forward trajectory through 2022, supported by downside protection and cash flow stability mechanisms in our contract. Even with the deferral of the TGP turnaround, we continue to expect approximately 25% adjusted EBITDA growth in 2021 compared to full year 2020. In both 2021 and 2022, we also expect approximately $750 million of free cash flow, defined as adjusted EBITDA less CapEx. That includes approximately 95% of our revenues protected by MVCs, sufficient for Hess Midstream to be free cash flow-positive after funding interest expense and growing distribution, while maintaining distribution coverage of approximately 1.4x without the need for any incremental debt or equity. Turning to our results. I will compare results from the second quarter to the first quarter. For the second quarter, net income was $108 million compared to $129 million for the first quarter. Adjusted EBITDA for the second quarter was $173 million compared to $195 million for the first quarter. The change in adjusted EBITDA relative to the first quarter was primarily attributable to the following: total revenues decreased by $18 million, driven by lower Hess and third-party production, including a decrease in processing revenues of approximately $10 million, a decrease in gathering revenues of approximately $4 million, and a decrease in terminaling revenues of approximately $4 million; total operating expenses, including G&A and excluding depreciation and amortization and pass-through costs, were higher, decreasing adjusted EBITDA by approximately $4 million, including seasonally higher maintenance and operating costs of approximately $5 million; higher costs associated with the TGP turnaround of approximately $3 million offset by lower general and administrative expenses of approximately $4 million, resulting in second quarter adjusted EBITDA of $173 million, exceeding the top end of our guidance range by approximately $3 million due to higher-than-expected volumes and lower operating costs due to the deferral of certain maintenance activities to the third quarter. Second quarter maintenance capital expenditures were approximately $1 million. And net interest, excluding amortization of deferred finance costs, was $22 million. The result was that distributable cash flow was approximately $150 million for the second quarter, covering our distribution by approximately 1.2x. On July 27, we announced our second quarter distribution that increased 5% on an annualized basis. Expansion capital expenditures in the second quarter were $78 million. At quarter end, that was approximately $1.8 million, representing leverage of approximately 3x adjusted EBITDA on a trailing 12-month basis. Turning to guidance for the balance of the year. In the third quarter of 2020, we expect net income to be approximately $90 million to $100 million and adjusted EBITDA to be approximately $155 million to $165 million. Third quarter maintenance capital expenditures and net interest, excluding amortization of deferred finance costs, are expected to be approximately $25 million, resulting in expected distributable cash flow of approximately $130 million to $140 million, delivering distribution coverage of approximately 1.1x with approximately 97% of projected revenues protected by MVCs. Our third quarter guidance includes updated costs based on the deferral of the TGP turnaround, which reduces expected operating cost by approximately $12 million and maintenance capital by approximately $8 million. We expect to spend approximately $8 million across operating costs and maintenance capital related to the turnaround in the third quarter, including work completed before the deferral, the immobilization of the workforce and preservation of materials. In addition, the third quarter guidance includes higher seasonal maintenance activity that, together with lower expected volumes, as our throughput decreased to MVC levels, decreases expected adjusted EBITDA by $5 million to $10 million relative to the second quarter. In the fourth quarter, with expected revenues at MVC levels and seasonally lower operating costs, we expect distribution coverage to be approximately 1.2x with revenues that continue to be approximately 97% protected by MVCs. Even in periods of great uncertainty, the strength of our business model is clear. With revenues that are approximately 95% protected by MVCs for the next 2.5 years and our annual rate redetermination mechanism that adjusts our rates to changes in volume and capital, we have differentiated visibility to our financial metrics, including approximately 25% adjusted EBITDA growth in 2020 and 2021. Conservative leverage of 3x adjusted EBITDA or less, distribution per share targeted to increase 5% annually, and expected free cash flow of $750 million in 2021 and 2022. This concludes my remarks. We'll be happy to answer any questions. I will now turn the call over to the operator.

Vinay Chitteti, Analyst

This is Vinay on for Jeremy. Just wanted to quickly touch upon your EBITDA guidance for 2020 and '21. With almost approximately $370 million EBITDA already in the books, the 2H guidance seems to be very conservative. I understand you guys have assumed zero third-party volume for the balance of the year, but we have also seen approximately 11% gas in 2Q when there were a lot of curtailments as well. Could you talk about like there seems to be a lot of upside risk for the EBITDA guidance here. Can you just talk about what are the moving pieces why you have assumed zero third-party volume assumption even after seeing a lot of recovery in market production since 2Q?

John Gatling, President and Chief Operating Officer

Yes. Maybe I'll start off with just addressing the third parties, and then I'll hand it over to Jonathan to address the financial aspects of it. So yes, we had a very strong first quarter, and it even continued into our second quarter from a third party's perspective. We averaged about 11% in the second quarter. Looking at our guidance right now, the low end of our guidance has third parties approximately zero. And the midpoint of our guidance has about 5% in there, and the upper end has about 10%. From our perspective, it really depends on what the producers are doing. And we're, again, trying to take a very conservative look at this. And that's kind of what you're seeing with our guidance as it relates to that. But just a reminder, I mean, the third-party producers, they're already hooked up to our system. When they bring that volume on, it will be available to us, and we'll have the system capacity to handle it. So really, we just wanted to kind of leave that open for the producers as they bring additional volumes in. So with that, I'll hand it over to Jonathan to address the financial side of that.

Jonathan Stein, Chief Financial Officer

Sure, thanks, John. Let me start by explaining the factors behind the changes in our guidance, and then I'll discuss how those changes will affect us. We increased the top end of our guidance by $10 million, driven primarily by a strong second quarter, which was $3 million above our previous estimate. We also deferred the TGP turnaround, leading to a $12 million reduction in our operating expenses. With this deferral, we were able to reintroduce some projects into Q3 that we typically undertake during this period, which has contributed to our updated guidance. Additionally, I mentioned a projected revenue decline of $5 million to $10 million from Q2 to Q3, but included additional projects within this projection. On the upside, it's important to note that we're currently at or below the Minimum Volume Commitments, which offer 97% protection for the remainder of the year. If volumes increase, we would first need to exceed the MVC levels before realizing any additional benefits. Moreover, even with cost deferrals pushed into next year, we still anticipate a 25% increase in EBITDA heading into 2021, supporting a free cash flow of $750 million next year. There are several factors at play, indicating potential upside; however, we must first surpass the MVC levels for that to materialize, which sets us up for ongoing growth in 2021.

Vinay Chitteti, Analyst

Thank you for the information. I'd like to discuss the 2021 guidance as well. A few points to note: Firstly, the 2020 EBITDA guidance appears promising, especially at the higher end of the range of $700 million to $710 million. Additionally, there will be an extra operational expense increase in 2021 of about $10 million to $15 million based on the adjustments made from your previous guidance in the third quarter to 2021, indicating significant upside potential. You have also reaffirmed your 25% EBITDA guidance. Could you explain what factors are contributing to the upside in the guidance related to the increased base and the operational expenses?

Jonathan Stein, Chief Financial Officer

Yes, of course. Looking ahead to 2021, we deferred $20 million of operating expenses and maintenance capital expenditures from 2020 for the turnaround. This year, we spent $12 million and expect to continue spending in Q2 and Q3 on this turnaround. While some work will be preserved, some costs will be released during the ramp-up. John also mentioned expansion capital that was deferred due to the tie-in of the TGP expansion, which amounts to about $7 million, coinciding with the turnaround. This results in an estimated $20 million to $35 million of additional costs expected for 2021. As we previously noted, we still anticipate 25% EBITDA growth going forward, and we will provide further details as we approach our 2021 guidance. There will certainly be increases and decreases in various elements, which could influence EBITDA and free cash flow. For instance, our interconnect capital expenditure for 2020 stands at $95 million, and we expect reduced drilling in 2021, so that figure may decline. We will share more details as we get closer, and notably, we have the rate reset at the end of the year, which will factor in any costs above the planned total. Overall, this still supports our 25% EBITDA growth, especially with the increasing MVCs, which will enhance revenue. This also underpins our forecast of $750 million in free cash flow, adequate to support our distributions next year without needing additional debt. Thus, there will be no change to our EBITDA growth or free cash flow projections for next year.

Vinay Chitteti, Analyst

I want to briefly discuss the free cash flow debt. You generated around $750 million in free cash flow in 2021 and 2022. Even after your distributions, you will have significant cash flow. I'm curious about your capital allocation strategy; will you consider increasing buybacks or look into acquiring smaller assets? How do you approach your capital allocation strategy?

John Gatling, President and Chief Operating Officer

Yes. Let me begin by discussing our focus on mergers and acquisitions before handing it over to Jonathan. We have emphasized that our priority is on our acquisitions, particularly in the Bakken region, where we aim to support both Hess and third parties. We are actively seeking opportunities to enhance our presence through bolt-on acquisitions. I believe there is significant potential for continued growth. As previously mentioned, we also have assets in the Gulf of Mexico, where Hess has properties that could provide a potential entry point into a new basin through our partnership. From our view, there are opportunities to invest in M&A, but we can afford to be very selective. We have a growth path available to us even without these acquisitions. There are further opportunities to strengthen our asset base, but it is essential that our approach is focused and strategically sound. Additionally, as we consider other basins, such as the Gulf of Mexico, we are looking to replicate the effective contractual structure we have in place for the Bakken assets. Overall, we have a well-defined strategy regarding our acquisition targets, and we are fortunate that we do not need to pursue acquisitions aggressively as we have organic growth opportunities. With that said, Jonathan, would you like to discuss the financial aspects?

Jonathan Stein, Chief Financial Officer

Yes, thanks. I want to emphasize what John said about our commitment to being disciplined. Our focus will be on using the free cash flow we generate after paying dividends while maintaining our conservative leverage target of 3x. We will assess any financial flexibility we have in a disciplined manner. As John mentioned, the return of capital to shareholders is an option, including buybacks. While our buybacks would primarily involve shares from the sponsors, they would provide valuable opportunities for all our shareholders. We will remain disciplined but will definitely consider these opportunities as they arise.

Spiro Dounis, Analyst

Just a follow-up on that last question there around M&A. And John, you mentioned Gulf of Mexico. I know prior to COVID hitting, it sounded like you guys were getting fairly close to doing something there. It sounds like something you're spending a lot of time on. I think since then, that's been stabled a bit. Just curious, do you have enough visibility now that you feel like you can maybe pick up the pencils there and do a little more work? And to what degree is the election factoring into really any strategic decisions at this point?

John Gatling, President and Chief Operating Officer

Yes, thank you for the question. I believe both aspects are positive. We never really stopped evaluating opportunities. COVID and the economic environment altered our direction a bit, but we still see high-quality assets in the Gulf of Mexico. Hess has done an excellent job developing assets that are crucial for any midstream opportunity in that area. From our standpoint, we see ourselves as natural long-term owners of those assets, and we are actively assessing them. We're excited about the prospects and maintaining focus on this. The political situation is something we need to monitor and understand, but we believe Hess has effectively managed the assets. Regardless of the administration's decisions, we feel confident in the high-quality, well-operated assets in the Gulf. We have a strong presence in the Gulf, as does Hess, and we plan to continue leveraging that operational excellence, similar to how we've succeeded in the midstream sector in North Dakota. From our perspective, this remains a promising option for us, and we will continue to explore it.

Spiro Dounis, Analyst

That's helpful. For my second question, I would like to follow up on a previous point. I understand you are being conservative in your guidance, but could you provide some specifics about your discussions with customers? One of your peers in the Bakken mentioned earlier that some completion crews are returning, there's a significant amount of DUC inventory, and the current crude price environment might be sufficient to bring shut-ins back into production. However, the next question is when the rigs will actually come back to the basin. I'm interested in hearing about your conversations with producers and how that has shaped your perspective.

John Gatling, President and Chief Operating Officer

We continue to maintain strong relationships with all our customers, particularly with Hess, but also with other producers in the basin. If you look at the weekly rig count, it fluctuates around just above double digits. We are closely monitoring that and are noticing some increased activity in completions. Production that was previously curtailed is coming back, and this is happening across the basin. However, the situation varies regionally based on where producers are bringing on production, which impacts how our gathering systems are configured. Currently, the overall situation is unpredictable. Although we are seeing some price improvements and additional activity, we are uncertain about the producers' future decisions. Therefore, we believe that the guidance range and targets we set are sensible. There's potential for us since we have the necessary infrastructure in place, along with capacity, and we're already connected to those customers. As they choose to bring that production back online, we are well positioned to integrate it into our system. It's important to note that in many of our systems, we are either below or at near minimum volume commitments, so the regional nature of our gathering system significantly influences our position relative to these commitments. All of these factors were taken into account as we established our guidance for the remainder of this year and into 2021.

Jonathan Stein, Chief Financial Officer

Yes, the uncertainty surrounding DAPL is something we are closely monitoring, especially in light of the decisions made by the court. Hess, for instance, is still shipping on DAPL. While we weren't specifically preparing for this event, we've been focused on ensuring we have the flexibility, capacity, and options to serve all our customers, whether they are located north or south of the Missouri River, as well as at our pipe terminals and rail terminals. We have maintained our rail terminal operations continuously since we began, which positions us strongly to provide reliable export support both for Hess and other third parties. This allows us to stand out thanks to our high-quality assets that offer great flexibility and the capability to export crude oil throughout the United States. While a shutdown of the DAPL line could lead to some additional costs for Hess, we possess the flexibility to help them reach their markets with minimal extra expenses due to our advantageous infrastructure.

Operator, Operator

Thank you all very much. This concludes today's conference. Thank you for your participation, and you may now disconnect. Have a great day.