Earnings Call Transcript - KNTK Q1 2023

Operator, Operator

Hello, everyone, and welcome to the Kinetik First Quarter 2023 Earnings Call. My name is Chach, and I'll be the coordinator for this conference. After the presentation, there will be a Q&A session. And now I will hand over to Maddie Wagner, Director of Investor Relations, to begin. Please go ahead.

Maddie Wagner, Director of Investor Relations

Thank you. Good morning, and welcome to Kinetik's First Quarter 2023 Earnings Conference Call. Here with me is our President and Chief Executive Officer, Jamie Welch, as well as Matt Wall, our Chief Operating Officer; Steve Stellato, our Chief Accounting and Administrative Officer; Tod Carpenter, our General Counsel; Trevor Howard, our VP of Finance; and Chris Kendrick and Tyler Mylan, our VP of Commercial. The press release we issued yesterday, the slide presentation and access to the webcast for today's call are available at www.Kinetik.com. Before we begin, I would like to remind all listeners that our remarks, including the question-and-answer section 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 U.S. 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.

Jamie Welch, CEO

Thank you, Maddie. Good morning, everyone, and thank you for joining us today. As the degree of interest in the Kinetik story increases, we have decided to shift our approach to our quarterly calls. We will be more selective with our prepared commentary to avoid unnecessary repetition with our press release and accompanying earnings presentation. Our goal with this change is to be respectful of your time and emphasize more of an open forum with the broader leadership team, which we hope leads to a more interactive and informative Q&A session. So let me get started. Yesterday, we reported first quarter 2023 adjusted EBITDA of $187.5 million, in line with our internal budget. Beginning in March, we saw a ramp-up in activity and volumes across our system. To put things into perspective, most of our turn-in-line activity in any year, and certainly after winter storm Yuri occurs during the late first quarter and continues through the third quarter. We expect 70% of our new wells connected to the system in 2023 to occur during the 6-month window from March through August. Today, gathered and processed natural gas volumes are at all-time record highs. In April, we processed an average of 1.52 billion cubic feet per day, representing a 21% increase over the equivalent fourth quarter 2022 volumes. We expect sustained momentum throughout the year, supported by an active customer base and our performance from recent wells connected to the system. We are certainly seeing rising GORs across our system, indicating that the basin is getting gassier. To succinctly frame our situation, we exceeded our 2023 exit rate guidance of 1.5 billion cubic feet per day of processed volumes in April and currently expect to exit 2023 at 1.6 billion cubic feet per day of processed volume. This new exit rate represents a year-on-year increase of over 25%. In late March, we closed on a small acquisition of a midstream infrastructure system in Reeves County, supported by a new 20-year agreement with one of our largest customers. The $65 million acquisition represents a less than 4x EBITDA multiple right out of the gate. We also executed a win-win incentive agreement with the customer, accelerating additional near-term drilling activity on dedicated acreage for gas processing and produced water services. The material revenue uplift from this incentive program will effectively start in 2024 and results in less than a 4x setup multiple. As Kinder Morgan remarked last week, we are making progress on the PHP expansion. However, due to supply chain constraints for certain components and materials, the expected in-service date has been delayed to December 2023. During the first and second quarters, we have actively hedged our 2023 and 2024 commodity exposure. As of March 31, 94% of our remaining 2023 gross profit is from fixed fee contracts and hedges. We now anticipate achieving the high end of our 2023 EBITDA guidance of $800 million to $860 million, even with the delay in service of the PHP expansion. Our exit rate for 2023 is now well over $900 million of annualized EBITDA and our EBITDA step change from 2023 to 2024 remains intact. Our 2023 capital expenditures are trending towards the upper end of our guidance range, due principally to the accelerated producer activity requiring additional compression to support these higher volumes. We are continuing to evaluate portfolio monetization opportunities, particularly our stake in Gulf Coast Express pipeline as a means to accelerate the achievement of our capital allocation priorities. A potential monetization of GCX would have an immediate impact on the DRIP, accelerate the achievement of our 3.5x leverage target and allow us to pull forward the point at which we return capital to shareholders. On the operations front, our team has done an exceptional job ensuring flow assurance and reliability for our customers while keeping operating costs down. Despite higher-than-expected volumes and continued materials and labor cost inflation, remaining 2023 operating expenses are right in line with internal expectations from our budget in February. In April, we placed the Diamond Cryo expansion in service. The project was both on budget and on time. Now, our installed processing capacity exceeds 2 billion cubic feet per day. Our gathering system expansion into Lea County, New Mexico is proceeding as planned. The project is on budget and on schedule and should be in service in January 2024, well ahead of the expected contract start date of April 1. We are currently in commercial discussions with several New Mexico producers and are excited about the potential near-term opportunities. We will continue to provide more commercial and operational updates related to our New Mexico activities as they occur. Delaware Link, our 30-inch residue gas pipeline to Waha is on budget and on schedule. We are targeting an in-service date in October. And with that, I'd like to hand the call over to Trevor Howard, our VP of Finance.

Trevor Howard, VP of Finance

Thanks, Jamie. We reported pro forma adjusted EBITDA of $187 million in the first quarter of 2023. Looking at our segment results, our Midstream Logistics segment generated an adjusted EBITDA of $119 million in the quarter. As Jamie mentioned, we saw a ramp-up in volumes beginning in March, and we have seen meaningful growth in April, which will benefit our second quarter and full year results. Shifting to our Pipeline Transportation segment, we generated an adjusted EBITDA of $72 million, up 4% year-over-year. Growth within the segment was driven by volume and margin expansion at Shin Oak and Epic crude as well as the receipt of a tariff settlement at GCX. Throughout the quarter, we de-risked and strengthened our balance sheet. Through our commodity hedging program, we reduced our remaining 2023 commodity-linked gross profit to 6%, down from 10% when we initiated 2023 guidance. Next, from a capital investment standpoint, total capital expenditures for the quarter were $121 million, which is approximately 23% of expected capital expenditures in 2023. $49 million was within our midstream logistics segment and $72 million was at the Pipeline Transportation segment. For the quarter, we generated an adjusted distributable cash flow of $127 million and free cash flow of $26 million. Turning to the balance sheet, Kinetik exited the quarter with a 4.0x leverage ratio. Furthermore, we swapped a significant portion of our floating interest rate exposure to fixed in March. In total, since our comprehensive refinancing last June, we have executed $2.25 billion of fixed rate swaps for the May 2023 through May 2025 period. Our average swap rate implies an attractive 6.1% average cost of debt across our bank facilities and our 2030 senior notes. Currently, only 8% of our total current debt is exposed to floating interest rates. On April 19, we declared a $0.75 per share quarterly dividend to be paid on May 17. This represents a dividend coverage ratio of approximately 1.2x for the full quarter. During the first quarter, we opportunistically repurchased approximately 82,000 shares for $2.4 million under the previously announced $100 million repurchase program. The repurchased Kinetik shares will partially offset share issuances under the DRIP. Turning to our sustainability initiatives, I am pleased to share that we have made significant progress. We reduced our 2022 Scope 1 and Scope 2 greenhouse gas emissions intensity by 8% as compared to 2021. Similarly, we reduced our Scope 1 and Scope 2 methane emissions intensity by 13% year-over-year in 2022. This was achieved in part through our LiDAR program, compressor blowdown best practices and new equipment installations. As a direct result of our emissions intensity reduction efforts and corporate diversity initiatives, we achieved our sustainability-linked financing framework performance targets for 2022, which will result in interest savings beginning in July 2023. And with that, I would like to open the lines for Q&A.

Operator, Operator

The first question today comes from Spiro Dounis from Citi. Please go ahead.

Spiro Dounis, Analyst

Thanks, operator. If we could maybe start with Gulf Coast Express. It sounds like you're moving a little bit closer there to a more formal sales process. Team, can you maybe talk a little bit about the timing around that? And if you could maybe even see recommencing the dividend growth as soon as this year and now we until 2024? And then lastly, if there's anything else you'd consider maybe less core to you?

Jamie Welch, CEO

Spiro, I think as far as GCX is concerned, obviously, we are ready to start formally exploring the sale of that particular interest as evidenced by the fact that we put it in writing as part of our press release. I think that process typically should take you inside of 3 months. So look, I think expectations if a successful outcome was to eventuate, which we feel a high degree of conviction about, would see an announcement in or around that second quarter earnings for us in the beginning of August, which would obviously be ideal. As far as your question on accelerating the potential for the dividend, we still obviously have a significant capital program that we need to tackle for the balance of this year. Obviously realizing significant proceeds from a GCX sale at a very attractive multiple would make substantial inroads from both a balance sheet credit profile standpoint. And I think set you up for achievement of the capital allocation priorities and targets that we've laid out and identified for 2024. It's a long way of saying, I think the first thing is to moderate the DRIP. That obviously reduces dilution to our equity holders. I think that's the first step. I think 2024 is probably the first time that one could reasonably and conservatively consider doing something on the dividend or otherwise incremental return of capital to shareholders.

Spiro Dounis, Analyst

Got it. That's helpful. Second question, just thinking through 2024 CapEx. It sounds like activity levels have picked up dramatically since the last update, as evidenced by your guidance increase here. I remember last quarter, you sort of talked about this less than $150 million of CapEx for 2024. Is that still a good number to use here or do we see pressure higher?

Jamie Welch, CEO

I believe that's still a solid figure to reference. We've been consistent in our conversations, whether with you or with investors, about following through on our commitments. If the current trend continues into next year, we should be considering whether we will reach a final investment decision at the end of next year for a new processing facility. What has surprised us is that the outperformance isn’t limited to just one producer; we have several producers bringing wells online in dedicated areas that have significantly exceeded type curve expectations. With a decade of experience in this basin, we have a strong understanding of the rock's characteristics. Notably, the results we've seen from companies like Cowen, Diamondback, and recently Caterra on their resolute acreage have been quite surprising in a positive way. This indicates that the basin is becoming increasingly productive in terms of gas output. Therefore, the growth trend shown on Page 5 suggests it’s reasonable to expect continued growth, allowing us to effectively address the remaining $400 million of open space in a relatively short timeframe.

Operator, Operator

The next question on the line is from Tristan Richardson from Scotiabank. Please go ahead.

Tristan Richardson, Analyst

Just maybe curious on the volume ramp you're talking about, particularly in April. Maybe just where are you seeing the concentration of that strength? I mean, is this some of the new projects added in June of last year, some of those step-ups in MVCs, the DXL contract. Just maybe kind of curious where you're seeing some of the strength on the volume side.

Jamie Welch, CEO

Good morning, Tristan. I didn't think you changed your name, but that's okay. In short, we are observing increased activity in various areas, especially in the northern and western parts. We have always recognized that the western side of our system is highly gassy, and we're witnessing notable developments as we move into the top part of Reeves County and into Loving County. While we still have a little catch-up to do regarding some of the minimum volume commitments due to a slight dip in volumes for one customer, this is inconsequential compared to the main factor at play. The key aspect driving our performance is the activity level of a few key producers. As we've previously discussed, much of our activity typically occurs from March through August, which is the pattern we observe with our customers. Additionally, following Winter Storm Uri, producer behavior has shifted; many are hesitant to bring new wells online in February due to the catastrophic impact of that event. They've learned to focus their efforts starting in March and ramping up through September and October. November and December activities tend to be more unpredictable as they depend on how producers are faring against their guidance. Generally, we've viewed Central Southern Reeves as solid but not exceptional, and now we're experiencing impressive performance. We're seeing benefits from various projects, which positively impacts gas-to-oil ratios and overall activity levels. This also presents challenges for Matt and Lane in balancing the system and optimizing compression placements. Our commercial team is actively engaged in New Mexico, which introduces new opportunities for us, particularly with a contract starting in April with one of our largest customers. There is significant activity there that we are well-positioned to leverage, and our customers are pleased with our overall performance and execution.

Tristan Richardson, Analyst

Thank you, Jamie. Regarding the acquisition in Reeves County, could you clarify if the 4x multiple reflects future growth or is it based on current EBITDA? Additionally, concerning the higher end of the guidance, how much of that is due to volumes exceeding expectations versus the contributions from the infrastructure system in Reeves?

Trevor Howard, VP of Finance

Regarding the midstream acquisition of $65 million, we noted that it has a multiple of less than 4x. This is a small asset focused on produced water gathering and disposal, partnered with Permian Resources, whose team we greatly respect. Will and James have significantly grown their business and are quite innovative. We believe this partnership is mutually beneficial. The system is located on areas already dedicated to us for gas, so we're familiar with the entire geographical footprint. From their perspective, they have been pleased with our run times and consistent performance. They recognize that this is just the beginning. Our objective is to establish a strong alignment that will facilitate drilling on some of their gassier areas, particularly the legacy Centennial Silverback acreage, and provide them with an economic incentive, which serves as a contribution to aid in construction. This will influence their capital allocation for drilling. For us, it means we can increase our activity beyond their initial base plan. We provided them with $60 million, and they are accountable for completing a specific amount of lateral footage, which is closely monitored. In 2024, you will see the additional benefits beyond the base plan, which is a positive aspect compared to your current numbers or those of your peers. This additional $60 million is set to yield over $15 million in incremental EBITDA from the gas side alone. We appreciate that this acquisition leverages one of our more established contracts with favorable rates, allowing us to control residue and NGLs, which are essential to our gas value chain. In terms of overall performance, the increase from the water business contributes in the teens percentage-wise, while the rest is from outperformance. We have accounted for adjustments with Apache, balancing the positives from outperformance and this acquisition. I am proud of our team's ability to aim for the high end of our EBITDA range of $860 million for this year, especially given the current market volatility and challenges.

Operator, Operator

The next question is from Indraneel Mitra from Bank of America.

Indraneel Mitra, Analyst

Jamie, I wanted to take the other side on the GCX sale, I know you want to get to investment-grade status as fast as possible. But I know the rating agencies also look at scale and getting to $1 billion of EBITDA as well as earnings mix. So you'd be giving up, let's just say, roughly $50 million of high-quality take-or-pay contracts and moving more towards the GMP side, which has more volumetric risk. How do you weigh those issues and when you consider the sale in the coming investment grade with the sale of GCX?

Jamie Welch, CEO

Indraneel, that’s a great question and one we've discussed multiple times. We view it this way: yes, it does represent $50 million in high-quality cash flows. Looking at our midstream logistics business over the past year, our major announcements have been supported by significant commitments and MVCs. The counterparties we've engaged for these MVCs are of comparable quality to the shippers supporting GCX, meaning they are strong investment-grade entities. When we compare an MVC, which involves a financial obligation, to a take-or-pay arrangement for pipeline shipping, it's fundamentally the same obligation to pay. I completely agree with your perspective, yet we recognize that pipeline transport may decrease by $50 million. However, offsetting this, we anticipate an increase from the PHP expansion. Additionally, we have recent MVC contributions from New Mexico starting in October, with more expected. Transitioning to an MVC model allows us to establish a more de-risked GMP business typical in the Permian region, which should help alleviate concerns regarding cash flow risk.

Trevor Howard, VP of Finance

Indraneel, this is Trevor. I'm just going to jump in. I think one other point that's important is with our stock right now trading with a double-digit yield, it's a cost of capital discussion at this point. And so with using GCX proceeds, which on an unlevered basis, compared to our sale could be a less than 10% cost of capital, and you're subsidizing that instead of dipping is really how we're looking at it at this point. And frankly, from our vantage point, to the extent that we're able to significantly reduce or turn off the DRIP when you actually look at it on 2024 numbers, it's accretive to per share financial metrics. Which is a little bit unique when you think about selling an asset to pay down debt. And really, the offsetter is that you're avoiding a fair amount of dilution that would otherwise take place in the third and fourth quarters dividends.

Indraneel Mitra, Analyst

But to be fair, there is some capital intensity associated with the G&P business, right, to get that extra business. So how do you look at that when you look at adding the incremental EBITDA from GMP versus what you already have with GCX?

Jamie Welch, CEO

And that's a fair comment. The way to look at it is that when we announced the deals in October, the overall capital was manageable. It was less than one times build for probably one in contracts and virtually nothing on the other. As we consider the entry into New Mexico, that certainly has a capital component. However, once we open the store, we can source additional capacity beyond the minimum volume commitment without significant additional capital, which ultimately lowers the overall multiple and helps achieve your return and capital recovery. I understand your point regarding the $50 million; you don't need to invest more capital since it's already spent, and you will just benefit from it for the remainder of the contract life. As Trevor mentioned, our focus isn't solely on controlling the rating agencies and achieving investment grade; it's really about reaching a 3.5 times ratio. This allows us to proactively manage the balance of our Distribution Reinvestment Plan through 2023. As Trevor indicated, equity is expensive, and this plan generates significant additional shares each quarter. We've managed this and identified a path to adjust and improve the overall dynamic.

Indraneel Mitra, Analyst

Okay. Understood. And if I could sneak one more in there. Could you comment on what the initial build multiple is for the New Mexico contracts to build the pipe from New Mexico down into Texas? And then I understand that build multiple is going to compress over time as more volumes are able to flow into that pipe. So what is the maximum volume that you can flow, I guess, into that 20-inch pipe that you're building across the state when we look at it? And what is the build multiple now? And what do you expect it to eventually drive into?

Jamie Welch, CEO

So the build multiple today, just based on the MVC is less than 5x. It is the 20-inch can move about 200, 250 that we can move across that pipeline. And so if you add incremental volume, you would bring that multiple down by half? I think it's very compelling. I mean I don't know too many deals that you can do that sort of like at a 2.5 multiple if you sell it all out. So that should be a pretty good proposition.

Indraneel Mitra, Analyst

That's why I ask...

Jamie Welch, CEO

Yes, Neil, just one more thing just in conclusion, kind of combining those last 2 questions together. I think another thing in how we're thinking about the GCX sale is free cash flow from our business today is being earmarked towards deleveraging. And to the extent that we can subsidize incremental growth projects that are mid-single-digit multiples with harvesting a double-digit multiple sale allows us to recycle in an accretive way capital back into the business, which we think is value accretive to shareholders.

Operator, Operator

We have no further questions. So I'll hand back to Jamie to conclude.

Jamie Welch, CEO

Thank you very much for your time. I know everyone is very busy right now due to the recent earnings announcements. We look forward to seeing you at EIC in the next couple of weeks. Thank you.

Operator, Operator

This concludes today's call. You may now disconnect your lines and enjoy the rest of your day. Thank you.