Earnings Call Transcript - PAGP Q3 2023

Operator, Operator

Good day and thank you for standing by. Welcome to Plains All America's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's call is being recorded. I would now like to hand the conference over to your speaker today, Blake Fernandez, Vice President, Investor Relations. Please go ahead, sir.

Blake Fernandez, Vice President, Investor Relations

Thank you, Norma. Good morning and welcome to Plains All American third quarter '23 earnings call. Today's slide presentation is posted on the Investor Relations website under the News and Events section at plains.com. An audio replay will also be available after today's call. Important disclosures regarding forward-looking statements and non-GAAP financial measures are provided on Slide 2. An overview of today's call is provided on Slide 3. A condensed consolidating balance sheet for PAGP and other reference materials are in the appendix. Today's call will be hosted by Willie Chiang, our Chairman and CEO; and Al Swanson, Executive Vice President and CFO as well as other members of our management team. With that, I will turn the call over to Willie.

Willie Chiang, Chairman and CEO

Thanks, Blake. Happy Friday, everyone, and thank you for joining us this morning. Today, we reported strong third quarter results, along with the closing of 2 Permian gathering bolt-on acquisitions and the continued execution of our multiyear capital allocation framework which is focused on lowering leverage and increasing the return of capital to our unitholders. As a result of our year-to-date performance and the partial year contributions of our recent bolt-on acquisitions, we are raising our full-year 2023 adjusted EBITDA guidance to a range of $2.6 billion to $2.65 billion. This reflects an increase of $50 million to $100 million from the high end of our previous guidance range. A high-level overview of our updated 2023 guidance is located on Slide 4, and Al will share additional detail in his portion of the call. As summarized on Slide 5, OMAG JV acquired Rattler Midstream's Southern Delaware Basin crude gathering system and LM Energy's Northern Delaware Basin touchdown crude gathering system for an aggregate cash consideration of approximately $205 million, or approximately $135 million net to Plains. These bolt-on acquisitions are expected to generate unlevered returns in line with our return thresholds of approximately 300 to 500 basis points above our weighted average cost of capital, in addition to enhancing our position in the Delaware Basin. The assets will further position the Permian JV to expand its services and offerings and extend commercial relationships with both new and existing customers. Regarding today's capital allocation update, we continue to make meaningful progress towards our goal of lowering absolute debt and maintaining a strong balance sheet that can withstand various commodity cycles. As highlighted on Slide 6, we are lowering our long-term leverage ratio target range to 3.25x to 3.75x. This is intended to be a long-term range target where we may operate below the low end of the range during certain periods or temporarily above the top end of the range in the event of strategic transactions, with a goal of moving back into the target range on a long-term basis. We expect to exit the year below 3.5x due to a reduction in net debt of approximately $450 million, which is underpinned by the repayment of $1.1 billion of senior notes in 2023. In further support of our capital allocation framework laid out in November 2022, we intend to recommend to our Board a $0.20 per unit annualized increase in our quarterly distribution payable in February of 2024, as seen on Slide 7. On an annualized basis, the distribution would increase from $1.07 per unit currently to $1.27 per unit, representing a 19% increase. I would also note the proposed acceleration and timing of our annual distribution increase, which would fully increase forward from our May timing to February. This is all consistent with our objective of increasing returns to our unitholders and reflects our continued confidence in our business, which is bolstered by the benefits from the recent bolt-on acquisitions. Long term, our free cash flow generation continues to support our multiyear capital allocation framework, which continues to target annualized distribution increases of approximately $0.15 per unit each year until reaching a target common unit distribution coverage of approximately 160%. With that, I'll turn the call over to Al.

Al Swanson, Executive Vice President and CFO

Thanks, Willie. We reported third quarter adjusted EBITDA attributable to PAA of $662 million. This reflects the benefit of annual tariff escalators, higher volumes in regions outside of the Permian, contributions from recent bolt-on acquisitions, and the benefit of market-based opportunities. These were partially offset by lower-than-expected Permian volumes due to weather-related impacts on gas processing capacity and field compression issues that ultimately impacted oil production and extended into the middle of August. The NGL segment benefited from stronger regional basis differentials and additional spot opportunities on both propane and butane, resulting in higher realized frac spreads. Slides 12 and 13 in today's appendix include walks which provide more detail on our third quarter performance. A summary of our updated 2023 guidance is located on Slide 8. As a result of strong year-to-date business performance in both our crude and NGL segments and contributions from our recent bolt-on acquisitions, we are raising our full-year 2023 adjusted EBITDA guidance to $2.6 billion to $2.65 billion. Our updated outlook factors in lower-than-expected Permian production, predominantly driven by the weather-related impacts. We continue to expect year-over-year growth in our crude oil segment driven by tariff volume increases and tariff escalation. For the NGL segment, we remain highly hedged and expect a typical seasonal step-up in sales as we enter the winter months. Shifting to capital allocation, as illustrated on Slide 9. For 2023, we expect to generate $2.45 billion in cash flow from operations and $1.45 billion of free cash flow, which takes into account the cash outlay for our recently announced bolt-on acquisitions. This results in $450 million of free cash flow after distributions available for net debt reduction. We continue to self-fund $325 million of investment capital net to PAA, which is consistent with previous guidance. We have increased our maintenance capital budget by $15 million to $210 million net to PAA for 2023. This reflects additional maintenance capital for recent bolt-on acquisitions and higher integrity maintenance activity for the year. Before turning the call back to Willie, I wanted to share a few directional comments for 2024, with formal guidance to come early next year. We continue to expect growth in our crude oil business primarily driven by operating leverage, continued Permian growth, tariff escalation, and full-year contributions from bolt-on acquisitions. In our NGL segment, we have seen volatility in frac spread but have made meaningful progress in hedging over two-thirds of our expected 2024 frac exposed volumes at a spread above $0.60 per gallon. Additionally, we should benefit from the absence of planned turnaround activity next year, which negatively impacted commodity exposed volumes in 2023. With that, I'll turn the call back to Willie.

Willie Chiang, Chairman and CEO

Thanks, Al. Before finishing today's call, I want to reiterate a few key messages. First, current global events have highlighted and reaffirmed the importance of hydrocarbons in everyday life. Plains remains very well positioned as North American supply will continue to be critical to global energy security, affordability, and reliability. Secondly, and importantly, our business remains strong. We continue to execute our strategy of generating meaningful cash flow, maintaining capital discipline, reducing leverage, and increasing return of capital to our unitholders. Lastly, we continue to have confidence in our business, which is built on an integrated flexible asset base with operating leverage across our system. We appreciate your continued interest and support, and we look forward to fielding your questions as well as giving you further formal updates on our earnings call for 2024 in February. With that, I'll turn the call over to Blake to lead us into Q&A.

Blake Fernandez, Vice President, Investor Relations

Thanks, Willie. As we enter the Q&A session, please limit yourself to one question and one follow-up. For those with additional questions, please feel free to return to the queue. This will allow us to address questions from as many participants as possible within the time available this morning. Additionally, the IR team will be available to address any additional questions you may have. Norma, I believe we're ready to open up the call to questions.

Operator, Operator

Thank you. Our first question comes from the line of Michael Blum with Wells Fargo.

Michael Blum, Analyst

I wanted to first ask about the bolt-on acquisitions in the Permian. Do you expect this to be a regular occurrence? Are there more opportunities for consolidation in the Permian? Additionally, should we anticipate any activity like this outside of the Permian?

Willie Chiang, Chairman and CEO

Yes. Let me speak to the bolt-ons, Michael. It's a good question. As you know, we've got a great footprint that allows us to capture synergies and opportunities that are out there. We do think there are more opportunities. We’re going to be very disciplined in how we approach it. The valuations are going to be key. I think you'll see a continued focus on that. We look at all opportunities because our interests are in the best interest of our unitholders, but I think you'll see both bolt-on opportunities in both the Permian and outside of the Permian.

Michael Blum, Analyst

Okay, great. And then, my second question is probably related to the first. The rationale for reducing the leverage target, maybe you could just walk through that? And is that in any way related to what you see down the road in terms of M&A and having the flexibility to act there?

Al Swanson, Executive Vice President and CFO

Michael, this is Al. Our view was, as we intended to be running the company at a lower leverage than what we had been historically. Part of the reason for committing to it publicly like we have is our intent lets to do it. Two, we believe the broader energy sector is and will be running with lower leverage. We want to actually complete and get our upgrades to mid-BBB. We think this range that we've established puts us subtly in that with some flexibility for that, recognizing again, that our intent is to run the company a little bit more conservatively with the balance sheet.

Operator, Operator

One moment for our next question, please. Our next question comes from the line of Brian Reynolds with UBS.

Brian Reynolds, Analyst

Thank you for the insights on how weather affects volumes in the Permian this quarter. I would like to follow up on the outlook for the Permian. First, are there any recent crude gathering acquisitions in the basin that might impact volumes for this quarter or in the future? Secondly, I've heard optimistic growth expectations for the Permian going into 2024 and 2025. Could you provide an early perspective on what you anticipate for Permian activity as we approach next year?

Willie Chiang, Chairman and CEO

I'm glad you asked the question. We'll provide formal guidance in February on 2024 in the Permian, but I'll share some insights now. This year has been unusual due to weather issues in the summer that affected the second and third quarters. Our initial guidance for the year was 500,000 barrels a day growth from exit to exit, but we updated that in our last call to expect it to be slightly lower. Currently, we believe it's likely in the $350 to $400 range for the year. I want to mention that our October volumes and gathering show we're actually 175,000 barrels a day higher in October compared to the third quarter. This gives us confidence going into the fourth quarter. While predicting the future is challenging, we are noticing increased volumes as we begin the fourth quarter. Additionally, recent announcements, particularly regarding a large transaction with one of the major super majors, support our view that the Permian will remain significant for a long time moving forward.

Brian Reynolds, Analyst

Great. Appreciate that. And maybe to touch on the distribution, it seems to come up a little bit above expectations from last year's capital allocation update. So kind of curious if you can refresh us. Are there any structural changes that we'd be thinking about? Or is kind of targeting that 1.6 coverage over a multiyear framework still the right way to think about it? And how ultimately some of these acquisitions impact that distribution outlook going forward.

Al Swanson, Executive Vice President and CFO

Yes, this is Al. We still are committed in the future for the $0.15 annual increase in the 160% coverage at the common level. Part of the reason for moving it up and the extra nickel is related to the acquisitions that we've completed. They're accretive. Again, we've targeted hurdle rates that will bring good accretion for these bolt-on transactions and we also have seen strong performance out of our business. Once we complete this, we're back to the $0.15 and 160% coverage. We think the 106% coverage allows us to basically fund investment capital going forward and a number of small bolt-ons in the future without actually needing to raise external money. So kind of live on our own cash flow means.

Operator, Operator

One moment for our next question, please. Our next question comes from the line of Gabriel Moreen with Mizuho.

Gabriel Moreen, Analyst

Maybe, Willie, if I can just ask a follow-up on Michael's question about recurring bolt-on M&A you mentioned looking at things outside the Permian. Can you maybe elaborate on which basins you might think about as far as doing those bolt-ons, and is doing something like the Oryx joint venture structure appealing to you in other basins outside the Permian as well?

Jeremy Goebel, Analyst

Gabriel, this is Jeremy Goebel. I would say we're structure agnostic. We're just trying to basically garner the most synergies in a way that works for us and the counterparty. Where we would focus, it's where we have strength. I'd say from our vantage point, we have gathering assets in all the core areas where we have strength in our marketing business, our pipeline business, and our terminals, we can add value to assets. We'll continue to look there if you look across our footprint, where we have strength, is an area where we think we can add value and extract synergies into accretive deals.

Gabriel Moreen, Analyst

And then maybe if I can ask about sort of the hedging of the frac spread exposure heading into '24. Just you mentioned you had put a lot of the spread exposure to that at this point? Are you close to that 80% level that you're targeting? Do you see yourself getting there near-term? Or are you kind of leaving some stuff open in anticipation of some strength?

Willie Chiang, Chairman and CEO

Yes, Gabe, we’re not going to disclose the exact number, but Al's comments on being well over 60% hedged indicate that we have a significant portion of this hedged at favorable values, and we'll provide a further update in February.

Operator, Operator

One moment for our next question. Our next question comes from the line of Keith Stanley with Wolfe Research.

Keith Stanley, Analyst

I would like to follow up on the frac spread to ensure I have it correct. So, the 60% is hedged above $0.60 a gallon. Could you indicate if, directionally, 2023 was a bit higher than that when you created your plan? I'm trying to understand where that sits concerning the $0.60.

Willie Chiang, Chairman and CEO

Yes, Keith, this is Willie again. For 2023, we were very well hedged. We proactively put these hedges in place in late 2022. The weighted average value of that hedge is a little over $0.70. If you compare it to what we actually hedged in 2023, it's about a dime lower than that. The financial impact of this is roughly plus or minus $70 million. As Al mentioned, we also had a turnaround this year that we won't have next year, which may provide a better indication of where the NGL business is heading.

Keith Stanley, Analyst

That's very helpful. The second one I know the company has talked about the preferreds not being a near-term priority. Just curious with the official leverage target now at 3.25% to 3.75. Under certain circumstances, would you consider going above the leverage target in order to repurchase the preferreds? Or if you were to take out the preferreds at some point down the road, would you need to still stay within that new leverage band?

Al Swanson, Executive Vice President and CFO

This is Al. There's been no change in our thinking around the preferreds. Debt markets are fairly high; like an issue in a new 10-year would be 6.5%, 6.75%. It's a long way of saying that the rates on the preferreds are still fairly attractive relative to our weighted average cost of capital. Our intent would not be to meaningfully increase leverage to take those preferreds out. It's hard to say hypothetically what you might do a few years down the road, but we won't sacrifice our financial flexibility to reduce them, again, because they're not that high relative to our cost of capital. We think our weighted average cost of capital today is in the 11% to 12% range, and the preferreds on the same weighting are 200-plus basis points less. So again, but there will be one day where maybe we will be able to take them out, but we don't want to sacrifice financial flexibility.

Operator, Operator

One moment for our next question. Our next question comes from the line of Neel Mitra with Bank of America.

Neel Mitra, Analyst

I wanted to touch on the Permian long-haul volumes. It seems like they fell a little bit more disproportionately relative to gathering and intra-basin in the quarter versus the second quarter? And also, how did the basin perform just given the low Cushing inventories this quarter?

Jeremy Goebel, Analyst

It's Jeremy Goebel. Regarding the long-haul volumes, some market dynamics in Corpus led to a situation where it was more cost-effective for shippers to purchase at Corpus rather than transport from Midland. This was a choice made by several shippers on the pipeline, but it's a temporary situation. As we move into the fourth quarter, the pipeline is performing in line with historical trends, and there is strong long-term demand for shipments. The Basin saw a similar trend; as inventories decreased, there was a reduced need for movements in that direction. However, as inventories continue to decline, there are increasing opportunities in the Basin.

Neel Mitra, Analyst

Got it. Perfect. Could you generally share what you're observing in the basin regarding growth dynamics? I understand that most gas processors experienced flat volumes from May through August, similar to your situation. Can you discuss which regions were affected the most? Was the New Mexico Delaware hit harder compared to other basins? Additionally, what have you noticed from the producers during the heat that might have impacted their operations versus the infrastructure side, keeping in mind that your operations are back up and running with strong volumes in October?

Jeremy Goebel, Analyst

Thanks, Neel. It was that Stateline area north into New Mexico. I think the other dynamic there was some of the issues around flaring and the stopping of flaring. So it all hit at once, and it was within a three-month period, but the big surge in volume is coming from those same regions and part of the Northern Midland Basin. So I'd say it's recovering and then some, and we see that momentum carrying based on the connections we have made in November and will make this month and next month into next year that momentum should continue.

Neel Mitra, Analyst

And Jeremy, I don't know if I got a response on basin, how that was running during the quarter, if you don't mind commenting on that.

Jeremy Goebel, Analyst

Sure. It was in line with expectations, and as inventory strain, we would expect the volumes to increase.

Operator, Operator

One moment for our next question. Our next question comes from the line of Doug Irwin with Citi.

Unidentified Analyst, Analyst

Just a couple of follow-ups on guidance. So maybe I'll ask both at once. First, I'm just wondering if you could kind of help bridge the facts that the EBITDA guidance moved higher but then we saw cash from operations and free cash flow move a bit lower. I'm sure the acquisitions have an impact on that. Are there any other sort of moving pieces you can point to there? And then again, kind of on the implied fourth quarter guidance, the midpoint implies a step down versus this quarter. Just wondering if you can kind of help reconcile that step down versus some of the tailwinds in the year-end like these acquisitions and probably Permian growth rebounding a bit.

Al Swanson, Executive Vice President and CFO

This is Al. I'll take a shot at the first one. Yes, between the free cash flow and the cash from operations, effectively, the acquisitions reduced cash flow from the free cash flow number by roughly the $135 million that we described. The other two higher EBITDA has been in our forecast is offset by higher taxes as well as our assumed working capital and merchant needs, again which is all kind of timing related. Those were really the three things I would point to. As to guidance from the third quarter to fourth quarter, again, we feel like the midpoint of our range, we do see quarterly flux between them. It would probably be better to take offline with the IR team to kind of any more micro detailing type of discussion.

Operator, Operator

Thank you. One moment for our next question please. Question comes from the line of Jeremy June with JPMorgan Securities.

Unidentified Analyst, Analyst

This is Brian Reddy on for Jeremy. I think it's been hit on a couple of times in the call already but just to clarify, are you guys able to disclose what part of the guidance raise is attributable to the base business strength, given that you guys had already pointed the high in last quarter versus the incremental contribution for the bolt-on acquisitions?

Jeremy Goebel, Analyst

Sure. This is Jeremy. It's roughly $10 million to $15 million from the acquisitions.

Unidentified Analyst, Analyst

Okay, perfect. And then for the second one, last quarter you talked about Canadian optimization opportunities and maybe utilizing some of that underutilized capacity at Sarnia. So curious to hear updated thoughts here and what you guys are seeing in terms of low capital, smaller growth optimization opportunities.

Willie Chiang, Chairman and CEO

Yes, I’ll address that. As we mentioned during the last call, our East West system provides us with an advantage due to the spare capacity in the East, which was crucial for us to quickly address our debottleneck in the West. We continue to focus on various optimization opportunities for both our Empress compact sport SaaS and Sarnia. It's important to note that there are no major new project announcements beyond what we've already shared, but we definitely have capacity that we can further optimize and utilize without needing to initiate new greenfield projects.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from the line of Neal Dingmann with Truist Securities.

Neal Dingmann, Analyst

Just one first quick one. Could you just give an update? I think you've talked about this in the past, just on the minimum volume commitments where you stand there and kind of as you enter '24, how those sit?

Willie Chiang, Chairman and CEO

I'm not sure I understand the question. Can you repeat it?

Neal Dingmann, Analyst

Yes, just on the long haul.

Jeremy Goebel, Analyst

Sure. What I would say is we continue to have constructive dialogues with the customers. Nothing to highlight at this point. The Enterprise announcement is obviously additive to that equation, and market dynamics are such that with the continued acquisitions, enhancing relationships with customers, we feel we're in a good place and we'll give you guys an update when it's appropriate. We do believe in the basin long-term, and these acquisitions and improved recoveries should all support that ongoing growth through the decade and continued contracting in the pipelines.

Neal Dingmann, Analyst

Great. And then just on a second, could you give the latest on the continued Canadian opportunities such as in Edmonton or Ontario around the NGL extraction plant sites or some other things you have?

Jeremy Goebel, Analyst

Sure. Broadly in Canada around the NGL system, I think the opportunities you're going to see is the task is constrained the opportunity for East-West movements and higher margins and other things to purchase additional NGLs. There are opportunities throughout next year that we'll see, I don't know if that's what you're asking for, but it seems to me that there are margin enhancement opportunities around the system and we'll look to use our system to capture them.

Willie Chiang, Chairman and CEO

Yes, Neal, I would like to add that we are very optimistic about Western Canadian gas production as we consider our presence in Canada. With the expected increase in production and the additional takeaway capacity to the West Coast, we believe this will stimulate further production and provide us the chance to capture more NGLs from a wet stream.

Neal Dingmann, Analyst

Great detail. That's exactly I was looking for.

Operator, Operator

One moment for our next question. Our next question comes from Sunil Sibal with Seaport Global.

Sunil Sibal, Analyst

Thanks for all the clarity on the call. So just wanted to understand some of the dynamics on the EBITDA guidance increase. So it seems like from what you've indicated $10 million to $15 million impact of bolt-on acquisitions and at the same time, you're reducing your volume expectation. So is it fair to assume your unit margins are going up? And then any significant driver of that? Obviously, tariffs are increasing, but that was probably well known.

Al Swanson, Executive Vice President and CFO

Yes, I'll take a shot at it. This is Al. In the crude side, we have seen and are expecting more favorable market-based opportunities. We've seen over the year higher movements into and out of Cushing. Our non-Permian assets have performed well, and then clearly the contribution from the acquisitions. In the NGL segment, we've seen benefit from higher, better improved NGL yields. This is likely temporary in the AECO gas stream as well as more attractive differentials West to East, as Jeremy mentioned. So those are really the things that are driving it.

Jeremy Goebel, Analyst

One thing to note is that we view the Permian reduction as temporary. This is building momentum into the fourth quarter and into next year. Therefore, the perception that it slowed down our long-term expectations is due to temporary timing.

Sunil Sibal, Analyst

Understood. And then on the pipeline loss alone with all the recent acquisitions you've done, could you remind us what is your total explore on crude with the pipeline loss alone?

Blake Fernandez, Vice President, Investor Relations

Sunil, it's Blake. Historically, what we've said is 2 million to 3 million barrels; we haven't provided an update to that. I think it's correct to think as more volumes ultimately make their way into the system, that could increase over time, and we'll give an update when appropriate.

Operator, Operator

One moment for our next question. Our next question comes from the line of John Mackay with Goldman Sachs.

John Mackay, Analyst

I wanted to touch on kind of broader picture for Permian long haul. We've had some changes in the market recently, with Seminole coming out of service, the Gray Oak open season seems like it's about to go forward. I guess I'd just be curious to hear from your side where you see kind of overall balances for the market over the next couple of years, and whether or not we could see more conversions out of crude service and to something else?

Willie Chiang, Chairman and CEO

Yes, John, this is Willie. There are many factors to consider here. When I think about the proposed projects, they represent smaller increases, around 100,000 to 200,000 barrels a day. Looking further ahead, with the growth of the Permian, we maintain our view that capacity will become constrained. I don't believe new long-haul pipelines will be constructed. The recent Seminole announcement has impacted this situation as well. There are numerous factors at play, but our long-term perspective remains unchanged. We anticipate that capacity will continue to tighten in a market that will increasingly struggle to maintain long-haul lines.

John Mackay, Analyst

That's understandable. Perhaps we should switch topics. You mentioned working capital a bit in the last quarter, and although it's temporary and should recover, it appeared larger than what we've observed in several previous quarters. As we consider capital returns for next year, including possible buybacks, is there a minimum cash level you would prefer to maintain on the balance sheet? Also, does this quarter's increased working capital draw influence that calculation in any way?

Al Swanson, Executive Vice President and CFO

This is Al. We do see a fairly significant quarter-over-quarter working capital flex. We used the word working capital as if we're building inventory and we're borrowing short term on our credit facilities, it's a working capital use although technically, they're both in working capital. So it's kind of working capital and merchant requirements. We do see quarter-to-quarter fairly significant moves generally over a 12-month period; all those normalize out. We normally model assuming lower cash balances than what we've been running, and we'll be showing that when we show you the year-end balance sheet because the cash balances will have been consumed with the note we just paid down here in October. But normally, we would model about $100 million of cash on the balance sheet and we use our credit facilities in the commercial paper markets to balance this out. It is timing, and we end up reverting back to more of a normalized balance over the course of a few quarters.

Operator, Operator

Thank you for your questions. This concludes today's conference call. Thank you for participating in today's call. You may now disconnect. Everyone, have a wonderful day.