SM Energy Co Q4 FY2025 Earnings Call

Good morning, and welcome to today's call. I'm joined today by our President and CEO, Beth McDonald; and Executive Vice President and CFO, Wade Pursell. We're looking forward to sharing our latest results and our 2026 plan with you and answering your questions. Our discussion today includes forward-looking statements. Please see Slide 2 of our earnings presentation, Page 2 of the earnings release, Page 3 of our 2026 outlook release and the Risk Factors section of our most recent 10-K, which was filed earlier this morning for risks associated with these statements that could cause actual results to differ. We will also discuss non-GAAP measures and metrics. Definitions and reconciliations to the most directly comparable GAAP measures can be found in both the earnings release, outlook release and slide deck. Now I'll turn the call over to Beth. Beth?

Thanks, Pat, and good morning, everyone. It's an exciting day as we provide our first release of the new SM Energy. 2025 was a pivotal year for our company, and it set the stage for 2026 in this transformational moment. We improved on every part of our investment thesis, including returns to stockholders, operational execution, financial strength and increasing the scale and quality of our portfolio. With the full details in our posted materials, I will quickly hit some highlights from 2025. We delivered record operating cash flow, adjusted EBITDAX, production and oil volumes. Importantly, oil was 53% of the total. Our teams found new ways to rapidly apply best practices and increase operational efficiencies through longer laterals and development of deeper zones. We integrated our oil-weighted Uinta assets. Since late 2024, we have applied our proven technical capabilities to unlock greater value from this high-quality oil basin and its multiple stack pays. We strengthened our financial position by reducing net debt by $437 million, ending the year at roughly 1x leverage. As a result, we returned capital to stockholders distributing $104 million through dividends and share repurchases. Lastly, we expanded our scale and inventory across the top U.S. basins through organic reserve growth and our announced merger with Civitas. Now let's turn to 2026. We have 3 strategic objectives that you will continue to hear throughout the year: integrate, execute, bolster. First, Integrate. We are focused on integrating Civitas and capturing $200 million to $300 million in synergies. To date, we have already actioned $185 million of our target, which is close to $1 billion in present value and just under 20% of our market cap. Total synergies could unlock up to $1.5 billion in present value or nearly 30% of our market cap. Next, Execute. Our plan maximizes sustainable free cash flow. By investing in our high-return opportunities, we can continue to strengthen the balance sheet while accelerating the return of capital to stockholders. We will execute with a safety-first mindset and seek new ways to efficiently develop our assets to maximize free cash flow through disciplined capital allocation. We have reset and optimized our activity levels to accomplish this. Here are the key takeaways from the 2026 outlook. Our plan was developed to maximize free cash flow in a $60 oil and $3.50 gas environment. Capital investments will total $2.65 billion to $2.85 billion with our high-margin Permian activities receiving about 45% of the total. Total expected CapEx is about 14% lower than pro forma 2025. With lower capital, we reset activity levels to 11 rigs, down 3 rigs from a pro forma average of 14. We have prioritized value over volume. First quarter estimates reflect only 2 months of Civitas. Looking forward, volumes in the second half of the year are expected to range between 420,000 and 430,000 BOE per day at 55% oil, more indicative of our go-forward run rate. There are a few slides in the presentation that provide more detail and a reconciliation of production for your reference. Ultimately, our plan reflects greater capital efficiency to maximize free cash flow, strengthen the balance sheet and accelerate the return of capital. Lastly, our final objective is to Bolster. This relates to our balance sheet and our return of capital framework. I'll now turn the call over to Wade to cover this important catalyst for us. Wade?

Thanks, Beth. Good morning, everyone. So let's talk about Bolster now and how we'll strengthen an already strong capital structure. Starting with the balance sheet on Slide 15. This reflects the impact of the Civitas merger. I believe the 3 categories for measuring balance sheet strength are #1, liquidity; #2, maturity profile; and #3, total leverage multiple of annual EBITDAX. So first, liquidity. As we announced in late January, and our secured bank facility, the borrowing base was increased to $5 billion, with lender commitments increased to $2.5 billion. The maturity date was extended to January 30, 2031. Therefore, we currently have nearly $3 billion of liquidity. In addition, last week, we announced the sale of select natural gas weighted South Texas assets totaling $950 million, which we expect to close in the second quarter. The metrics behind this deal are very favorable to where SM stock trades today. This will further strengthen our significant liquidity position, which leads me to #2, maturities. We anticipate using some of this liquidity to take out all of the 2026 bond maturities this year and the $417 million bond due in 2027 at some point as well. The remaining maturities are staggered nicely. We'll continue to deleverage with our free cash flow. We may also look to term out some of the earlier maturities should the bond market terms look compelling. I should also mention that we recently received credit upgrades by S&P and Fitch. Now number three, total leverage multiple. Our total pro forma leverage is in the mid-1s area. We are comfortable with this area given the liquidity and maturities profile just discussed. However, our goal is to drive it down into the low 1s area, further strengthening our position, which is a perfect segue to the return of capital on Slide 16. The increased scale and quality of our assets, combined with our strong balance sheet, give us confidence to increase the fixed dividend by 10% to $0.88 per share annually. Our base fixed dividend remains a core component and with this increase provides a current yield of just under 4%. Remaining free cash flow will be allocated between debt reduction and stock buybacks, enabling us to deleverage from increased post-merger debt levels while continuing to take advantage of the compelling value we see in our equity. Today, our plan is to allocate 80% of our quarterly free cash flow after dividends to debt reduction and 20% to stock repurchases. Looking forward, as we reduce debt, we would expect to increase our allocation to share buybacks. And on that note, I'll turn the call back to Beth for closing remarks. Beth?

Thanks, Wade. As our results and plan demonstrate, we are relentlessly focused on maximizing free cash flow, reducing debt and accelerating returns to stockholders. We have new flexibility in how we allocate capital across our expanded portfolio, where our inventory now spans more than 8 years. As such, we are able to prioritize value over volume. We look forward to reporting on our progress throughout the year. Joe, this concludes our prepared remarks, and now we're ready to take questions.

And our first question comes from the line of Brian Velie with Capital One Securities.

I thought I could maybe dive in here real quick. In terms of total production guidance for this year that you put out your initial numbers last night there, you pointed out in the release that a portion of the decline year-over-year is the result of the 3-stream conversion to 2-stream conversions. I wondered if you could talk through where those conversions are happening to help give us an idea of the magnitude of that piece of the impact. And then maybe after that, how we can think about modeling or anticipating price realizations that go with those NGL and gas streams on those assets?

Yes. Thanks, Brian, for that question. The plan is really focused on prioritizing value over volumes. We're maximizing free cash flow to bolster the balance sheet and enhance our return on capital framework. We have a lot of confidence in this plan, and we understand there's a lot of movement going on within the production itself. If you turn to Slide 9, you can see a reconciliation for your reference. And when you normalize for all those moving items, the production change is not that different. Let's speak specifically to the question that you had on the 3-stream to 2-stream conversion. If you look at it by basin, there's really no change for SM South Texas or Uinta Basin clearly. For the DJ, we would exit about 20% of DJ BOEs to be allocated to NGLs. So when you're modeling that, you can continue to use Civitas' historical gas and NGL realizations as estimates. When you turn to the Permian, the value is really small. We really only expect about 5% of the BOE to be reported as NGLs going forward there. And you can use Civitas' historical NGL realizations. And for Permian gas, you could use SM's realizations. So within that reconciliation, I think it's important that most of you guys kind of focus on the right-hand side of that slide, the second half '26 volumes, which are expected to be the 420 to 430 MBOE per day at 55% oil and that's really where we start to see our capital efficiency increase as we have our go-forward run rate.

Yes, if you look at total capital, Brian, about 45% will be in the second half. So if you think about what that run rate looks like, I think it's going to look pretty capital efficient.

Okay, that's great. That's a good transition to my follow-up, if I may. I noticed your first quarter capital expenditures are heavier compared to a consistent distribution throughout the year. Would it be accurate to assume that part of this is related to the pro forma total of 14 rigs that Beth mentioned in her prepared comments, which appears to be your starting point, and from there, you're planning to reduce to about 11 rigs by year-end? Is that what's influencing that higher spending in the first half, or is there something else that I should consider?

Yes, I'll start and then let Wade finish on that. First of all, we just love the strength of our combined portfolio. And this transaction really provides us some optionality and really, frankly, optimization beyond what either company could do individually. With that, we come into the year with 15 rigs. So we started with a high CapEx spend and then it will lower throughout the year to average out around 11%. And so yes, there is that optimization of the program on the back half of the year. And we really look forward to our technical team, seeing them in action on this new portfolio and seeing that continued optimization on the back half of the year. Wade, do you want to add anything?

No, that covered it well.

Next question comes from the line of Tim Rezvan with KeyBanc Capital Markets.

I want to follow up. Wade, we had a quick chat last night. You mentioned that you won't have a formal debt or leverage target going forward. Our modeling, which is a work in progress, indicates a path to below $5 billion by 2027. I know you emphasized liquidity, but we are also considering the other side where we appreciate your transparency regarding the 8-year inventory life. Given that this is possibly shorter than some competitors or your desired timeframe, how do you view the proper leverage profile since you aren't quite where you want to be with inventory life? I'm trying to balance these two topics.

Yes, that's a great question, Tim. We are quite pleased with our inventory. Regarding leverage, I mentioned that we're in the mid-1s area, which makes us very comfortable. I emphasized this earlier, and it remains true, especially considering our liquidity, maturity profile, and the oil price being calculated at a mid-cycle level or lower. This is crucial to note. Our goal is to bring leverage down into the low 1s area, which I would describe as 1.2 or 1.3. If our liquidity position remains consistent, the maturity profile is manageable, and commodity price assumptions are reasonable, we will increase the percentage of stock buybacks as we move toward that low 1s area.

Yes, Tim, I want to address the inventory briefly since you mentioned it. The inventory was valued at $60 and $3, which is quite different from last year when it was at $70 and $3.25. Our inventory consists of high-confidence locations rather than just random spots on a map or acreage calculations. We are very confident in the high-quality, low breakeven inventory we have, which is leading to longer laterals and improved capital efficiency.

Okay. I appreciate the context. And then as a follow-up, this is sort of a related theme, Beth. That the Permian assets you're acquiring from Civitas, on the Midland, you've operated there obviously many years. Civitas had commented in the past, about really focusing on the Wolfcamp A and B for their inventory. They didn't talk about the Jo Mill, the CRD or even the deeper intervals. So I know it's early days, but that's probably the easiest asset to sort of integrate given your skill level there. Can you talk about what's sort of baked into that 8-year number? Are you using those same assumptions that Civitas had? Or maybe broadly speaking, do you anticipate organic additions as you do more work on the Civitas Midland assets?

Yes, good question, Tim. The first thing I would say is that we love the strength and position of our portfolio, especially as it relates to the Midland Basin and our technical team is jumping right in and combining with the prior team from Civitas which we now just call those people our teammates at SM Energy. But we're very happy with what we've done so far. We're 4 weeks in, but we'll continue to use our high-quality, multivariate analysis, our geomechanical modeling that we have going on in the Southern Midland Basin as we optimize that stacked pay development. And we'll continue to see those optimizations in the back half of this year and into '27. So is the work done? No. We have a lot of work to do, but we have the best people and the best processes, along with the best technical data to get us there.

The next question comes from the line of indiscernible with ROTH Capital Partners.

My first question is whether you can explain the capital and production cadence for 2026. I understand it will be weighted toward the first half, and production is expected to be around 420,000 to 430,000 BOE per day in the second half of the year. I'm curious if the capital in the first quarter will be the highest of the year and if production will peak in the second quarter of 2026.

I'll begin by addressing that. We are focusing on value rather than volume in our strategy to optimize free cash flow. We acknowledge that the first quarter and into the second quarter come with certain variables and changes, as highlighted on Slide 9. It's crucial to consider the legacy Civitas assets, which experienced high capital expenditures initially, and we saw a notable decline of about 14% in those assets from September to January. We have incorporated this decline into our program, which is a factor not reflected in this reconciliation. The key takeaway is that as we approach the second half of the year, the run rate for that time is favorable. We plan to allocate 45% of our capital in the latter half of the year, which will have a 55% oil mix. This is where you should concentrate, as there are fewer fluctuations anticipated in the first two quarters.

And it's built to where it rolls right into 2027 at that level.

That's very helpful. So maybe my second question would just be about the cash tax. Do you expect to pay any cash tax for 2026?

Yes, we expect cash taxes to be very minimal this year. I'm happy to share that this is primarily due to the advantages provided by IDCs and some benefits from the recent legislation. Despite the divestiture and the associated gain, we anticipate only minimal cash taxes this year.

The next question comes from the line of Oliver Huang with Tudor Pickering & Holt.

For my first question, just when you're thinking about the Permian program that you all have laid out for this year, any sort of color you can provide around the composition of the program, just how much of that activity is expected to come out of the Delaware? And then when we're looking at the Midland, any sort of split on your traditional oilier RockStar area versus the southern part of the basin where assets carry a higher GOR mix?

Yes. Let me get started. We really appreciate our strong inventory position, particularly in the Permian Basin. We consider this a key asset for us, and we will continue to enhance it over time. The program has a significant portion allocated to the Permian due to its excellent returns and margins. The program's composition consists of about one-third Delaware and two-thirds Midland Basin. Within the Midland Basin, we are still refining the allocation across the overall program. We will keep doing that to improve our returns and capital efficiency through this year and into 2027.

Okay. That's helpful color. And maybe just for a follow-up question. I know you all mentioned earlier that back half of the year run rate seems like a good starting point to carry forward. Just given all the moving pieces for A&D, the conversion to 2 stream on certain volumes, any sort of color on where maintenance CapEx for you all sits on a pro forma basis at that run rate?

Looking ahead to 2027, we haven't yet delved into the specifics that we will eventually address. However, if you assume that capital expenditures will be similar to this year's or slightly less, you should be within that range.

Okay. Perfect. And just to clarify, when you say this year's CapEx, is that assuming 12 months for both Civi and SM or what you all have kind of rolled out for the 11 months of Civi and 12 months of SM?

I'm assuming the guided number there when I say that.

That's one time cost.

Next question comes from Michael Scialla with Stephens.

I wanted to ask about Slide 4 and how it shows the percentage of production from each of your four core areas compared to the capital expenditures on Slide 8. They seem somewhat similar. I understand that production is an outcome rather than a target. However, considering this information, do you expect production to grow in any specific area? Is it possible that production is increasing in the Uinta while decreasing slightly in the DJ and Permian? What can we infer from the amount you're spending versus your expected production profile for each of those regions?

Yes. Thanks, Mike. I'll just start and then I'll let Wade add any color to what I'm saying. If you look on Slide 4, those are really the 2025 production volumes, and where that stands kind of on a pro forma basis? And then as we roll into 2026, just like you said, we're prioritizing value over volume specifically. When we looked at the capital allocation across all of the basins, we're really focused on maximizing free cash flow. That's why on Slide 8 in the bottom right, you see the capital allocation by basin. And I think that really addresses most of where the production is as well as kind of the split there in the Permian of 1/3 to Delaware and 2/3 to the Midland Basin. Do you want to add anything?

No, that's good. I mean, as you know, Mike, we built the plan with a focus on sustaining free cash flow over the years through efficient operations in those areas. That's all I would add.

Okay. I guess I was just trying to think of, is one area of sort of looked at as more of a free cash flow generator or cash cow, while you're trying to grow any of the areas. It looks like Uinta maybe has some ability to grow? Is that a fair assumption?

I'd say, when you look at the combined portfolio, we've known that Uinta and South Texas, both are growth areas for us. We have multi-stack pay there with great returns. And I think as we look at the combined portfolio and the strengthened position that we have in the Permian Basin, we'll continue to evaluate that with our technical teams to see how we can continue to grow that area because it has such great returns and great margins as well.

There are no further questions at this time. I'd like to hand the call back to Beth McDonald for closing remarks.

Thanks, Joe. Thank you all for your time today and your questions. As we close, I want to reiterate our 3 strategic priorities of integrate, execute and bolster. First, integrate. The Civitas integration is progressing well, and we are really pleased and proud with the strong performance of our team. We've already actioned $185 million of our $200 million to $300 million target which represents under $1 billion of present value or nearly 20% of our market cap. For execute, we're focused on execution across our scaled strengthened portfolio to maximize free cash flow and deliver differential stockholder value. And bolster, we recently announced our $950 million divestiture that will strengthen our balance sheet and accelerate return of capital to stockholders under our new return of capital program. We look forward to seeing many of you in the coming weeks. Have a great day.

Thank you. This concludes today's conference. You may disconnect your lines at this time, and enjoy the rest of your day.