Earnings Call Transcript - NGL Q1 2022

Trey Karlovich, CFO

Good day and thank you for standing by. Welcome to the Q1 FY 2022 NGL Energy Partners LP Earnings Conference Call. At this time, all participants' lines are in the 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. I would now like to hand the conference over to your speaker for today and CFO, Trey Karlovich. Please go ahead. Great. Thank you. And thank you, everybody, for hanging on as we got connected. And as a reminder, this conference call includes forward-looking statements and information. Words such as 'anticipate', 'project', 'expect', 'estimate', 'plan', 'goal', 'forecast', 'intend', 'could', 'believe', 'may', 'will', and similar expressions and statements are intended to identify forward-looking statements. While NGL Energy Partners (LP) believes that its expectations are based on reasonable assumptions, there could be no assurance that such expectations will prove to be correct. A number of factors and risks could cause actual results to differ materially from the projections, anticipated results, or other expectations included in the forward-looking statements. Certain of these factors include changes in general economic conditions, including market and macroeconomic disruptions and related governmental responses; the prices of crude oil, natural gas liquids, gasoline, diesel, biodiesel, and energy prices generally; the general level of demand and the availability of supply for crude oil, natural gas liquids, gasoline, diesel, and biodiesel; the level of crude oil and natural gas drilling and production in areas where we have operations and facilities; the effect of weather conditions on supply and demand for crude oil, natural gas liquids, gasoline, diesel, and biodiesel; the availability and cost of capital and our ability to access certain capital sources; and political pressure and influence of environmental groups upon policies and decisions related to the production, gathering, refining and processing, fractionation, transportation, and sale of crude oil, natural gas, natural gas liquids, gasoline, diesel, or biodiesel, and other refined products. Other factors that could impact these forward-looking statements are described in the risk factors in the partnership's annual report on Form 10-K, quarterly reports on Form 10-Q, and other public filings and releases. You should not put undue reliance on any forward-looking statements. All forward-looking statements speak only as of the date hereof and except as may be required by the state and federal securities laws, we undertake no obligation to publicly update or revise any forward-looking statements as a result of new information, future events, or otherwise. This conference call also includes certain non-GAAP measures, namely EBITDA, adjusted EBITDA, and distributable cash flow, which management believes are useful in evaluating our financial results. Please see the Partnership’s earnings releases, investor presentations, annual report on Form 10-K, and quarterly reports on Form 10-Q for more information on our use of non-GAAP measures, as well as reconciliations of differences between any non-GAAP measure discussed in this conference call to the most directly comparable GAAP financial measure. This information is also available on our website at NGLenergypartners.com, under the Investor Relations tab. Again, apologies for the delay, but welcome to our first quarter of fiscal 2022 earnings call. We just issued our earnings release and filed our 10-Qs this afternoon, and I plan to quickly discuss our financial results and then we will open the line up for any questions. Overall, we had a very strong quarter in our Water Solutions segment with a 19% increase in disposal volumes over our previous quarter, and we continue to maximize our EBITDA per barrel, which increased 17% over last quarter driven by strong disposal rates per barrel and lower operating expenses. We have some inventory and hedging noise impacting our crude segment this quarter, which we expect to make up this year as we turn our inventory and realize our current hedge positions. Our Liquids segment reported lower earnings than typical for this quarter as we moved out of the peak winter season and started to prepare for storage through the summer in a rising price environment. We also had some profits embedded in our inventories and hedges in this segment as well. Remember this is a seasonal business that generates most of its cash flow during the butane blending and propane heating seasons, which run from the fall through the winter, and we continue to believe this business will be in line with the expectations for the year. The steep run-up in commodity prices during the period, including crude oil, propane, butane, and biofuels has driven an increase in our inventory balances and working capital. Working capital needs increased almost $100 million this quarter. We offset a portion of this increase with the sale of Sawtooth, which we announced and closed in mid-June. The $70 million gross proceeds were utilized to fund transaction costs and reduce debt including about $19 million of the 2023 notes, with the remaining going against our revolver during the period. Our funded capital expenditures totaled $47 million this quarter, including the accrued capital expenditures from the prior quarter. Our capital expenditures are front-half weighted this year. This combined with operating cash flow resulted in an overall increase in debt balance of approximately $49 million for the quarter. We noted last quarter that we expect to generate significant excess cash flow during the year with a focus on debt reduction and leverage improvement. The majority of that excess cash flow will be recognized in the second half of the year as we complete most of our capital projects, liquidate inventories, and monetize our working capital over the coming months. This assumes we are in line with our guidance and there are no significant increases in commodity prices, which could cause our working capital requirements to increase as well. We are reaffirming our fiscal 2022 EBITDA guidance range of $570 million to $600 million and guiding to the lower end of that range following the first-quarter results and the Sawtooth sale. Our total capital expenditures are still expected to come in the middle of our $100 million to $125 million range for this fiscal year. We reported a net operating loss for the quarter of $69 million, which includes a $60 million loss on the sale of Sawtooth. Our adjusted EBITDA totaled $91 million this quarter. Water Solutions adjusted EBITDA was a record $81.5 million for the quarter driven by Delaware Basin volume growth, operating expense reductions, and water sales, including freshwater reuse and recycling. Disposal rates per barrel remain strong at $0.61 per barrel, and operating cost per barrel came in at $0.26 per barrel. Overall, EBITDA per disposal barrel for this segment was $0.54 per barrel, the highest level we have had in quite some time. Crude Oil Logistics adjusted EBITDA came in at $13.1 million for the quarter. However, we estimate that about $15 million of deferred profits is in our inventory and hedge book, and will be recognized in the coming quarters as we turn inventory and realize current hedge positions. This assumes crude prices do not escalate significantly over this period of time. Grand Mesa volumes came in at 77,000 barrels per day, a nice recovery from last quarter as DJ Basin completion activity is slowly increasing from last fall and winter. Liquids Logistics reported adjusted EBITDA of $5.6 million this quarter, which is traditionally a lower earnings period for the segment. Both our butane and propane businesses believe they are well-positioned going into summer storage season and ultimately the peak-demand periods for both businesses. We continue to see lower volume demand for our refined products business. However, we benefited from an increase in biofuel prices during the period. Our corporate costs were about $9 million this quarter, in line with expectations and with prior periods. We continue to focus on the following factors for this fiscal year and believe investors should continue to do the same. Delaware Basin oil production and completion activity, and the associated demand for water services remain key. As noted, we saw a significant increase in the quarter in disposal volumes and continue to see growth into the second quarter as well. We expect ratable growth in this area throughout the fiscal year, and we are also growing our resale and recycle services in the Basin. DJ Basin production growth from our core producer customers, driving volume increases on Grand Mesa Pipeline, where we started the year slightly ahead of our initial expectations and expect continued ratable growth throughout the year here as well. We're also expecting a strong recovery in demand for refined products and blending feedstocks, most notably butane to pre-pandemic levels. We expect blending demand to return to more normalized pre-pandemic levels. However, the recent resurgence in COVID is something we will continue to monitor and react accordingly. We will also continue to focus on cost reductions across all of our segments and at the corporate level, and look to minimize capital expenditures to meet our operational needs. This current quarter was impacted by the run-up in commodity prices, which drove certain hedge losses, most notably in our Crude Logistics Segment and working capital needs on our balance sheet. Assuming prices do not significantly increase from these levels, we would expect to recognize offsetting inventory and hedge gains in the coming quarters to bring the Crude Logistics Segment and our working capital borrowings back in line with expectations. Our liquidity position was about $300 million at June 30th, which we believe is adequate to operate our business in this environment. We purchased a small portion of our 2023 notes during the quarter, and expect to repurchase more bonds as we generate excess cash flow throughout the year. That concludes our prepared remarks for the quarter. Mike is with me and we will now open the line up for your questions.

Mike Krimbill, CEO

Erika, can you please open the line for questions?

Operator, Operator

Yes. I'm sorry. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Tarek Hamid from JPMorgan. Your line is open. Please go ahead.

Tarek Hamid, Analyst

Good afternoon, guys. I guess just first on the derivative loss in the crude oil segment, it looks like it's about $38 million in the first quarter. Can you just talk a little bit about how much of that was realized or unrealized, and again, what you'd expect to see in terms of derivatives over the remainder of the year?

Mike Krimbill, CEO

Certainly. We experienced a notable increase in commodity prices from April 1st to June 30th. Recently, prices have dropped slightly. During that time, we were managing our inventory and adjusting our hedges, which means we will recognize the hedge losses in the current period. As we adjust those for future periods, we anticipate that profit will start to return. Specifically, in Crude Logistics, we recorded a realized loss of $52.7 million and have unrealized gains of $14.5 million. This unrealized amount is what I was indicating as the $15 million we expect to recover in the future. The realized loss of $52.7 million has been included in our reported EBITDA, while the $14.5 million will be recognized later.

Tarek Hamid, Analyst

And then, in terms of what you would expect from realized gains or losses, just the $15 million realized gain, you'd expect on a go-forward basis? Obviously, things can change quickly, but in terms of where it's at right now?

Mike Krimbill, CEO

Yeah, it would change depending on where commodity prices go, obviously. But any offset that we should see on the physical side. Again, there can be some timing delays, but overall, we would expect to make up any difference on the physical. Which again at that $52.7 million loss for the quarter, we made up a significant portion of that on the physical side, but we haven't turned all that inventory yet.

Trey Karlovich, CFO

Got it. And then in terms of just the reaffirmed guidance, just mathematically, getting to the low end of guidance for the rest of the year requires EBITDA to be about $160 million per quarter. That's just the $570 minus $91 divided by 3. As you think about the bridge to that, obviously, a chunk of that is sort of a normalization of the hedge position in crude oil. But how much of that is just growth in water to sort of getting you to those sorts of earnings numbers to hit guidance? We are anticipating consistent growth in our Water segment, which had a very strong quarter. I believe Water's performance met or exceeded most market expectations. We expect this business to continue growing steadily throughout the year. It's important to note that our Liquids segment earns most of its profits in the third and fourth quarters, so the first and second quarters do not fully represent growth trends. You cannot simply assume three quarters at $160 million; the Liquids segment, especially in the third and fourth quarters, will be stronger than in the earlier quarters. Additionally, we expect the Crude business to align again with our previous run rate expectations.

Tarek Hamid, Analyst

Got it. And then just the last one for me, you talked about CapEx being front-end loaded. Anything else we should think about in terms of uses of cash throughout the course of the year, besides CapEx and potentially getting some working capital back?

Trey Karlovich, CFO

No. Those are the keys. Again, getting working capital back to the March levels. Our uses of cash are going to be interest expense and then CapEx. And again, the CapEx - interest expense was expected to be about $250 million this year, and CapEx is $100 to $125 million. The remainder would go to debt reduction.

Tarek Hamid, Analyst

Got it. I'll jump back in the queue. Thank you.

Trey Karlovich, CFO

Thanks.

Operator, Operator

Your next question comes from the line of Philip Duffner from Aurelius Capital Management. Your line is open. Please go ahead.

Philip Duffner, Analyst

Hi, Trey. Thanks for taking my question. The first one is on Crude Logistics. When you just ran through the hedging losses and the unrealized gains, but if you were looking at Q1 at a normalized number adjusting for whatever was going on with the hedges, what would be the adjustment and what would be the EBITDA?

Trey Karlovich, CFO

Yeah. We would've been at about $29 million for the quarter for crude, instead of $13.7.

Philip Duffner, Analyst

Got it. And in terms of the Liquid business, what caused it to be weaker than it has been in the past?

Trey Karlovich, CFO

A couple of points, Philip. First, as I mentioned, commodity prices are significantly higher, which affects demand. People are generally delaying their purchases at these elevated commodity price levels, and we do not expect this to have a major impact on the overall year. However, it did affect the quarter, along with some inventory issues. If you examine our Liquids business, the first quarter performed between $10 million and $15 million, which is pretty typical. I attribute the most significant factors for this quarter being below that level to the two issues I mentioned, with each contributing roughly half. We anticipate demand will rebound, particularly for the butane business, where we expect an increase in blending this fall compared to last year. We're remaining cautious regarding the COVID situation and the Delta variant, but we believe the economy will not shut down again and we do not foresee a return to lockdowns like we experienced last year. Therefore, we expect a recovery. The propane segment will depend greatly on heating demand, which is still uncertain. Overall, at this moment, we do not think the first quarter will have a substantial impact and believe we will maintain our trajectory.

Philip Duffner, Analyst

Got it. And just one last question in the cash flow statement, under-investing activities, you have a $60 million loss related to the net settlement of derivatives. How does that relate to the numbers you've mentioned? And what's in the income statement?

Trey Karlovich, CFO

I noted that most of the $52.7 million is related to crude. Additionally, there will be one more add-back concerning some crude positions we established in conjunction with the new Extraction agreement. This information is detailed in the earnings release and the 10-Q.

Philip Duffner, Analyst

Thank you.

Trey Karlovich, CFO

Of that $60 million, a little over $50 million is related to the crude segment.

Operator, Operator

Your next question comes from the line of Patrick Fitzgerald from Baird. Your line is open. Please go ahead.