Magnolia Oil & Gas Corp Q3 FY2024 Earnings Call

Good morning, everyone, and thank you for participating in Magnolia Oil & Gas Corporation's Third Quarter 2024 Earnings Conference Call. My name is Cindy, and I will be your moderator for today's call. At this time, all participants will be placed in a listen-only mode and our call is being recorded. I will now turn the call over to Magnolia's management for their prepared remarks, which will be followed by a brief question-and-answer session.

Thank you, Cindy, and good morning, everyone. Welcome to Magnolia Oil & Gas' Third Quarter Earnings Conference Call. Participating on the call today are Chris Stavros, Magnolia's President and Chief Executive Officer; and Brian Corales, Senior Vice President and Chief Financial Officer. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. Additional information on risk factors that could cause results to differ is available in the company's annual report on Form 10-K filed with the SEC. A full safe harbor can be found on Slide 2 of the conference call slide presentation with the supplemental data on our website. You can download Magnolia's third quarter 2024 earnings press release as well as the conference call slides from the Investors section of the company's website at www.magnoliaoilgas.com. I will now turn the call over to Mr. Chris Stavros.

Thank you, Tom, and good morning, everyone. We appreciate you joining us today for a discussion of our third quarter 2024 financial and operating results. I will provide some comments on our quarterly results, which demonstrate the continued execution of our full year 2024 plan and the consistency of our business model, as well as highlighting some of our accomplishments. And finally, provide an early look into 2025. Brian will then review our third quarter financial results in greater detail and provide some additional guidance before we take your questions. As I continually remind the financial community, Magnolia's primary goals and objectives are to be the most efficient operator of best-in-class oil and gas assets, generate the highest return on those assets while employing the least amount of capital for drilling and completing wells. We also strive to return a substantial portion of our free cash flow to our shareholders in the form of ongoing share repurchases and a secure and growing dividend. Finally, we plan to utilize some of the excess cash generated by the business to pursue attractive bolt-on oil and gas property acquisitions, where we have built a competitive advantage and leverage both our technical knowledge and experience in the areas where we operate. Acquisitions are targeted not to simply replace the oil and gas that has already been produced, but importantly, to improve the opportunity set of our overall business, enhance the ongoing sustainability of our high returns, and increase our dividend per share payout capacity. We look for acquisition opportunities to provide upside optionality with a lower cost of entry and that are both financially accretive and accretive to our stock. We firmly believe that our business model and strategy provide us with a durable competitive advantage to sustain our moderate growth over time and allow us to access serial compounders of value for our shareholders. Looking at Slide 3 of the investor presentation, we delivered another consistent quarter of strong financial and operational performance, which includes our initiatives to lower our field-level operating costs. I want to commend our operations team, field workers, and supply chain team for their continued efforts through this year to reduce our operating costs and improve the efficiency of our capital program. These actions have resulted in improved margins and additional free cash flow that can be used to enhance Magnolia's per share value. Total company production during the third quarter was approximately 91,000 barrels of oil equivalent per day and in line with our earlier guidance. Overall, our quarterly production was impacted by multiple unplanned third-party midstream facility outages, some of which occurred late in the period. These outages primarily affected our natural gas and NGL production by approximately 1,000 BOE per day during the quarter and were fully resolved by the end of the period. Total company oil production during the third quarter was nearly 39,000 barrels per day, which represented growth of 18% from year-ago levels, and we expect this level to remain resilient into the fourth quarter. Production in the Giddings area was 68,700 barrels of oil equivalent per day during the quarter, growing 12% compared to the year-ago quarter, with Giddings oil production growing 24% on a year-over-year basis. We continue to see strong overall well performance throughout our assets, which underpins the strength in our earnings and free cash flow. As we wind down the year, we continue to expect high single-digit year-over-year total production growth for 2024, with this year's oil production now anticipated to exceed the total BOE rate of growth. We spent $103 million drilling and completing wells during the third quarter, which is well below our capital guidance of $120 million and represented just 42% of our adjusted EBITDAX of $244 million. This lower-than-expected level of capital spending resulted from a mix of ongoing drilling and completion efficiencies, a decline in our overall well costs, and a small amount of capital which is deferred into the fourth quarter. The improvements in well costs and ongoing overall spending efficiencies have provided us with spare capacity within our capital plan, which will allow us to drill an additional four-well pad in Giddings during the fourth quarter that was not part of our originally planned 2024 capital and activity. We expect this additional pad to be a dock at year-end with anticipated completion sometime in the first half of 2025. This pad should provide us with some additional operational flexibility into next year. As I said, I'm very proud of the hard work shown by our operating personnel in the field. Their continual efforts have helped us to further reduce our field-level operating cost to $5.33 per BOE in the third quarter, a decline of 11% compared to this year's first quarter and exceeding our earlier target to lower our lease operating costs by 5% to 10% during the second half of 2024. Realized savings over this period came from a mix of improved pricing and product substitutions for workovers, water hauling, chemicals, and replacement parts in the field. Additional savings are being seen from optimizing our contract labor needs for some of our field rental equipment through the implementation of field management software, which has reduced our cost for water hauling and will be further utilized to lower costs from other field services over time and into next year. Low capital spending and further reductions in our lease operating costs led to improved free cash flow generation of $126 million during the third quarter. We returned $88 million or 70% of our free cash flow to shareholders through a combination of our quarterly base dividend and ongoing share repurchase program. Our high-quality assets and capital discipline inherent in our business model provide for a low reinvestment rate and consistent free cash flow generation. Our plan is to continue to return a significant portion of this free cash flow to our shareholders to grow share repurchases and to grow the base dividend. We also continue to look for attractive bolt-on acquisitions to utilize our knowledge and experience, have the ability to generate returns well above our cost of capital, and can work to sustain the durability of our business model. During the third quarter, we completed several small transactions at both our Giddings and Karnes operating areas, acquiring royalty, leasehold, and incremental working interest totaling $15 million. These deals increase the value of our future development locations in these areas. As we close out 2024 and look forward to next year, we plan to execute the same business model that has delivered both strong operating and financial results over the past six years. The recent initiatives we have taken this year, focusing on reducing both our field LOE and our well costs, allow us to endure product price volatility and position us for success into 2025. I'll now turn the call over to Brian for further details on our third quarter financial and operating results, in addition to fourth quarter guidance.

Thanks, Chris, and good morning, everyone. I will review some items from our third quarter results and refer to the presentation slides found on our website. I'll also provide some additional guidance for the fourth quarter of 2024, before turning it over for questions. Beginning on Slide 4, as Chris discussed, Magnolia had an excellent third quarter. During the quarter, we generated total net income of $106 million and total adjusted net income of $100 million or $0.51 per diluted share. Our adjusted EBITDAX for the quarter was $244 million, with total capital associated with drilling completions and associated facilities of $103 million or just 42% of our adjusted EBITDAX. Third quarter total production volumes grew 10% year-over-year to 90,700 barrels of oil equivalent per day, and our diluted share count fell by 5% year-over-year to 198.4 million shares. Our annualized return on capital employed during the third quarter was 22%, showing our continued capital efficiency. Looking at the quarterly cash flow waterfall chart on Slide 5. We started the quarter with $276 million of cash. Cash flow from operations before changes in working capital for the third quarter was $241 million, with working capital changes and other small items impacting cash by $33 million. Total drilling completions and associated facilities capital incurred, including leasehold, was $105 million. As Chris mentioned, we closed multiple small royalty and working interest deals during the third quarter for $15 million. We paid dividends of $27 million and allocated $61 million towards share repurchases, ending the quarter with $276 million of cash. Looking at Slide 6. This chart illustrates the progress in reducing our total outstanding shares since we began our share repurchase program in the second half of 2019. Since that time, we have repurchased 70.7 million shares leading to a decrease in diluted shares outstanding of approximately 23%. Magnolia's weighted average fully diluted share count declined by more than 2 million shares sequentially, averaging 198.4 million shares during the quarter. We have 3.9 million shares remaining under our current share repurchase authorization, which are specifically directed toward repurchasing Class A shares in the open market. Turning to Slide 7. Our dividend has grown substantially over the past few years, including a 13% increase announced early this year, to $0.13 per share on a quarterly basis. Our next quarterly dividend is payable on December 2 and provides an annualized dividend payout rate of $0.52 per share. Our plan for annualized dividend growth is an important part of Magnolia's investment proposition and supported by our overall strategy of achieving moderate annual production growth, reducing our outstanding shares, and increasing the dividend payout capacity of the company. Magnolia has the benefit of a very strong balance sheet, and we ended the quarter with $276 million of cash and $400 million of senior notes, which mature in 2026. Including our third quarter ending cash balance and our undrawn $450 million revolving credit facility, our total liquidity is $726 million. Our condensed balance sheet as of September 30 is shown on Slide 8. Turning to Slide 9 and looking at our per unit cash costs and operating income margins. Total revenue per BOE decreased year-over-year due to the decline in oil prices when compared to the third quarter of 2023. Our total adjusted cash operating costs including G&A were $10.83 per BOE in the third quarter of 2024, an increase of $0.15 per BOE or 1% compared to year-ago levels and a decrease of $0.27 per BOE, or 2% sequentially from the second quarter of 2024. The sequential decrease was primarily a function of lower LOE and production taxes. Our operating income margin for the third quarter was $15.45 per BOE, or 39% of our total revenue. Turning to guidance on Slide 10. We expect our full year 2024 drilling completion associated facilities capital spending to be approximately $470 million, around the midpoint of our original guidance from February of $450 million to $480 million. This includes slightly more activity than originally planned with the addition of a four-well pad being drilled in Giddings during the fourth quarter. We expect fourth quarter drilling and completion associated facilities capital of approximately $125 million. Total production for the fourth quarter is estimated to be approximately 93,000 BOE a day, delivering high single-digit total year-over-year production growth during 2024, with annual oil production growth slightly higher than BOE growth. Oil price differentials are anticipated to be approximately a $3 per barrel discount to Magellan East Houston, and Magnolia remains completely unhedged for all of its oil and natural gas production. The fully diluted share count for the fourth quarter of 2024 is expected to be approximately 197 million shares, which is 5% lower than fourth quarter 2023 levels. We expect our effective tax rate to be approximately 21% and our cash rate to be approximately 5% to 7% for both the fourth quarter and the total year. This is lower than our prior guidance due to a refund we received during the third quarter this year. We're now ready to take your questions.

We will now begin the question-and-answer session. Our first question comes from Neal Dingmann of Truist Securities. Go ahead, please.

Good morning, guys. Nice quarter and happy Halloween. My first question is on your remarkable continued Giddings growth. Specifically, I realize much of the last quarter growth was a result of that prior acquisition, but I was just wondering, could you all discuss the continued drivers around the success of these assets that enabled you to keep the reinvestment rate so low?

Yes. Trick-or-treat, Neil. Thanks for the comments and question. Look, I'll tell you this takes a village; it's never easy. And we've been working at this for a pretty good long time now, more than six years. Call it, seven years. We have some fantastic talented people, geologists, geophysicists, reservoir engineers, drilling, and completion folks. All of them have been integral in getting us to where we are now. So I thank them for that. On day one, we didn't necessarily understand it, but we knew that we had a field with a lot of oil and hydrocarbons in place, and that through some time and work and practice, sort of like riding a bike, that we could figure it out. And I think we have shown by the progress that we've made. So the point of the acquisitions that you mentioned is to expand off of our knowledge. Our knowledge is sort of the springboard and a base, but the acquisitions are designed to take us beyond what we may already know and have figured out and act as sort of little tributaries to get us even further beyond what we already know. So the benefit to your question, the benefit of the low reinvestment rate, Giddings does have generally, what we've seen anyway, is a subtler decline rate than a typical shale area. Certainly, a lower decline rate than what we see in other areas. The performance of the wells has typically exceeded our expectations over time. We drilled more than 100 in Gen 3 wells in Giddings and we're often surprised, typically over time in a positive way. So we continue to do what we're doing. We learn more every day, every time we put down a well. And I think we'll continue to benefit from that knowledge and experience, and it will take us further, not just through the field but provide us with other opportunities where we can utilize some of that understanding subsurface. So I hope that gives you a little color.

It does well, Chris. And then my second question, just around your announced multiple unplanned third-party midstream facility outages. While the recent outages, I know you talked about have been completely rectified. Are you concerned about more of these reoccurring outages? And further, would you consider spending any of your capital towards future infrastructure, maybe to address some of this?

Yes. All of this revolves around having control. Ideally, you would want complete control over your direction, including what you produce and where you take it, as well as regarding pipelines and facilities. Unfortunately, Magnolia is at a size where we must collaborate with larger midstream companies that have the necessary expertise, capabilities, and financial resources. However, I wouldn't feel overly confident in relying on them entirely. It is what it is. If I have any concerns about predictability and reliability moving forward, they mainly relate to power issues, which can be unpredictable. Some of the challenges they have encountered, without specifying, have been related to power, and that might continue to be a concern. I remain worried about reliability related to power, and we will have to monitor how that develops. As for whether we would consider investing our own capital in this area moving ahead, I think that in the near term is unlikely, although it might be possible in the future. However, I don't envision a large-scale investment that would grant us complete control over our operations. We have to accept the situation as it is. We work with them to the best of our ability, and I know they make an effort as well. Yet, there are challenges like weather, power outages, and mechanical failures that seem to be more frequent over time. Therefore, I would request that they strive to exceed their recent performance.

Make sense. Thanks so much, Chris.

Thanks for the question; it is pretty clear the LOE optimization program is paying off. I realize you guys don't have any guidance out there for next year. But just from a directional standpoint, where do you think both unit LOE costs and unit GP&T costs will trend in 2025 relative to your second half kind of exit rate? And I guess with the natural gas trip looking higher for next year. How might that impact either?

Yes. Thanks for the question. We've done, I think, what's been a pretty decent job in terms of reducing costs, as I said, double-digit reductions from where we had been early in the year, into the second half. We're always looking to improve, and I will never say that we're done. I would say that maintaining these levels is probably fair going forward, and we'll continue to push beyond that. And we may see some additional small to modest gains before the year is done and into next year, I certainly would press for that. But you're constantly pushing back on underlying field inflation as well as increasing environmental and regulatory requirements. So like I said, we'll always look for more to improve our margins. But I think it would be great if we can at least hold these levels into 2025 and maybe see some modest improvement. But I think it puts us in a good place should product prices weaken even further into next year. So I think this has all been a good exercise for us.

Okay. Sounds good. Regarding the $15 million in small deals that closed during the quarter, was there any significant production associated with those deals that closed?

No, there was not. These were really incremental working interest, mineral interest and some things of that nature, but there was really nothing around production that was any consequence.

Good morning, Chris and Brian, and thanks for taking my questions.

Good morning.

I wanted to start out on services. I was hoping that you all might be able to speak to how you feel about where service costs sit today relative to the oil and gas commodities from an alignment perspective? Looks like it's continuing to trend in the right direction based off what you saw this past quarter, but really just trying to get a better sense of how you all think costs might trend moving into 2025.

Thank you, Oliver. We have incorporated some capital savings, resulting in lower capital expenses in the third quarter, which provides us a bit of flexibility for the fourth quarter to drill an additional pad. However, I've noticed that things have been softer than I expected a month or two ago. Additionally, we've recently renegotiated several key contracts for services and materials, which should yield some small incremental savings for next year, specifically in the mid-single-digit range. This applies to various categories, including OCTG, steel casing, pressure pumping, and rigs, with averages fluctuating around the mid-single digits. Looking ahead to next year's capital, I expect to moderate growth. At current commodity pricing and adhering to our 55% cash flow cap for capital spending, we should be able to achieve mid-single-digit growth. However, I don't foresee our capital spending significantly exceeding what we planned for 2024. We have built in a good level of flexibility, but currently, it appears to be aligned with what we consider optimal.

Perfect. That's super helpful color. And maybe just for a second question, on your land position. I know the legacy position had been in the high-90s percent from HBP perspective when considering some of the bigger packages over the last year, both in April in that core Giddings area and even the one up north that closed late last year, is there anything that we should be aware of in terms of just required drilling or lease obligations and how that might impact near-term capital allocation decisions?

No, it's very similar to what it had been. There's nothing meaningful that would have changed in terms of creating additional obligations necessarily at all really, not from those deals.

Yes. I'm here now. I'm asking on behalf of Carlos. Thank you for taking my call. So, the question is, even though you pulled early the four-well pad, it looks like the capital uptick is minimal, not a material deviation from your ratable quarterly D&C spend. So, in that sense, how much of the D&C costs are accounted for? Is it only drilling? Is it both? Otherwise, is the incremental capital just a proxy for your continued capital efficiency improvements? Thank you.

Yes, I don't know about it being a proxy for anything on a continual basis as that it can fluctuate from quarter to quarter just depending on the timing of activity. But we did include in our forecast for the fourth quarter, we did include the drilling costs for that pad that we will drill, which I would tell you to be approximately $10 million to $15 million roughly. So, that's all incorporated into that.

Okay, perfect. And my next question was regarding the LOE target reduction. On top of what's the right go-forward number? And if you can add color on how you got there? Because in our view, depending on what it is, it can be a moving goalpost instead of a fixed number?

Well, I just said, I expect that there may be some modest fluctuation. The direct LOE is a lot of what we're working on, but there are a lot of components within there. So, you've got workover costs and workovers that depending on workover activity and what may be needed from time to time, period to period, that may create some small, modest fluctuation quarter to quarter. There's not a ton of control over that; sometimes you just need to do what you need to do. But I would tell you that in almost every respect in every bucket of costs, we've made positive inroads in terms of reducing those things, particularly around direct LOE and field management software implementation. So, I think there's more to be had, more to be picked up. But again, there are always things that you're pushing back on, as I mentioned, regarding some regulatory matters, environmental items, things of that nature, and some general field inflation. But I do believe that where we were in the third quarter is at least as good a proxy for going forward, and I do believe we can do better than that. So, going into next year, 525 to 535 feels pretty good to me.

Perfect. Thank you very much. Appreciate your answers.

Morning, guys. I wanted to ask first just on the general M&A market and kind of how you see the opportunity set both at Giddings and the broader Eagle Ford trend. Is it currently more of these small $5 million to $15 million bolt-on acquisitions? Or are there larger opportunities in the hundreds of millions of dollars as well?

I would say it's a combination of both small and larger opportunities that we are exploring. We often consider smaller deals that can enhance the value of our current drilling locations, which are typically identified by our land team that focuses on local opportunities. Additionally, there are larger asset packages available that we may pursue if feasible. We're assessing a variety of opportunities, and I believe we have a strong portfolio to work with. Essentially, I view this as having a hand of cards in front of me, and my goal is to select those that will add value. It's important to simplify our operations rather than complicate them. Although we set high standards, we're actively evaluating many potential opportunities.

No, that makes a ton of sense. And then I guess the next one is just on your thought process around choosing to pull your activity forward with the continued D&C efficiency gains you all have seen. Why are you choosing to pull activity forward versus maybe take the CapEx savings? And then also, if we move into 2025 and we run into a similar issue in the fourth quarter of 2025, would you also think about pulling activity forward then as well?

I believe our perspective on the evolution of product prices as we approach next year indicates that conditions remain somewhat weak. Given the uncertainty surrounding product prices, I think it makes sense to bring some activities forward to give us greater operational flexibility and options. After all, we have the financial resources available, and we are discussing amounts around $10 million to $15 million. Therefore, it seems more prudent to enhance our flexibility and optionality in our plans rather than just banking the funds. So, I'm in favor of this approach.

Yeah. Good morning, Chris and team. Just one tactical question was strategic tactical one. It looked like there were some midstream interruptions in the quarter that you called out. It sounds like those have largely been resolved, but do you feel good about those challenges going forward and you have confidence that you've worked through it?

I feel positive about our current situation. We've addressed the earlier issues, and everything has been resolved. Challenges like these can occur, but we've worked well with our third-party midstream providers who have responded adequately to the issues. While unforeseen circumstances can arise on the power side that may affect facilities, everything is now in good shape. Overall, I believe we are ready to move forward.

Good. All right. Very good. Regarding the philosophy around hedging, you are almost completely unhedged for your oil and gas production. Could you explain why you believe this is the right approach? What would it take for you to adopt a more aggressive stance on managing risk and hedging moving forward? Please share your thoughts on hedging.

The way you described being almost completely unhedged is actually not accurate; we are completely unhedged. My perspective on this is similar to fire insurance. We've always viewed it that way. It's like trying to foresee a fire and whether you need insurance in the first place. This is an inherent risk in our business. We don't engage in significant financial risk, and we have minimal debt. There are costs associated with hedging, much like paying an insurance premium. I believe that hedging complicates the business unnecessarily. Our investors want exposure to the commodity while knowing they can rest easy about our financial stability, thanks to our low leverage. This strategy allows us to fully benefit from potential commodity price increases while having protection from downturns due to our low debt levels. I believe this represents an ideal situation, and that is our guiding philosophy.

Good morning, folks. Thank you for taking my question. I'd like to follow up on the prior question. Obviously, you don't need to have traditional hedges given the balance sheet strength. But I think the decision to hedge basis is really independent of the balance sheet, given a lot of the dynamics going on right now. We talked to your team recently and we heard that you're not concerned by the basis blown out at Houston Ship Channel. Some of your public peers have a different view. We've seen ship channel and caddie basis out about $0.20 for the next couple of years. So just if you could talk about Chris, why you're comfortable not doing basis swaps? Do you feel like there's overblown fears about what Matterhorn is going to do to the Gulf Coast area? I love your comments on that. Thank you.

Yes, I'll respond to this. As you can imagine, it's a complex situation. We have a good level of confidence regarding the ship channel, which is the second-best hub for selling our gas after Henry Hub, and as mentioned, it's about $0.20. The additional volume coming to the Katy area via Matterhorn is likely already reflected in the pricing curve. Our understanding aligns with general market insights. The Permian isn't producing 2.5 million Bcf of natural gas every day, and we don't anticipate an overwhelming influx of gas to Matterhorn as if a dam were breaking. The initial flows in early October were about 250 million a day, but that was just one interconnect completed. More interconnects will be completed, enabling additional gas flows into other pipeline storage facilities. However, this increase will take time. There are other factors at play, such as the Plaquemines LNG facility starting commercial operations, which may draw some gas from the Northeast away from the Texas market, possibly balancing some of the impacts of Matterhorn. I'm unsure whether this would provide a precise one-for-one offset. There are many variables in this situation that might mitigate the effects of the Matterhorn line. However, attempting to hedge basis under these circumstances is complicated and may lead to more speculation on our part, which we choose to avoid.

Okay. That's a good answer. I appreciate that context. And then just, I want to circle back on your prepared comments on oil, Chris. I just want to make sure we understand what you're saying. You talked about oil exceeding BOE growth; that's pretty clear. You said you expect oil to remain resilient into the fourth quarter. Should we take that to mean like the current low-40s oil SKU is something you think is sustainable? I'm just trying to understand what that means? Thank you.

I believe for the fourth quarter, the oil volumes we expect will be roughly the same as we move into that period. It might improve slightly, but I'm not certain at this point. My expectation is that it will remain fairly consistent compared to the third quarter in terms of volume, and overall, the BOEs will increase slightly. Generally, this should keep us around a similar percentage, if that makes sense.

Good morning, everyone. I appreciate you fitting me in. Chris, you mentioned earlier that you've been consistent in identifying bolt-on opportunities and you referenced your desire to make a good hand. Is it becoming more challenging? Considering you’ve been at this for a while, do you think it will be harder to make a hand with bolt-ons in 2025 and beyond, or do you still feel optimistic about it?

No, I don't think it's harder. I just think you need to have some level of patience, and you can't just jump at every opportunity. As I mentioned, we explore many options. There are a lot of small private entities out there or opportunities that sometimes require thinking outside the box and leveraging your understanding and relationships in the areas where you operate. I believe you may need to be more thoughtful about it, but yes, I think there will continue to be opportunities available. Sometimes when I think about it, it's probably all of the above. And I wouldn't tell you it's necessarily just in our neck of the woods at all. It's a Lower 48 issue. And there's increasing demands on obviously around pull on power. And that will only grow. And so you just have to understand that the grid and power capabilities and generation are susceptible just like anything else. And we've seen it related to weather issues to some extent, partly that. But as demand and pull on facilities grow that makes things tighter over time and only potentially more problematic. And I'm not speaking for us specifically; I just think this is a growing issue that folks need to consider.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.