Talos Energy Inc. Q2 FY2024 Earnings Call

Good morning ladies and gentlemen, and welcome to the Talos Energy Second Quarter 2024 Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Thursday, August 8th, 2024. I would now like to turn the conference over to Clay Jeansonne for the start. Please go ahead.

Thank you, Operator. Good morning, everyone, and welcome to our Second Quarter 2024 Earnings Conference Call. Joining me today to discuss our results are Tim Duncan, President and Chief Executive Officer, and Sergio Maiworm, Executive Vice President and Chief Financial Officer. For our prepared remarks, we will refer to our second quarter 2024 Earnings Slide presentation, which is available for viewing and downloading on Talos's website. Now let's start on Slide 2, cautionary statements. I'd like to remind you that our remarks will include forward-looking statements. Actual results may differ materially from those contemplated by these forward-looking statements. Factors that could cause these results to differ materially are set forth in yesterday's press release and our Form 10-Q for the period ending June 30, 2024, filed yesterday with the SEC. Forward-looking statements are based on assumptions as of today, and we undertake no obligation to update these statements as a result of new information or future events. So in this call, we may present GAAP and non-GAAP financial measures. A reconciliation of GAAP to non-GAAP measures is included in yesterday's press release, which was filed with the SEC and is available on our website. And now I'd like to turn the call over to Tim.

Thanks, Clay, and welcome everyone to our call. We're looking forward to highlighting a fantastic quarter from an operational and financial execution standpoint and introducing a new project we picked up in the quarter. Let's dive right into the slide deck, starting with slide 3. On this introduction slide, I like to begin on the right side of the page and discuss the core tenets of our strategy. We prefer oil-weighted production in the Gulf of Mexico and believe it's crucial to have infrastructure that allows us to focus on short cycle times in our drilling inventory and lower break-even points. If we execute that program effectively, it leads to consistent generation of free cash flow, which we certainly experienced in the second quarter. We have always been committed to maintaining low leverage throughout our 13 years of operating Talos Energy, which has positioned us as the fifth largest operator in the Gulf of Mexico and the fourth largest acreage holder there, with production guidance for the year ranging between 89,000 and 95,000 barrels of equivalent per day. This quarter really emphasizes the impact of our journey and what our team has achieved. On Page 4, we'll go over some highlights from the quarter. I want to draw your attention to three key figures: 955,000 barrels of oil per day, $344 million in adjusted EBITDA, and $148 million in adjusted free cash flow. All of these are records for our company in this quarter, and we take great pride in that. They are supported by having 81% oil liquids, leading to a $40 BOE net back EBITDA margin. We invested $123 million in capital this quarter, resulting in a 36% reinvestment rate based solely on our capital program. Including $22 million spent on P&A, the reinvestment rate rises to 42%. As we've mentioned in previous calls, this year was expected to provide robust free cash flow generation due to new project deliveries and the addition of the rig in the second half of the year, which our team has successfully executed. With that free cash flow, we also continued to reduce our debt, paying down $100 million and using some of our previous buyback authorization to repurchase 3.8 million shares in the open market. We increased that authorization for an additional $150 million, as mentioned in our earnings release. On the left side of the page, I want to highlight a couple of things. While maintaining our leverage at 1 time, we achieved that goal early in the first quarter due in part to the sale of our CCS business. Our integration and synergies are progressing well, and I look forward to discussing that further in a few slides. The HP-I drydock went smoothly, as we expected, and we are excited to introduce a high-impact project called Monuments. It's our first real Wilcox play, which we have researched for some time, and we will discuss it later in this call. Moving to Slide 5, I want to commend our team's hard work in executing our core business this year, completing the important QuarterNorth transaction, and then swiftly integrating that transaction. This enabled us to deliver a pro forma business that reflects the strong results illustrated on this page. Our goal was to execute our core business effectively while bringing new projects online in Venice and Lime Rock, and integrating QuarterNorth to lower our base decline, ultimately providing more consistent results each quarter. As shown in the first two quarters, we exceeded consensus on production, adjusted EBITDA, and adjusted free cash flow significantly, particularly on adjusted EBITDA in the second quarter. On Page 6, our focus for 2024 remains clear as we prioritize executing on these assets and generating substantial free cash flow. The $148 million in free cash flow from the second quarter, combined with the first quarter, brings the total adjusted free cash flow for the year to $225 million, indicating a remarkable free cash flow yield. I'm pleased with that and satisfied with our business execution. I've mentioned earlier about completing QuarterNorth, and I want to update our guidance for the third quarter, which is expected to be between 92,000 and 97,000 barrels equivalent per day. This is a bit wider than our guidance for the second quarter of 93,000 to 96,000, which we find appropriate given the weather season, and we look forward to meeting that guidance. Our financial execution has been robust this year, having reached our one-time leverage target in the first quarter partly due to the sale of CCS. We plan to maintain this level and work to gradually lower it throughout the year. Being ahead of schedule allowed us to buy back shares in the second quarter, and we will continue to generate significant free cash flow. There might be a slight slowdown in the second half of the year as we receive the West Vela rig to drill our high-impact program, but we remain excited about our prospects. We're enthusiastic about the developments at Katmai and the prospects we are preparing for 2024 and 2025, especially the Monument project we recently invested in, which brings exceptional value. In the midst of all this, we are committed to adding value strategically, and the Monument project serves as an example. We're entering post-FID at a low entry cost with immediate value add. We will delve into this project in more detail shortly. Let's continue with the execution and discuss the integration of the QuarterNorth asset. The team has done an excellent job; we were able to close this transaction ahead of schedule, which facilitated our transition to physical integration. This includes aligning offshore personnel with our offshore assets, consolidating office spaces, and overhauling accounting systems, a significant undertaking that required great effort from many individuals. Although this surge in activity likely raised our G&A figures in the second quarter more than we would have liked, I expect a substantial reduction in those costs in the third and fourth quarters. We may have slightly overshot our G&A in the second quarter to ensure proper completion of the integration process, but you can anticipate a decrease in G&A going forward. We are particularly excited about the synergies we've identified to enhance our business moving forward. Previously, we estimated savings from integrating these assets and anticipated approximately $7 million in insurance synergies; however, we've achieved around $10 million in savings. Initially, we forecasted $25 million in synergies from QuarterNorth for 2024, coinciding with the $5 million savings from the TLCS CCS business sale, raising our projection to $30 million. We are now revising our forecast upward to about $35 million, resulting in an overall synergy forecast increase to the $65 million range.

Thank you, Tim, and good morning, everyone, and thank you for joining our call this morning. Before diving into the next slide, I just wanted to provide a couple of thoughts on the business so far and going forward. We continue to be laser-focused on execution of our business plan as evidenced by the performance in the second quarter. It's another quarter of very strong execution in delivering results above and beyond the market expectations and I expect this execution to continue in the second half of the year as well. We're reaffirming our full-year operational and financial guidance and we expect to hit all of our numbers in the coming quarters. We are also providing third quarter production guidance of 92,000 to 97,000 barrels of oil equivalent per day which is in-line with current market expectations. It is a bit of a wider range than usual, but that is reflective of the fact that we are entering the thick of weather season offshore, so we think this range is appropriate at the moment. Tim already highlighted monuments, but I just wanted to touch on a couple of different points. First, as Tim mentioned, the net value creation of acquiring those assets is $265 million which is greater than 10% of our market cap. So just by bringing this asset into our portfolio, we're immediately creating significant shareholder value just by having this asset and delivering on this asset in our portfolio. The other point that this asset further bolsters our inventory by preserving other high-quality locations of inventory for future drilling. Lastly, I just wanted to thank the incredible Talos team for the very successful integration of QuarterNorth and for working diligently in finding additional synergies and I believe that we're going to continue to do that going forward.

You know, Sergio if I can jump in as well. As you think about the things I talked about earlier in my slides and we think about the Sunspear completion which is actually a probable undeveloped, if you think about all that upside we see in the broader Katmai complex, those are things that are outside the proved. And so if we think about this business and proved as a proxy value for how to think about the value per share, the next question is fine, but then how confident can I be that they're going to deliver and continue to deliver and have that proved to be sustainable. I think the message we're trying to deliver is we've got a lot of that value outside of proved that we think creates the sustainability of this business. So we are looking forward to that execution and then ultimately revisiting the impact that has on slides like this which leads me to Page 17 and why we think the equity value of this company is determined to go up and we think it's certainly a discount for those entering into the equity story now.

Ladies and gentlemen, we will now begin the question and answer session. Your first question comes from the line of Neil Mehta from Goldman Sachs. Your line is now open.

Yeah. Thank you, Tim, Sergio and team and congrats on a very good free cash flow execution this quarter. One specific question and then one big picture question. The specific one's on monument. Can you talk a little bit more about how that came together and the market has received it well? Are there other opportunities like that as we think about the opportunity set in the Gulf of Mexico?

Yes. Hi, Neil thanks and welcome to the call. I think it came together just as we've been building such a big acreage position. I talked about in the remarks that when we do these transactions, we underwrite prove, but we typically buy big acreage positions around these transactions. Look the last few transactions came with over 700,000 acres, and then we also participate. And we're typically a top five participant in deep water in these lease sales. And so we've had our eye on the trend and had our eye on the play. If you look at that slide where I highlight the Wilcox, I noted this Coronado well that has pay in it. We picked that up in a transaction in 2019. That was our entry point and then we started building from there. So you've got two things in play. Did we build an acreage position around this before this deal? Yes. Now, how do we think about the right way to enter and the partnership in which to enter? And so Beacon's a great operator. This is really their kind of focus is Wilcox development. They are a partner of ours. If you go to the drilling calendar there was a well Clayburn where they're a partner of ours. So we knew them well. We've also announced a partnership in an exploration JV with Repsol over the last six months that we're working on. So we have partners that we recognize that are developing a major project right around the acreage position that we've been building. So it's a great spot for us to watch this come together. And then specific to the project monument, Beacon's already drilled four wells recently in their phase one campaign. They are constructing a facility that will be delivered in the first quarter. They expect production in the second quarter. So we are going to get a front row seat in watching that come develop as we start to spend capital on this project in 2025 and then ultimately drill and complete a couple of wells and get them online in late 2026. So acreage position came together over time, partners that we recognize, active activity where we can watch and learn. And ultimately, we think that helps with the execution of the other acreage we've put together. So it's a lot of things coming together to make this work, but it's part of the evolution of the company as well.

Thanks, Tim. And then the follow-up is more big picture question which I really like, Sergio your Slide 16 that walks through how you guys think about value. And the area that I would imagine that you would get pushback on this calculation is really the use of PV-10 because there's implicit I think with the stock trading worth of a 20% free cash flow yield, a view that the cost of capital for Gulf of Mexico E&P is higher than a 10%. So how do you respond to those out there who think that the cost of capital is well higher than the traditional PV-10 metric and how do you change the market perception about the risk profile associated with your operations?

Yeah, sure, Neil. Thanks for the question and thanks for joining us. Look and I mentioned that in my prepared remarks as well, right? We do recognize that some folks may think about the discount rate here or the cost of capital a little bit higher than the PV-10s and that's fine. But I think the main focus of that comment was that there is so much value above and beyond PV-10 above and beyond proved reserves, that even if you assume a higher discount rate, there's so many other avenues that you can get to a much higher stock price or market capitalization than what we currently have, that folks should feel comfortable, even with a higher discount rate, that the stock is actually pretty undervalued compared to the fundamental value of our business, right, even at a slightly higher discount rate. So I don't necessarily disagree too much with perhaps a little higher than PV-10 would be the most appropriate discount rate of the business, but I don't think it's that much higher either. But even if you assume that, you can still arrive at a much higher valuation than currently.

Yes, and I think what I tried to add to that, Neil, is I think investors can ask, look, these guys have now built a certain level of scale, a certain level of diversity, that we've built into the asset set pro forma from the QuarterNorth transaction. And, can they keep it up? And I think that's where you dig into the projects and you think about something like Katmai, and you think about something like Monuments that we've added, and then you think about the drilling portfolio that we're going to execute next year and how we think about layering that on year-over-year. I think we're just in a heck of a lot better position. And most of that value is outside proved, as Sergio alluded to.

Your next question comes from the line of Leo Mariani from ROTH. Please go ahead.

Hi guys. Question here on Monument. Obviously nice to see the project enter the fold. I know you guys commented that a little bit of additional CapEx to Monument this year basically is kind of counterbalanced by a little bit of other CapEx that may be slipping a little bit into next year. But as we look into 2025 or 2026, really just trying to get a sense of the capital that you folks are talking about on the Monument project, do you view that as really kind of additive to the budget over the next couple years? Or can Talos continue to shuffle some things around and possibly push out a few other projects so that the $160 million over the next couple years isn't necessarily completely additive but might take the place of some other spend?

Yes, that's exactly right, Leo. And if we think about the incremental spending on Monument, and again we alluded to that being $160 million net to our interest in 2025 and 2026, probably two-thirds of that weighted into 2026. And so, we don't expect to change the long-term view of how we think about capital inside the budget. We can move some projects around. So much of our acreage position is operated. It is under our control. Frankly, it's around our infrastructure. So we'll be able to still, as we think about broadly putting the year-over-year program together, it'll just be around shifting projects. Look, we've said that we're not going to bury ourselves in the rig market. We are going to try to be opportunistic there. And so there are a lot of moving pieces that will allow us to let this fit right in, particularly in 2025, and then we've got plenty of time to manage around 2026. So I think we were in a good spot, and it worked out that we were able to add this project and not change any of our guidance for 2024 as well. So everything looks good in that regard.

Hey, Leo, this is Sergio. Let me start with the share repurchases question and then Tim can address the Carlos Slim part of your question there. Look, the share buyback program, that's an opportunistic program. We are going to continue to evaluate the market. We're going to continue to look for opportunities to do all of that. Same with the debt repayment. We have a goal of continuing to deliver the balance sheets, and we're going to continue to do that. But if the right set of circumstances present themselves, I think we would absolutely look for potential buybacks. So I don't think it's going to be one or the other. I think there could be a possibility of us continuing to evaluate doing both throughout the remaining of the year.

Look, on the Slim family office and purchasing of our shares, we got to know, obviously the entire organization last year when we transacted around Zama. And I certainly don't want to speak kind of for their investing history, but I think it's well documented on telecommunications and infrastructure and banking. And I don't know how much they've done specifically to upstream oil and gas. As they got familiar with the project, familiar with how we execute our business, I think they saw a long fundamental view in the company. I think they have a long fundamental view on the constructiveness of the commodity, and we became a good investment for them. Look, they've been nothing but supportive so far for us. It is something we can keep an eye on, but we certainly, like having such a sophisticated, long-term, fundamental holder of our stock. And so, we don't communicate with them often on what they're thinking. There is just really the Zama project we have in common. But, we know that they're weighing up on energy-related items, and they have a fundamental view that our stock's cheap, and certainly we appreciate it.

Hey, good morning, guys, and congrats on a strong quarter. My first question, I was just hoping you could provide a little color on the CapEx guidance for the back half of the year. Based on first half actuals and the drilling schedule on Slide 8, it looks like a little step up in the back half of the year. Do you see this being fairly level-loaded, or is the end of the year going to be a little higher than 3Q?

I can start there Jarrod. This is Sergio, by the way. Look, we're still thinking that it's relatively level third and fourth quarters. Obviously, with the rig, the West Vela, arising towards the end of the third quarter, that may shift around a little bit depending on when the rig is actually delivered. But I would say it is probably going to be relatively balanced on both quarters.

But heavier than this quarter. Yes, look this has been a fantastic quarter. We knew it might be a little lighter on CapEx. We were hot on P&A in the first quarter, so it would be lighter in the second. And that allowed us to generate just an impactful amount of free cash flow. As we get the rig delivery, we'll see what happens in the weather season. We'll probably have a little more CapEx spend, and then we'll see where free cash flow lands.

Perfect. Thank you. And then my last one is just on the Lobster water flood. I know in the release you said you don't expect to see the production increase for 12 months to 18 months. But I was just kind of curious if you've seen any response on it yet.

Well, we've seen very good performance on injection. I mean, the difference there compared to, say, the tornado water flood. And keep in mind for those just trying to understand this is a water flood project where we are not sourcing any outside water. All of it is coming from other wet sands inside the same geological well bore. And so we are pulling these wet sands in. They then flood the pay sands and ultimately up dip geologically. Other producing wells start to increase their production and increase their reservoir pressure. So it worked marvelously at tornado. That was deep water. Those rock properties were world-class here, a little bit more of a mature field, actually a bigger structure in more wells. It's going to take a little longer to get that water to influence those wells. But the first measure is, can you see the injection happening and working? And we're seeing it work unbelievably well. In fact, I would tell you, we're injecting probably 50% more water than we anticipated. And so we think we'll start to see some responses in the next several months. And then we'll start to see real production increases as we get into 2025. But we're absolutely happy with the way we've completed the wells and the way we are getting injection into the reservoir. And that's the first thing you have to have. If it starts to back up on you, then something went wrong in terms of what you thought about the geology, but everything is working out like we hoped it would. In fact, probably better.

Thanks. Good morning, Tim. Are there other opportunities across the asset base for water floods like you've done at tornado and lobster?

I can promise you, as soon as it started working on tornado, we started gowering the assets for another idea. And lobster was that idea. I think it's tricky. You've got to really check a lot of boxes. Frankly, you've got to have a little bit of nerve and courage to just do it. What we are doing. These two projects. We're great examples of it. Again still a lot to do on the lobster side. We'll keep looking. I think we have a team that, when you feel you taste a little bit of success and that effort has paid itself, you start looking for other ideas. I don't have one on the horizon, as I answered a question for you, Jeff but look, I mean, the fact that we found two ways to use this application, both in deep water, which again was the first of its kind in the world. And it is such the environment. And then in this shelf where it's been done before, but not in a while. You know, we are happy with what we're doing in that side of our portfolio.

Can you talk about at a high level, how you think about the capital program in 2025? Just with all the moving parts of consolidation and whether or not there are additional opportunities like you've executed on Monument. Do you want to keep dry powder, I guess, as a question for the thing that you don't know today?

Well, I mean, I think you have to be, you know, kind of flexible in how you build your plans that you can move some capital in and out so you can fit a project in. But, you know, as we think about 2025 and any year we start thinking about, you know, walking into the next round of drilling, in our basin, it gives us three things. It gives us good geology, good pricing and infrastructure. And we've got to just keep working on how to utilize all three of those in our drilling program. So although we have some really high-impact things happening with what's going on in Katmai, Daenerys and now Monument. We've got to go back and find those exploitation, blocking and tackling things like Venice and Lime Rock, which is what we are doing in Sunspear and putting those more projects in the portfolio next year as well. Somewhere in there, we've got to be tactical around our assets in business development. So we always have a little bit of dry powder. We bake into the guidance and we bake into the budget in case something comes our way that can be tactical and can fit in. If it really, really makes sense, then we have to come back to the market and say, look, now we are talking about outside the budget capital allocation. You know, that's a decision we can certainly make at the board level and see how that ranks against debt repayments and something like a share buyback. But, you know, we like where the opportunity set is in the Gulf. We like what the extra infrastructure of the last transaction and including the infant transaction, is done in our ability to put together a portfolio of opportunities.

I'd like to ask one quick question on Mexico. With the change in the administration, does that impact at all any of the discussions with respect to progressing Zama, or is that still just all handled at the ministry level?

Yeah, it really doesn't. I mean, I think it is really more, you know, there was obviously a lot of moving pieces when we were arguing over unitization and operatorship and there's been a little more stability by adding such a big local content partner like the Carso organization. That changed some of the development plans and now some of those, you know, kind of reworked and re-compromised development plans are going through a feed study and then I think we'll have some updates on that as we get to the second half of the year. So, really all that is less related to the politics and more related to just new partnerships, compromised field development plans, putting that into a feed study, and then ultimately getting it closer to FID. So really unrelated to the politics.

Hi, good morning. I just had a couple. You know, one listening to the discussion and sort of what you laid out in your presentation, it sort of got me thinking, maybe like as a reality check, do you see, I guess I'm wondering if you're seeing the same signs I am, are you getting any signs of investor awareness of just creating value through conventional geology in E&P? And another thing that makes me wonder about this is we've seen some sort of out of the blue onshore A&D in basins, looking to redevelop conventional targets. And then sort of the discussion about looking beyond proved reserves to the possible and probable, they seem like sort of positive throwbacks. So I just wonder if you're seeing any appetite out there for just people seeing value creation through geology.

You know, that's a tough, I look, it's a great question. I frankly love the question. It's a tough one to answer. You know, it's not, when we talk to some of these investors, we try not to say, hey, look, why don't you focus more on us and away from whatever you are doing, you know, from time to time. We understand, you know, the views of thinking about multi-year inventory and tills and how that fits across acreage set and how all that fits into a shareholder return model. Look, we aspire to get this company to a place, you know, where it's got the scale and diversity to deliver on those things as well. And doing the buybacks, I think it is important first step for us. But I do think one thing we try to always emphasize about this basin, it has been the second biggest producing oil basin in the country for a long time and for a sustainable amount of time is that some of the things that we talk about when we think about onshore shale inventory, i.e. the next one is the next best one because the geology is so described and the technology is so well understood that that's what you should assume. You should not have those assumptions in the Gulf of Mexico. We reinvent this basin over and over again. The technology here is really about drilling applications, subsea applications and seismic applications. And we kind of illuminate things this year that we just couldn't see 10 years ago. So I think it is an opportunity to bring investors back to the basin and say, hey wait a minute, some of the assumptions that I just presumed to make when I look at some of my onshore candidates of things to go buy, when I go offshore, these guys have been able to put drilling campaigns together again and reinvent themselves and utilize that infrastructure. They have the benefit of the pricing. They have the benefit of being oil-weighted. One thing we didn't talk about, Monument, it's 91% oil-weighted. That's going lead to significant net back margin. So, there are some things that we think the boxes that this basin still checks that you can't always check as easily on somebody onshore plays, recognizing there's some really interesting plays there. We're not trying to push away from that, but we're trying to reintroduce and provide that optionality in someone's portfolio, what our company and what our assets can bring to bear. And frankly, the fact that they are undervalued right now is a great opportunity to enter, kind of enter the equity.

Right, absolutely. And you hit right on where I was going, which is sooner or later, depending, all whether new play or rediscovered play, you do run up against inventory. And that's very much been a driver of consolidation onshore. And it, again, sort of leads me to the idea of, sort of, I was saying before recognizing value in bases that for technology do, can go a lot further. And it does seem that this long period with capital investment kind of on a global level of under-investment in new exploration. And a topic I've heard more this running season, on the horizon, maybe really serious issues with fighting base decline that, again, it is sort of a dull, long-term topic, but it's kind of, once again, we're sort of right back there and inventory is just kind of the latest sort of symptom of it?

Yes. Look, and I think, again, some of the onshore plays you're in core areas. Now, look, let's not underscore that their completions are more efficient and they are being more efficient with that acreage. They're finding new benches. So, again, I'm not going try to campaign against that. I appreciate the emphasis there. But I do think when you go offshore, and you go to conventional geology, if you can find the right mix of risk and reward, you can bring in some assets. And look, we obviously have confidence in Hope Katmai as one of them. They just have a different decline profile. Now, offset that, you don't get as many shots on goal in deep water, but then you do have an opportunity to find material things and put those into your portfolio. And those are differentiating. And, geology is laid down asymmetrically. It's a log-normal distribution of outcomes. And ultimately to drive the skewness, you have to have some really interesting big projects in the portfolio. And conventional geology, offshore operations, it allows you to introduce those from time to time. And frankly, when you step back from that and put it on a global scale, I think big offshore projects have differentiated a lot of otherwise onshore weighted companies. And we can think about things happening in Guyana and Trinidad and Tobago and Namibia. So look, we are early in our journey, but I think we've got the right mix of skills in the company to build something from here.

There are no further questions at this time. I'll hand the call back over to Tim Duncan for closing remarks. Sir, please go ahead.

All right, thanks. Look, we appreciate everybody joining the call. It's a great quarter for the company. It's a great quarter for everybody involved in how hard we've been working to show the market that this collective set of assets can be differentiating for us and generate some cash flow. It is also kind of a turning point on where we are trying to take the company, the execution we're trying to deliver and the value we're trying to add. So really appreciate everyone's attendance and we look forward to visiting you guys after the third quarter.

Ladies and gentlemen, this concludes today's conference. Thank you very much for your participation. You may now disconnect.