HighPeak Energy, Inc. Q3 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the HighPeak Energy 2023 Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. And I would now like to hand the conference over to your first speaker today, Steven Tholen, CFO.

Good morning, everyone, and welcome to the HighPeak Energy’s third quarter 2023 earnings call. Representing HighPeak today, our Chairman and CEO, Jack Hightower; President, Michael Hollis; Vice President of Business Development, Ryan Hightower; and I’m Steven Tholen, the Chief Financial Officer. During today’s call, we will make reference to our November investor presentation and our third quarter earnings release, which can be found on HighPeak’s website. Today’s call, participants may make certain forward-looking statements relating to the company’s financial condition, results of operations, expectations, plans, goals, assumptions, and future performance. So please refer to the cautionary information regarding forward-looking statements and related risks in the company’s SEC filings, including the fact that actual results may differ materially from our expectations due to a variety of reasons, many of which are beyond our control. We will also refer to certain non-GAAP financial measures on today’s call, so please see the reconciliations in the earnings release and in our November investor presentation. I will now turn the call over to our Chairman and CEO, Jack Hightower.

Thank you, Steve, and good morning, ladies and gentlemen, and I want to thank you for joining our third quarter earnings call today. My prepared remarks will begin on Slide 4 of our presentation. Historically, I always start off saying it’s an exciting time to talk about HighPeak. And there is no question that this is an exciting – but beyond that exciting time, this is a transformational quarter for HighPeak Energy. It’s perhaps our best quarter in the history of the company to date. Our production averaged over 52,000 Boe a day for the quarter. Our third quarter EBITDAX translates to over $1 billion on an annual run rate. We transitioned from a historical capital outspend to generating a material amount of positive free cash flow, and we secured necessary capital and liquidity needed to accomplish our long-term strategic plan. We definitely are substantially a different company today than where we were just a few short months ago and we’ll further discuss these points in greater detail as we go through the presentation. So if you’ll turn to Slide 5 in the presentation, this will start the amazing, exciting time at HighPeak. Looking at this slide, we achieved three major company milestones during the third quarter that not only position us to achieve our primary goals, but also these are transforming us into a completely different looking company. All three of these milestones were in accordance with our internal projections and our expectations. First and foremost, we averaged over 50,000 barrels a day, which not only highlights the high quality of our asset base but also establishes a new level of scale for HighPeak, considering the increase in production from an average of 42,000 barrels a day, representing a 25% increase compared to our second quarter average and over 100% increase compared to our third quarter 2022 average. That is phenomenal growth when we only had two rigs running. Prior to that, we had six rigs running, but last quarter we saw a reduction to two. Secondly, in conjunction with our increase in production, our third quarter EBITDAX increased 44% compared to our second quarter and equates to over $1 billion on an annual run rate again setting a new record scale for the company. Third, we reached a milestone of generating significant free cash flow during the third quarter of over $75 million. This is a major achievement for the company and illustrates the quality of our asset base and our strong financial health. At current prices and our third rig cadence, we expect to generate positive free cash flow this quarter and throughout 2024. I can’t emphasize enough that we’re going to continue our strategy of responsible growth while maintaining capital discipline. In accordance with our updated development program, we averaged 2 rigs and 1 frac crew during the quarter. We recently introduced both a third rig and a second frac crew into the field after the quarter. We plan to maintain the 3-rig program throughout the remainder of the year and the second frac crew is currently completing a handful of DUCs that we generated during the third quarter. This third frac crew will be used intermittently while we run through rigs. As previously stated, moving forward, we intend to finance our development program through cash flow from operations, generate additional free cash flow, reduce our outstanding debt, and increase our return to shareholders. At the end of the quarter, we still had a considerable number of wells in progress, which will continue to support our production profile as these wells are turned online. We ended the quarter with a little under a one turn of leverage, which is a significant improvement over the past three months. If commodity prices remain stable, we expect to exit this year at well below one times net debt to EBITDA, and continue that progress into 2024. Pro forma with the closing of our super priority revolving credit facility, our liquidity is greater than $220 million. Our recent debt refinancing should provide all the capital we need to accomplish our objectives. Now turning to Slide 6, this is a very enticing slide. As evidenced by the charts, we have demonstrated a track record of delivering consistent organic production and cash flow growth through the drill bit. Very few companies have grown the way we’ve grown through the drill bit. Over the past year, our quarterly production average has grown over 100%, which has also translated into significant cash flow growth during the same timeframe despite declining oil prices. We continue to exemplify our high-quality asset base through our consistent growth in production, our high oil and liquids content, and our sustained peer-leading margins, all of which are reflected on this slide. It’s also a true testament to the high quality of our reservoirs that our current production level continues to be supported by a small number of producing wells. It’s worth noting that we’ve been able to achieve this level of growth while maintaining a very reasonable amount of leverage, which is now back below one turn. The result of the above attributes is our transition to free cash flow generation, which we expect to maintain going forward without sacrificing our measured production growth expectations. Now I’m going to turn the call over to Mike Hollis to discuss the next few slides on our operational efficiencies. Mike?

Thanks, Jack. Now turning to Slide 7, as Jack mentioned earlier on the call, we have continued to sustain our peer-leading EBITDAX margin. You may notice that this slide looks a little different this quarter for a couple of reasons. HighPeak is now an accelerated filer. Therefore, several in our peer group are releasing their data at the same time or later than we are. Not to mention there has been some major consolidation since last quarter. As a result, we’ve added a few large peers to the group. The new chart on the left shows second quarter results as well as the third quarter results, which are the blue boxes for HighPeak and for the peers that have already announced. Please note that HighPeak has continued to maintain its high oil cut and its peer-leading margins. This oil cut gives HighPeak a higher leverage to oil price. Thus, with that higher leverage and our focus on reducing our operating costs, HighPeak’s margin spread has expanded even further this quarter above our peer group average. From this chart, you’ll see that HighPeak's margin growth quarter-over-quarter is much higher than any of the peers shown, indicated by the larger move from second quarter to third quarter. As you know, Q3 average oil prices increased by approximately $8.50 per barrel compared to the second quarter. With that said, during the same period, HighPeak’s margin per BOE increased by almost $10 per BOE, much more than any of our peers. We expect our margins to continue to expand with our forecasted production growth and as we realize additional benefits of our LOE cost cutting initiatives. I want to emphasize again that not all BOEs are created equal. HighPeak’s margin was approximately 60% higher than our peer average during the second quarter. Although we do not have all the third quarter margin numbers available for our peers yet, it would be safe to say that HighPeak’s margin will expand further relative to the pack in Q3, driven mainly by our high oil cut. However, if we apply the second quarter factor of 60% to our third quarter production level of 52,700 BOEs a day, it would equate to the economic equivalent production level of our peer group at approximately 85,000 BOE a day. Said another way, our average peer would have had to produce 85,000 BOEs a day with their product mix to achieve the same EBITDAX that HighPeak generated. Now turning to Slide 8, HighPeak is currently running 3 drilling rigs, focusing on the Wolfcamp A and Lower Spraberry development. We will turn online approximately 41 wells in the second half of 2023, reinforcing confidence that we will hit our guided exit production volume. The addition of the third rig will add meaningful volumes in the second half of 2024. We continue to be encouraged by our strong well results to the north and east in our Flat Top area; that is the northern block of our acreage. With the strong Wolfcamp A and Lower Spraberry results from the Conrad pad in Eastern Borden County, it’s the light blue wells and the strong Wolfcamp A results from our neighbor south and east in Mitchell County; that’s the Oasis and Luxor pad you can see the gray well touching the southern edge of our Scurry County acreage. In response to these strong well results, HighPeak has spud our first Wolfcamp A well in Scurry County, and details will be forthcoming late Q1, early Q2. We are also encouraged by some Middle Spraberry results directly west of our Flat Top block. We plan to monitor these wells to determine if they will compete for capital in the future. But it’s easy to see HighPeak’s large inventory runway in the Wolfcamp A and Lower Spraberry. When you add in the other zones, we will be able to generate significant free cash flow for decades. We are beginning to see rig rates and frac costs beginning to roll over. It’s too early to say what costs will do in 2024, but with our electrical infrastructure, recycled produced fluid, dual fuel implementation, and our use of locally sourced wet sand, these will all help insulate HighPeak from any potential cost inflation in the future. Looking into 2024, HighPeak’s electrical build-out and solar farm will provide reduced lifting costs and significant protection from high spot pricing during peak summer months. It stands to reason that the solar panels will gather significant sunlight during peak demand hours. This summer, we saw unhedged power spike roughly five times the normal cost levels. This fixed, low-cost solar power will reduce our lifting costs and further increase our margins next year. We continue the efficient build-out of our oil and gas midstream pipelines, ensuring HighPeak receives the highest realized prices for our products. Our dedication to financial discipline and prudent management is reflected in the generation of over $75 million of free cash flow last quarter, which demonstrates our strong financial health and stability. We maintain a keen focus on capital discipline, reducing our debt, and ensuring continued return of capital to our stakeholders. I want to extend my heartfelt gratitude to our remarkable team of employees who have been the driving force behind our success. With my comments now complete, I’ll turn the call back over to Jack.

Thanks, Mike. If you’ll turn to Slide 9, this represents one of the major accomplishments in the third quarter. Our successful debt restructuring is truly a transformative event. In fact, to our knowledge, this transaction is the largest privately arranged financing for a public energy company. This financing included a very diverse and sophisticated group of energy lenders, all of whom conducted extensive due diligence and analysis. Many individuals and almost every external engineering firm in the United States studied our assets, demonstrating a high level of confidence in our team and in our unique asset base, along with the upside opportunity we have as a company. We’re extremely pleased with the investor group and the structure of the new term loan facility. This unique structure provides the company with numerous benefits, including streamlining our capital structure and extending all debt maturities to September of 2026, securing our financial position by providing certainty amid an ever-changing banking market, and removing the risk associated with standard borrowing based redeterminations linked to reserve-based loans and commercial bank availability. It also provides the company with flexibility to pay down debt with a 1.5 year no-call and the ability to pay down debt without penalty utilizing free cash flow, which will allow for rapid de-leveraging. We also recently closed our $100 million super priority revolving credit facility, which provides additional liquidity and flexibility for working capital. Due to this transformative debt refinancing, we are stronger, more resilient, and better equipped to seize opportunities in this dynamic energy market. Now turning to Slide 10, now that our debt refinancing is behind us, our capital structure is in great shape. Our current EBITDAX run rate exceeds $1 billion. Our net debt level is already below one turn, as we discussed earlier. It will continue to decrease as we generate additional free cash flow and pay down debt. I want to clarify that our goal is to continue to pay down debt while adhering strictly to capital discipline and not overextending ourselves, ensuring we operate within our free cash flow. With the pro forma of our new revolving credit facility, we have over $220 million of liquidity. This provides all the capital we currently need to accomplish our long-term strategic plan. As depicted on this slide, our financial statistics have improved significantly over the past three months, and assuming commodity prices remain stable, we anticipate continued improvement in the coming quarters. Furthermore, I’d like to emphasize that based on our third quarter EBITDAX run rate, our stock price is currently trading at approximately 3 times multiple, which, in my opinion, is relatively cheap compared to our SMid-cap peer universe given our asset quality, drilling inventory, return on investment metrics, financial strength, and growth profile. As reflected in recent transactions in E&P, differentiating between the multiples and the value of disparate asset groups is often challenging. Yet there’s no doubt that many of these new transactions have traded at much higher multiples, as would be expected with good assets. Given these factors, it should be no surprise that I believe our current share price does not reflect the true underlying value of the company’s assets. So now if you’ll turn to Slide 11, I’ll summarize the current status of HighPeak. We continue to check all the necessary investment criteria boxes. Our prime oil-weighted Permian Basin asset base has now achieved significant scale, illustrated by our current production of over 50,000 barrels a day and an EBITDA run rate of over $1 billion. We’ve streamlined our capital structure and pushed back all of our debt maturities until 2026. Our financial metrics have improved significantly over the past quarter, and we have clear visibility to further near-term enhancements. We’ve de-risked our contiguous acreage position in our core development zones and possess a long runway of Tier 1 inventory to develop, along with exciting additional opportunities. We’ve transitioned from a historic capital outspend while rapidly growing our business into a company that generates substantial free cash flow that will continue into the future. Regarding our objectives for 2024, they are clear and defined. We will remain focused on responsible growth while upholding capital discipline. Again, from this point forward, we expect to fund our development program with our operational cash flow. We will also be mindful of building on our well performance successes while reducing costs on both CapEx and OpEx. We anticipate the consistent generation of free cash flow will provide us with greater options, including continued debt reduction, which is a vital aspect of our new term loan facility. Additionally, we foresee an increase in capital returns to our shareholders. This return of capital can be achieved through various means. First, as previously discussed, a possible outright sale of the company is on the table. It’s no secret that we are in the midst of a highly active M&A market cycle. I believe this theme will persist in 2024, particularly for companies like HighPeak, which possess such high-quality assets and ample remaining resources. We may also consider increasing our current dividend in next year's budget and might explore implementing a share buyback program, especially if significant dislocations in our share price relative to the true value of our asset base persist. In addition to debt reduction and returning capital to shareholders, we expect to continue, as we have historically, our performance of growing reserves and production. No other company has achieved the growth we've experienced over the past three years. If commodity prices justify it, we remain positioned to further increase our drilling program, enabling us to pull additional value forward for our investors. Importantly, understand that this is contingent upon commodity prices allowing us to justify increasing our drilling program. We will maintain positive free cash flow and uphold financial discipline. These are the significant reasons I remain confident in our ability to create added value for our shareholders. I’m very excited about the opportunities that lie ahead for HighPeak. So with my comments complete now, we’ll open up the call for questions from our analysts.

Thank you. Our first question is from John White with ROTH MKM Capital. Your line is open.

Thank you, operator. Good morning, everybody. I want to make any comments about well downtime due to wells that are offsetting frac operations in the fourth quarter?

Yes. Mike, why don’t you answer that question?

Absolutely. Yes, John, nothing different than normal blocking and tackling. Obviously, the wells closest to whatever you are stimulating tend to be shut in to protect them and ensure we get a good frac on the wells that we are currently stimulating. But there is no change from our usual protocols. Obviously, when you move from one frac crew to another, the second frac crew we have is just to handle a few of the DUCs that we generated over the last several months. Therefore, we don’t foresee a very material change; certainly, all offset wells will be impacted temporarily, but nothing significant.

Yes, I’m sure you’ve learned to live with it, and I think a lot of the financial community has too. Companies are reporting that the tight oilfield service market has loosened to a certain extent or are you seeing that as well?

Absolutely. So obviously, oilfield tubulars began to roll over about a quarter ago. They’ve more or less flattened out, so we’re benefiting by working through some of the inventory we had. What you're seeing for all the tubular goods and casing that we deploy today reflects the newer, lower pricing that is present in the current market. Again, we don’t have many long-term contracts on drilling rigs or frac crews, virtually none, so we engage in spot pricing. Coming out of COVID, we were penalized when prices rose. However, now, as prices are rolling over, we're witnessing rig rates drop again, not significantly, just a couple thousand dollars a day. On the pumping side, the dollar per pumping hour is also beginning to roll back, showing declines in the mid-single digits to under 10%, which we expect for 2024. However, this will all depend on market activity. Additionally, we are cushioned from some of those costs due to planning we’ve executed in the past, such as the proximity of a local wet sand mine next to our two acreage blocks, which helps reduce transportation costs. Overall, we slightly depend on diesel prices for transportation, but diesel prices have remained relatively stable over the last couple of quarters. Therefore, as we project into 2024, forecasting is difficult, but pricing seems likely to remain relatively flat. With our lowered activity levels, we’ve been able to optimize rig fleets and frac crews and achieve higher utilization of local materials, recycling water, and importantly, using electricity rather than diesel for our rig operations. This will result in a comparatively higher weighted change in our CapEx than what you may observe within our peer group due to the initiatives we have implemented over the past couple of years.

Thanks for that comprehensive detail and excellent result. And I’ll turn it back to the operator.

Thank you, John.

Thank you for your question. Our next question comes from Jeff Robertson from Water Tower Research. Your line is open.

Thank you. Good morning. Mike, to follow-up on the cost, can you give an estimate for the net cost currently to run one frac crew and one rig for one year?

You bet. Jeff, HighPeak’s business model is somewhat unique compared to some of our peers in the western and central part of the basin. This is because a rig at HighPeak generates more completed lateral footage per year than many of our peers. Hence, while our dollar per foot completed (DC&E) cost runs $150 to $200 per foot lower than that of our peers, we can afford to spend more per rig because it drills more footage that we can complete. In light of this, basically, a rig and a frac crew averages about $200 million annually.

Thanks. Operating costs decreased in the quarter, and you've outlined some areas you've been working on over the last couple of years to continue driving cost savings on both capital and operational expenses. Can you discuss your current standing there and any directional insights for 2024?

Certainly. You can see LOE is coming down quarter-over-quarter. We've initiated several initiatives that have proved helpful, such as increasing production over time, which assists with some of the fixed cost solutions, optimizing artificial lift systems, and improving some of our chemical and treatment programs. Additionally, we are implementing more upgrades in our produced water infrastructure. Of great significance is the ongoing energization of our solar farm, which has been somewhat delayed by governmental issues and the Inflation Reduction Act, but it's projected to commence operations soon. We're planning a ribbon-cutting event this Friday. Once the solar farm is online, it will reduce our energy costs and mitigate the floating prices we pay for electricity, as we can't hedge all of it, only in blocks. This should lead to lower operational expenses overall, especially during periods of peak demand in the summer. We anticipate a lower dollar per BOE for HighPeak, estimating it to be in the $7.50 range while aiming to outperform that. However, it's essential to recognize a distinction here: our high oil mix impacts marginal costs. Consequently, if we had a similar economic mix to some peers, our LOE could be around $5, making us one of the most competitive in our peer group. We still have progress to make, but improvements will drive costs downward into next year.

Thanks. Jack, you talked about capital return to shareholders. And I know the term loan has a $30 million per quarter amortization feature that begins at the end of the first quarter of next year. Can you address how you think about achieving the best outcome for shareholders when weighing the options of debt repayment against dividends and potentially share repurchases?

Yes. Jeff, it’s challenging to differentiate between the three. We see it more as a collective strategy, and we believe we can address all three facets simultaneously. Certainly, we will be reducing debt through the amortization process, and we also have a cash sweep opportunity. Thus, when we have cash and it accumulates on our balance sheet, we can put it to good use, either by supporting our share price via a repurchase or increasing capital returns to shareholders through dividends. Moving forward, we will balance these considerations, recognizing that our debt will steadily decline. By mid-2024, we will be in a strong financial position, allowing us the flexibility to execute these strategies, especially when our stock is not reflecting its fair value in the market conditions.

Thank you very much. One moment please. Our next call comes from Nicholas Pope with Seaport Research. Your line is open.

Good morning, everyone.

Good morning.

Good morning, Nick.

There’s been a lot of moving parts in the last few months. I want to clarify your guidance on production. Just to ensure that I’m clear on your expectations for the exit rate or fourth quarter and current expectations for production here in the near term?

Yes. Nick, we’re not changing our guidance. As Mike mentioned, with the wells due for completion in the fourth quarter and the current momentum for increasing production, we fully expect to reach our exit rate of 57,000 barrels a day, as previously provided in our guidance. Those figures could change positively, but I don't foresee them changing negatively due to fluctuating production schedules and wells being fracked. Ultimately, we will achieve the 57,000 barrel a day exit, and production will likely continue to escalate into the first quarter. Additionally, once we reach a debt-to-EBITDA ratio of less than 0.75 turns, we could potentially add another rig while maintaining strict adherence to capital discipline.

That's great. I appreciate that. Furthermore, regarding the progression of working capital over the past few quarters, it became quite negative leading into the refinancing process. However, it seems this quarter brought it back into balance. Is this the run rate you expect for working capital in the near term, especially with your significant CapEx relative to the accrued numbers? I’m trying to understand what those movements will look like moving forward and what your plans are?

Reflecting back, we had six rigs running and experienced a considerable decline in oil prices, which impacted our position substantially. Now, we have clarity about oil prices, and a considerable amount of our production is hedged. We estimate that it costs us roughly $200 million per rig. So with capital expenditures expected between $600 million to $700 million and our current production at 52,000 barrels a day, generating over $1 billion in run rate EBITDAX, we certainly possess sufficient free cash flow to fulfill all objectives for 2024. Unless we see an abrupt decrease in oil prices, and as noted in the past, we can reduce rig numbers within 30 days if necessary. We will remain committed to capital discipline and control our working capital appropriately, ensuring we never return to past unfavorable positions, especially since we've achieved a plateau of growth not seen last year when we were at 27,000 barrels a day. We've grown to our current level of 52,000 barrels a day, and this quarter has certainly been transformative for the company.

That's great. Thank you for your time, everyone.

Thank you, Nick.

Thank you. I am showing no further questions at this time. This does conclude our question-and-answer session. Thank you for your participation in today’s conference. This concludes the program, and you may now disconnect. Have a good day.