Kinetik Holdings Inc. Q1 FY2024 Earnings Call

Good morning and thank you for attending the Kinetik First Quarter 2024 Results Call. My name is Elisa, and I will be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the call to our host, Alex Durkee's, Investor Relations. Alex, please go ahead.

Thank you. Good morning, and welcome to Kinetik's First Quarter 2024 Earnings Conference Call. Our speakers today are Jamie Welch, our President and Chief Executive Officer; and Trevor Howard, our Chief Financial Officer. Other members of our senior management team are also in attendance for this morning's call. The press release we issued yesterday, the slide presentation, and access to the webcast for today's call will provide forward-looking statements and actual results could differ from what is described in these statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. We may also provide certain performance measures that do not conform to US GAAP. We've provided schedules that reconcile these non-GAAP measures as part of our earnings press release. After our prepared remarks, we will open the call to Q&A. With that, I will turn the call over to Jamie.

Thank you, Alex. Good morning, everyone, and thank you for joining our call today. Kinetik had an exceptional start to 2024 with continued momentum throughout April and early May. We reported our first quarter results yesterday afternoon, exceeding our own internal budget and positioning Kinetik for a strong year ahead. First quarter adjusted EBITDA was $234 million, a 25% increase year-over-year, reflecting robust underlying volume growth and contributions from the Permian Highway Pipeline expansion and Delaware Link. We processed gas volumes of 1.53 billion cubic feet per day, representing 13% growth year-over-year and down less than 1% quarter-over-quarter, due to planned maintenance at several processing facilities, Alpine High curtailments as a result of depressed Waha prices and winter weather in January. During the quarter, we completed our planned maintenance projects at our Diamond Cryo East Toya and Pecos Bend processing facilities. We opportunistically scheduled these projects ahead of the ramp in producer turn-in-line activity starting in March and the Lee County contract commencement on April 1. As a result of the massive bed change outs, we have improved our plant recoveries and system efficiencies. I would like to thank the operations team for their hard work and commitment to safety during this time. They did a phenomenal job ensuring safe operations and system reliability for our customers. More recently, we completed our system-wide front-end amine treating project with the installation at our Pecos Bend processing facility in April. We can now offer enhanced blending and treating services across our system and accept gas that previously did not meet our gas quality specifications. As producers explore different benches such as the Avalon and Bone Spring and further expand the boundaries of the Delaware Basin, treating and blending will become critical to manage the elevated levels of H2S and CO2, and Kinetik stands ready to support this next phase of growth out of the basin. As we shared during our February call, we placed our gathering system expansion into Lee County, New Mexico in service on January 18, over 2 months ahead of schedule. The NVC-backed agreement went into effect on April 1, and we are currently receiving volumes well above that threshold. The expansion into Lee County, combined with our enhanced treating and blending capabilities, positions Kinetik to capture incremental market share in New Mexico. Furthermore, with the in-service of the PHP expansion in Delaware Link, we can now offer producers an integrated wellhead to Gulf Coast solution. With volatile and even negative natural gas prices at Waha since early March, it has been top of mind for producers to access premium priced natural gas markets, particularly along the Gulf Coast, which offers more price stability. Waha gas daily prices averaged negative $0.72 per MMBtu in the month of March and April. Many of our customers benefited handsomely during this period by having their gas sold at Gulf Coast markets rather than in-basin at the Waha Hub. As a reminder, Kinetik's equity gas exposure shifted from Waha to the Gulf Coast following the in-service of the PHP expansion on December 1. The depressed in-basin Waha prices had not only generated opportunities with Kinetik's reserve PHP capacity, but have also further strengthened our partnerships with existing and new customers in need of egress out of the basin. We continue to forecast pressured in-basin pricing until additional pipeline capacity is placed in service. However, Kinetik and our customers are very well positioned with egress from the Permian to demand centers along the Gulf Coast. March was payment on March 7, the core shareholders completed their commitment to reinvest their dividends. This commitment was important in that it enabled us to execute upon key financial priorities, such as fully redeeming the Series A preferred in 2022 and fund our elevated 2023 capital program. It further demonstrated strong alignment with all stakeholders. Moving forward, we're excited for all shareholders to now receive cash dividends starting with the first quarter dividend payment today. Subsequently, in March, we facilitated a secondary offering, which fully exited Apache's remaining ownership in Kinetik. When combined with the prior secondary offering in December, we increased our public float to nearly $1.5 billion and quadrupled our average daily trading volume to nearly $30 million. We saw exceptionally high investor demand and participation in the secondary, and I want to thank our investors for their continued support and belief in the Kinetik story. And with that, I would now like to hand the call over to Trevor.

Thanks, Jamie. In the first quarter, we reported adjusted EBITDA of $234 million. For the quarter, we generated an adjusted distributable cash flow of $155 million and free cash flow was $108 million. Looking at our segment results, our Midstream Logistics segment generated an adjusted EBITDA of $143 million in the quarter, up 20% year-over-year, largely driven by increased processed gas volumes and enhanced marketing opportunities captured on our PHP capacity. Shifting to our Pipeline Transportation segment, we generated an adjusted EBITDA of $96 million, up 32% year-over-year and 12% quarter-over-quarter. Sequential growth within the segment was driven by 3 full months of contributions from Delaware Link and the PHP expansion. To date, our commodity exposure pertaining to our equity volumes is approximately 50% hedged on average across commodities, with a higher hedge percentage on propane, butane, and crude. Total capital expenditures for the quarter were $61 million, which was lower than our internal expectations, as we completed the New Mexico gathering expansion and several planned maintenance projects in the quarter. Our leverage ratio for the credit agreement stands at 3.8x. In addition to the series of steps taken in March, generating incremental value for shareholders, which Jamie touched on earlier, we also executed an accounts receivable securitization facility for $150 million in April. We used the proceeds from the AR facility to pay down our existing term loan A to $1 billion, allowing us to extend the maturity of the Term A an additional 6 months to December 2026. Looking ahead, we continue to expect volatile commodity prices in 2024, especially for natural gas. As an industry, we collectively benefit from a more constructive natural gas price environment. However, Kinetik stands well-positioned relative to its peers with capacity on PHP allowing us to provide access to Gulf Coast pricing to our customers and to continue to capture incremental marketing opportunities. Despite current gas prices, oil-directed producer activity remains unchanged on our system, and we have seen the return of activity at Alpine High following curtailed volumes in March in response to negative gas prices at the Waha Hub. We expect to see a step-up in volumes in the second quarter that continues through the remainder of the year, reflecting the completion of planned maintenance projects, the New Mexico MVCs, and customer development activity heavily weighted in the second and third quarters. Before shifting to Q&A, I would like to share the significant progress we have made on our sustainability initiatives. We entered into a first-of-its-kind agreement with Infinium, an industry leader in the production of synthetic eFuels, to dedicate the sale of carbon dioxide captured from one of our processing complexes for use as a feedstock in the production of ultra-low carbon eFuels using their proprietary process at Infinium's project Roadrunner. Notably, there are no capital or operating costs to Kinetik, and this project will create another revenue stream for Kinetik. Our hope is that this partnership can serve as a model for others in the industry and support broader decarbonization efforts. Throughout 2023, we made strong progress in our Scope 1 and Scope 2 greenhouse gas and methane emissions intensity reduction initiatives. When compared to the 2021 baseline, we have reduced greenhouse gas and methane emissions intensity by 12% and 34%, respectively. And we have now surpassed our 2030 methane emissions intensity reduction target of 30%, well ahead of schedule. Despite this early achievement, which required considerable financial and human capital investment, we remain focused on furthering our sustainability efforts as a key pillar of Kinetik's everyday operations. We look forward to providing even more detail this summer in our upcoming 2023 sustainability report. And with that, I would like to open the line for Q&A.

Thank you. We will now begin the question-and-answer session. The first question comes from Michael Blum with Wells Fargo. Your line is now open.

Thanks. Good morning everyone. I guess first question is just really on the full year guidance. In the press release, you noted that you sort of exceeded your internal forecast for Q1. So just wondering, does that imply that you could be coming towards the higher end of that range?

Michael, that's a great question. We're still in the early stages and currently reviewing our numbers from April. Overall, things are looking positive with respect to our guidance range, so we prefer to hold off on making any predictions about where we will ultimately finish. We have three quarters remaining and just one quarter behind us. It feels like the end of the first quarter of a sports game, and there is still a lot ahead. Everything is really looking encouraging, which is fantastic. I must commend the operations team for their incredible work. I may not have mentioned this to you before, but when we spoke with several investors, we highlighted that we had every reason to face challenges in the first quarter. We communicated that we conducted maintenance and most of the bed change-outs, and we did experience some winter weather in January, which is expected during that season. Additionally, we faced negative pricing at Waha, and Apache had to curtail some of the Alpine High volumes. There was a series of factors that could have justified underperformance, but we acknowledged those challenges, persevered, and continued to move forward. That speaks volumes about the resilience of our business and the operational performance of our system.

Okay, great. That makes sense. I wanted to ask about GCX. Are there any updates on potential expansion? Currently, it seems the sales process is on hold. Also, do you have an interest in participating in some of the new Permian gas takeaway projects that are emerging? Thanks.

Regarding the expansion of GCX, we have consistently expressed our confidence that it will happen; it's merely a matter of time. To highlight the urgency, the cash price today for Waha is minus $3. This clearly indicates a need for more egress capacity, and we strongly believe this is essential. We've observed discussions among industry leaders about the necessity for collaboration to address this issue because the current situation is not beneficial for anyone involved. We are fortunate to have PHP capacity, which is highly valued by our customers and helps set our services apart from the competition. Nonetheless, we acknowledge that the industry must unite and advocate for increased egress from the basin, as we believe this is a significant barrier to unlocking the full potential of the Permian Basin.

Thank you.

The next question comes from the line of Spiro Dounis with Citi. Your line is now open.

Thanks, operator. Good morning team. Jamie, maybe if we could go back to the outlook for the rest of the year perspective, a lot of the year still left to go, but wondering if you could just put a finer point on some of the tailwinds you're seeing that were not contemplated in the original guidance. I know Trevor talked about the Alpine High activity coming back. I imagine that was not foreseen. So curious how many of those sort of tailwinds are sort of adding up here?

Thank you for your question, Spiro. Good morning. I'm looking forward to seeing you on Tuesday. Regarding your inquiry, there are several components to consider. When Trevor referenced Alpine High returning, it primarily means we are lifting the curtailment. The real driving force has been our operational performance. The recoveries have been outstanding. If you remember, during our call at the end of February, we noted that we had significant plant maintenance to complete, particularly due to bed change-outs, something we hadn’t done before at Diamond. We had maintenance ongoing at East Toya, Pecos Bend, and several other sites, including compressor maintenance. Now that we’ve completed that, the recoveries have been exceptional. I want to emphasize the importance of operational performance and reliability in growing this business. Our team, particularly led by Matt Wall, has done an excellent job. The recoveries are certainly contributing positively. We have noticed some early signs of improvement, as Trevor mentioned; oil-directed drilling remains unchanged. The only customer system that altered its behavior due to negative gas prices was Alpine High, and that situation is clearly visible. We haven’t faced any disruptions, and if anything, this highlights the solid fundamentals of our business. We are seeing good volume levels coming out of New Mexico, and we are performing very well.

Got it. That's great to hear. Second one, maybe just turning to market share. You talked about maybe 2 areas where you could see a little bit more gains there. One, was on the treating side, it sounds you're able to accept a broader range of gas quality now. So first, curious if you're seeing the volume impact from that just yet and how to think about the upside there? And then you also mentioned more customers or new customers on the egress side. I guess how much more room is there for you to gain on that side?

I think I’ll address your questions in reverse order. On the egress side, we encounter inquiries from both existing and new customers every day about new gas packages. We are always receptive when they express a desire for Gulf Coast pricing. When calculating the weighted average sales price for residue gas, we offer customers options, including Waha or a combination of Waha and Gulf Coast pricing. More customers are consistently expressing their preference for Gulf Coast pricing. Building strong relationships with our clients involves fostering a partnership mentality, which is beneficial for future development and opportunities. We do have capacity to manage not only due to our majority ownership of PHP and its performance but also because of the space we have secured through contracts. This topic is under constant discussion with many of these clients. Trevor, would you like to address the first question regarding trading?

Yes. Thanks for the question, Spiro. I'd say, we are seeing some benefits on the volume side, but really where we see it is margin expansion, which is fantastic, right? Because that's 100% incremental to the bottom line without taking up what is really a precious asset in the basin right now, which is any remaining spare processing capacity. So we're seeing the benefits right now that with system-wide front and amine treating fully complete. We have an immediate step up in margin. And then the commercial team is working right now to continue to sell out the remaining space, both for suite and sour gas treating and processing.

We are observing, as we noted in the February call, that some customers are experiencing significantly high levels of CO2, and we are fully accommodating that. We have a tiered structure in place for our treating fees. In addition to CO2, we also manage H2S and are starting to see some nitrogen as well. What's notable about our business is that, due to the size of our systems and the sources of our gas, we have a considerable amount of sweet gas that has virtually no impurities, alongside gas that contains higher levels of impurities. The blend of these two types results in pipeline-quality gas that meets all tariff requirements, which is highly advantageous for both our customers and producers. As Trevor mentioned, we are compensated for this, making it a win-win situation overall.

Got it. That's great. I will leave it there and look forward to seeing you all next week.

We'll see you Tuesday.

Thank you. The next question comes from the line of Tristan Richardson with Scotiabank. Your line is now open.

Hi good morning guys. Jamie, maybe could you talk a little bit about the NGL side of downstream. I mean, we're closing in on a couple of third-party pipe expansions. Can you talk about how you see your NGL solutions trending once we see these expansions online? And then particularly in the context of thinking about Kinetik barrels that may come up for recontracting.

Thank you for the question, Tristan. We have been clear about our commitments on the NGL side. We have three different agreements: one with Lone Star regarding legacy plants, one we inherited with Cap Rock, and another related to Eagle Core Midstream Ventures, which includes East Toya and one of the Pecos Bend facilities. Additionally, we have an enterprise commitment mainly because Enterprise was the sole connection to Diamond Cryo. Apache was a foundational shipper on the Shin Oak pipeline, so we have contracts with Lone Star that will expire in 2026. There are two of those contracts, and they will roll off. We also have a dedication with Targa on Grand Prix that will extend to the early 2030s. Regarding Diamond Cryo, we recognized that the best processing capacity was there, and our goal is to maximize its utilization. We expanded its capacity from 600 to 720, and the only other tenant is Apache. We have a beneficial and flexible relationship with EPD on Shin Oak, which provides us with economic advantages. We're invested in a third of Shin Oak, and we believe everything is positioned well for a positive outcome. We will determine our future barrels and expansions based on flexibility with Cap Rock, especially when that contract ends. This is a focus area for Anne Psencik and the team as we look ahead. While the current basin situation has been tight, there's pressure on pricing, which favors customers more than infrastructure owners. We will see how this develops over time. Other players will have similar contract expirations around mid-2025 and 2026, with about 1.5 million barrels a day of incremental expansions anticipated. So, it's an important segment to observe as these NGL 1.0 contracts are set to expire in the 2025 to 2027 timeframe. We'll see how everything unfolds.

Appreciate it, as always, Jamie. And then maybe more near term, just thinking you talked about lead counting project volumes coming in, in April and May above men's, maintenance done in time to see March turn-in-lines increasing. I mean, is there a particular cadence we should think about for turn-in-lines for the rest of the year as you talk about the low double-digit expectations for '24?

Trevor, what do you think?

Yes, thanks for the question, Tristan. It's quite consistent with what we have seen over the past few years, especially following winter storms, where a significant portion of our TIL development occurs. Most of our TILs really take place late in the first quarter and into the second quarter, and by September, we generally see the majority of our TILs for the year. Therefore, we should expect a similar volume ramp as last year, where producers are currently bringing wells online. We anticipate the return of Alpine High curtailments in the second quarter once the maintenance issues on the egress pipes are resolved and in-basin pricing recovers. By mid-summer, we should see increased volumes, which are expected to continue rising throughout the remainder of the year until our producers complete their TIL programs for fiscal year 2024.

Appreciate it. Thanks, gentlemen.

Thanks, Tristan.

Thank you. The next question comes from the line of Keith Stanley with Wolfe Research. Your line is now open.

Hi, good morning. First, I just wanted to follow up on the Alpine High curtailment. So you're expecting them to come back once the maintenance ends, I guess, later this month? And how good do you feel about them doing that and keeping volumes on? And then just how meaningful is Alpine High to overall Kinetik G&P volumes at this point?

Good morning, Keith. We have observed a return of volumes, but we must be cautious about shutting in production for extended periods, as it can risk reservoir damage. It's important to avoid actions that might lead to long-term consequences. We are seeing those volumes resuming, and they could increase significantly due to our auto choke system in place. Regarding the overall impact, based on pro forma Callon data, approximately 28% of our volumes are associated with Apache, including DXL, Callon, and Alpine High, with only Alpine High being affected by gas prices. Despite this, our business has performed exceptionally well in terms of profit, and this positive trend has continued into April and into the first week of May. As we look ahead, it seems promising, and we anticipate that once maintenance is completed in the next two weeks, everything should be up and running, and we are simply waiting for the additional timelines to come into play.

Keith, I'd also like to highlight that we have a small amount of equity space on PHP. This actually serves as a beneficial natural hedge; when we encounter in-basin gas prices that necessitate curtailments, it turns out to be a net positive for the company due to the available space. It has provided a good hedge in March and April as we manage through this maintenance period and the shoulder season in the basin.

That's helpful. Thanks. Second question, just how are you thinking at this point about growth opportunities into next year? It seems like you have some more opportunities. You have a new plant potentially of maybe a Phase II in New Mexico, GCX expansion. Should we think of investments and growth for the company is accelerating into next year as you look at the opportunity set or just any thoughts around that?

I believe that, regarding growth opportunities, we are always exploring potential avenues for expansion. We've had significant success with organic growth and will continue to pursue those opportunities. We believe they add considerable value to Kinetik. As we look towards 2025 and the opportunities available, you’ve highlighted some that we have previously discussed, and we will monitor what we can secure and how that impacts the overall trajectory of EBITDA. We are also very conscious of maintaining capital discipline.

Thank you.

Thank you. The next question comes from the line of John Mackay with Goldman Sachs. Your line is now open.

Hey good morning. Thanks for the time. Figured it might ask on the Infinium agreement. I think the projects used to come online in 2026. Just interested if you guys could kind of frame up what the size of the opportunity could be for you guys if there's more of this that you can do kind of what to watch next.

John, good morning. Thank you. We have Tyler Milam, who leads our new Energy Ventures business and has played a key role in the Infinium deal. Tyler, would you like to provide more details?

Sure, thanks, Jamie. Hi John, I want to highlight that we have contracted one of our cryogenic complexes with Project Road Runner through Infinium. To clarify, while we are still evaluating our other three complexes, I believe there is significant potential ahead. We continuously explore ways to lower our greenhouse gas emissions, which is one of our corporate objectives, while also creating a revenue stream without requiring additional capital from our organization.

Yes, John, it's interesting that the whole concept behind Infinium was predicated on the conversion of what was a traditional sweet system, which was the old BCP Eagle Claw Cap Rock to a system that could take sour gas. We are seeing greater levels of sour gas. We, therefore, see much more CO2 tonnage created, and Tyler working with Infinium said, with all the CO2 tonnage, this is a stream that we can give you by pipe, and they can then obviously, using their process, they can convert it into eFuels. No capital, no OpEx for us. It's fully paid for. We got a really nice return. So we're getting paid on the treating side by our customers. And with the byproduct that we're creating, which is incremental direct CO2, we are getting paid for the CO2 stream.

That's great. That makes sense. And you kind of touched on my next question. You touched on it a little bit earlier on the call, too. But maybe you can kind of just frame up the size of this sour gas opportunity overall. I mean, it feels pretty large. It feels like there's some producers pushing in there, and maybe some of your midstream peers aren't necessarily keeping up. So just wondering if you could kind of frame up that broader opportunity on both gathering, processing, treating side, et cetera.

We'll let Mr. Kendrick take the floor.

Hi John, this is Chris. Look, it's a great question. And as we've alluded to earlier, as we continue to go north in the basin and as our customers drill shallower formations, we see a higher amount of CO2 and some higher amount of nitrogen. So one of our goals has been, once our trading is installed, is to add additional fees and treat that gas. One other point I'd like to make, too, is we have some incremental treating capacities down at Diamond. So, Matt and the operations team is looking at ways to optimize our system to be able to add more CO2 to the system, so we can extract fees there. So I think the opportunity is great. I think the oil cuts are great from these benches. So the customers want a solution to be able to treat not only the CO2 but handle the nitrogen. So we try to get in front of that and are currently talking to a number of producers about a solution there.

And it's also true, I think, Chris, that on the shallower formations to Avalon and Bone Spring, we see less water produced water. So I do think there is an element on this, which is the produced water and the gathering and disposal of that is an element, significant costs from the producer side. Not having to deal with as much water is obviously a huge net benefit for them. So I do think that goes into the overall equation of the decision-making process for our producers and where they're focusing. And so therefore, our ability to take wider ranges of CO2, high levels of H2S, and even nitrogen and blend it and treat it is a massive competitive advantage for us in the context of what our customers are now focusing on.

Super. Thanks for that.

Thank you. The next question comes from the line of Neel Mitra with Bank of America. Your line is now open.

Hi. Thanks for taking my question. Jamie, just wanted to kind of touch on the cadence of rich gas growth going through April and May. It seems like that's been strong, but I was wondering with the gas takeaway situation right now, if there's been any producer issues with getting the gas out of the basin. I know there's been a lot of ethane recovery and maybe moving to markets that are less than desirable. But just trying to understand the flow assurance there.

Yes. Thank you, Neel. Good morning. As we mentioned in our prepared remarks and in response to another question, the pace of oil-directed drilling remains unchanged. In fact, we've seen it continue to increase, which is typical. The second quarter through the third quarter is essentially peak season for turn-in-line activity, as it occurs when we are beyond the challenging climate and weather periods of the year. What’s particularly interesting for us is the high demand from customers who know we have space on PHP. They are reaching out, expressing their need for assistance with their gas. We are very focused on our customers and are committed to helping them. We see ourselves as partners with our customers, assisting them in achieving their goals. Chris, do you have anything to add?

Jamie, I think that's right. I think Jamie alluded to this earlier, Neel, that having the PHP space is one big differentiator for us, and it has allowed us to provide egress takeaway, not see the curtailments unlike maybe some of our peers that don't have access to the Gulf Coast. So it's been a great tool to have, and we're going to continue to use it to help grow our business.

Got it. And then second question. Now the Apache exited the position, and we have a bigger public float you're still a capital constraint in the sense that you want to get to investment grade, and it looks like you're on the path there, and you expanded into other puts it the Permian and the New Mexico area. How are you looking at M&A now in terms of maybe like a bolt-on gathering system, given that you've been able to integrate your upstream and your downstream position like with PHP and other downstream solutions for those customers? And how would that work in terms of maintaining your leverage ratios and also increasing the public float. Is that something that you are considering or have on as an option?

Neel, I believe we have consistently mentioned that we explore various opportunities, both organic and inorganic. We set a high standard for all prospects, evaluating them based on short-cycle value accretion, overall value contribution to the complex, leverage, and ratings impact. We take all these factors into account. When we identify an opportunity that meets our criteria, we will pursue it. However, we have been pleased with our organic growth strategy. With the completion of last year's capital program, our focus is now on execution, as demonstrated in the first quarter, and that is how we have projected our performance for the rest of the year.

Perfect. Thank you.

Thank you. This will conclude the question-and-answer session for today's call. I would now like to hand the call back over to the team for any final remarks.

Thank you very much, everybody, for your time this morning. We look forward to seeing you. I know it's a busy time of year, lots of conferences and stuff, so we look forward to seeing you in the next 30 days. Thank you. Bye-bye.

This concludes today's conference call. Thank you for your participation. You may now disconnect your lines.