Western Midstream Partners, LP Q2 FY2021 Earnings Call

Good day, and welcome to the Western Midstream Partners' Second Quarter 2021 Earnings Conference Call. All participants will be in listen only-mode. After today's presentation, there will be an opportunity to ask questions. Please note, today's event is being recorded. I would now like to turn the conference over to Kristen Shults, Senior Vice President, Finance and Communications. Please go ahead, ma'am.

Thank you. I'm glad you could join us today for Western Midstream's Second Quarter 2021 Conference Call. I'd like to remind you that today's call, the accompanying slide deck and last night's earnings release contain important disclosures regarding forward-looking statements and non-GAAP reconciliations. Please reference Western Midstream's most recent Form 10-K and Form 10-Q and other public filings for a description of risk factors that could cause actual results to differ materially from what we discuss today. Relevant reference materials are posted on our website. With me today are Michael Ure, our Chief Executive Officer; and Craig Collins, our Chief Operating Officer. I'll now turn the call over to Michael.

Thank you, Kristen, and good afternoon, everyone. Yesterday, we reported second quarter 2021 net income of $226 million and adjusted EBITDA of $491 million, an 11% increase over the prior quarter's adjusted EBITDA. With strong producer activity levels and Winter Storm Uri behind us, both the DJ and Delaware Basins outperformed our second quarter expectations and generated increased throughput across all products in the portfolio. We continue to generate significant free cash flow by remaining disciplined in our cost and capital spending. For the second quarter, we generated $380 million of free cash flow and $247 million of free cash flow after distributions. We also increased our second quarter distribution to $0.319 per unit, representing a 1.3% increase over the previous quarter, which is in line with our commitment to an annualized distribution growth of 5%. In a few moments, Craig will provide additional color on producer activity levels. We did, however, want to quickly comment on the second quarter impacts that drove higher-than-anticipated O&M expense and our thoughts on G&A going forward. Related to O&M, we incurred $6 million in additional utility charges that were invoiced by our providers related to Winter Storm Uri. The majority of these utility expenses are contractually passed through in gross margin and therefore, had a minimal impact on adjusted EBITDA for the quarter. We also recognized $4 million for a one-time environmental liability recorded in June. This relates to an incident that occurred several years ago, and the asset has since been decommissioned. As these charges subside, we expect O&M expense to normalize during the third quarter. Despite these one-time events, our O&M as a percentage of adjusted gross margin decreased compared to the prior quarter. We also saw a year-over-year increase in G&A for the three months ended June 30, 2021, from costs associated with contract and consulting, primarily related to IT services and fees associated with the transition and transformation of our IT infrastructure. This increase was embedded in our 2021 guidance, and we expect G&A to remain at this level as we fully absorb the cost of being a stand-alone enterprise. Turning to the second half of the year, we're seeing increased producer activity, specifically in the Delaware Basin, and we've been successful in attracting incremental third-party business. To prepare for increased throughput, we now expect to be at or above the high end of our 2021 CapEx range of $275 million to $375 million. We've reduced our cost structure and enhanced our operational efficiencies, and we expect increased capital spend to be dedicated to gathering these incremental volumes. While we expect these capital efficient dollars to generate a modest increase in 2021 adjusted EBITDA, this uptick in activity gives us optimism on 2022 throughput levels and thus, 2022 EBITDA. Coupled with our second quarter outperformance, we now expect to be near the high end of our 2021 adjusted EBITDA range of $1.825 billion to $1.925 billion, despite the $30 million adjusted EBITDA impact of Winter Storm Uri during the first quarter. We are still fully committed to maintaining our leverage target at or below 4.0x at the end of this year and at or below 3.5x at year-end 2022. By retiring near-term maturities and generating incremental EBITDA, we can more quickly reach these targets, allowing us greater optionality and flexibility to adapt to evolving market conditions. Our performance through the first half of the year has enabled us to enhance stakeholder value. To recap, as of today, we have already retired the entire $431 million senior notes due in 2021. Through the unit buyback program and Anadarko note exchange, we have repurchased 31.34 million units, which represent over 7% of our outstanding units. We intend to opportunistically employ our previously authorized $250 million unit repurchase program, of which we have approximately $200 million remaining. Along with our planned increase to our quarterly distribution, we look forward to using these multiple paths to return value to stakeholders as conditions dictate. With that, I'll turn the call over to Craig to discuss our operations in the second quarter.

Thank you, Michael. Before we get into this quarter's operational performance, I would like to take a moment to discuss the Crestone deal announced in our earnings release. During the second quarter, we executed a long-term gas gathering and processing agreement with Crestone Peak Resources. As part of the deal, Crestone dedicated approximately 74,000 acres in the Watkins area located in Adams, Arapaho and Albert Counties in Colorado to us, as well as up to 148,000 additional acres that may be acquired and connected to its gas gathering system in the future. I want to thank our operations, engineering and commercial teams for their continued dedication and success in growing our third-party business. The deal demonstrates our ability to remain competitive by leveraging our expansive backbone infrastructure and focusing on cost and operational efficiencies. The competitive advantages we provide to producers like Crestone are only made possible by our dedication to safe, sustainable and efficient operations. We're excited about our partnership with Crestone and look forward to supporting their development plans in the DJ Basin for years to come. Turning back to the second quarter. Our throughput increased across all products as we experienced a full quarter with strong producer activity and without the market disruptions from Winter Storm Uri in the first quarter. As a result, our gas, oil and water throughput in the Delaware Basin increased by about 10%, 14% and 16%, respectively, from the prior quarter. In the DJ Basin, our gas and oil throughput outperformed our expectations in the quarter, increasing about 5% and 20%, respectively, from the prior quarter. The increase in rig activity early in the year, coupled with the continued completion of DUC inventory, resulted in producer outperformance during the second quarter and led to record gas throughput of 1.43 billion cubic feet per day in May. We expect DJ throughput levels to decrease in the third quarter as fewer wells are expected to come online in the back half of the year. However, we expect the recently announced Crestone deal to help offset these declines beginning in 2022. Across the portfolio, gas throughput increased by about 5% or 220 million cubic feet per day on a sequential quarter basis. Our water throughput increased by about 93,000 barrels per day, representing a 16% sequential quarter increase. Throughput from our crude oil and natural gas liquids assets were up about 14% or approximately 83,000 barrels per day from the previous quarter. Our per Mcf adjusted natural gas gross margin increased by $0.02 on a sequential quarter basis to $1.21 due to increased throughput and a higher average gathering fee in the DJ Basin. Our per barrel adjusted gross margin for crude oil and NGL assets decreased by $0.05 on a sequential quarter basis to $2.40 as a result of lower gross margin contributions from equity investments. Looking ahead, as Michael said earlier, the spike in commodity prices has helped to increase our producers' activity, and we're seeing this more so in the Delaware. Most of this movement is from our private producers. In fact, based on our current Delaware Basin forecast, we expect private producers to account for approximately 58% of our non-affiliate gas throughput in 2022 as compared to 50% of our non-affiliate gas throughput in 2021. Our public producers continue to spend capital relatively in line with our original 2021 budgets. The Permian and specifically the Delaware Basin, where we operate, continues to see the highest activity levels among the U.S. basins. As a result of our top-tier position in the basin, we expect these companies, both private and public, to continue to devote large portions of their capital programs to our acreage. These are strong tailwinds for our business, and they are the reasons that we're optimistic regarding the rest of 2021 and looking forward to 2022. At the beginning of the year, we expected to exit 2021 with a relatively flat gas throughput and a percentage increase in oil by high single digits and water rates by low double digits versus 2020 exit rates. Today, we expect a similar oil exit rate of high single digits but now have higher expectations for gas to increase by the mid-single digits and water to increase by the high teens. I'll now turn it back over to Michael for closing remarks.

Thanks, Craig. As we've stated in our prior calls, our staff continues its hard work towards our goals in safety, asset integrity and being strong stewards of our environment through minimizing our environmental footprint. We look forward to issuing our second ESG report ahead of our third quarter call, where we'll highlight the tremendous progress we've made in the first 18 months as a stand-alone company and discuss our embedded ESG goals for the future. I want to close by expressing my thanks to our employees and contractors. They spent our first six quarters as a stand-alone company establishing the foundation for WES, enhancing safety and protecting the environment, creating sustainable cost efficiencies and ensuring the reliability and performance of our system. We again see the fruits of our labor with the Crestone deal and our ability to facilitate the accelerated producer activity we see today. With our talented workforce and upward trend in the commodity environment, I'm proud of the tremendous potential we have at WES as we enter the second half of the year. With that, we'll open the line for questions.

Today's first question comes from Kyle May at Capital One. Please go ahead.

I was wondering if we could start by talking a little bit more about the Crestone dedication and see if you could give us a sense of when those volumes will be additive and maybe the potential size of the volume contribution?

Yes. Thanks, Kyle. So the way that we expect that to impact us is we'll have minimal capital in 2021 with the volumes really to hit our system starting in 2022. So the biggest impact from a cash flow standpoint will start in 2022 and beyond.

Got it. Okay. That's helpful. And previously, I believe you had suggested that CapEx in 2022 would be similar to the budget for 2021. Now that you're looking to be near the upper end of the guidance range this year, can you give us any preliminary thoughts about the budget for next year?

Yes. I wouldn't draw conclusions as it relates to 2022 as it relates to the expected increase in capital for 2021. What we saw in 2021 was an increase in activity levels for the back half of this year and into 2022. So as we think about capital, the back half of this year wouldn't be deemed indicative of what we might expect in 2022. A lot of that will depend on what the activity levels are expected to be going into 2023 and beyond. But what we saw in 2021 for the increase is additional well connects, hookups, and directly production-oriented capital that will accrue to the system into 2022. So we'll come back with expectations on capital for 2022. I would not read into this increase as being indicative of what we might expect into future periods.

And our next question today comes from Jeremy Tonet, JPMorgan. Please go ahead.

I would like to begin by discussing our approach to capital allocation. Could you provide more detail on how you view the balance between the 5% distribution growth, debt reduction, and unit repurchases? Are there specific guidelines or considerations that influence your decisions on where to allocate capital, particularly looking ahead?

Yes, it's a great question. So the primary focus is that we want to exit this year again at or below 4x and exit 2022 at or below 3.5x. So that's the primary focus for us. Related to that is the near-term maturity that's coming due in the first part of 2022 that we're going to pay off using free cash as well as the maturity in 2023 that we're going to utilize paying off free cash flow. So as a result, those being the first major tenets for us and the use of that capital. We plan to continue to opportunistically look for buyback opportunities. And as it relates to the distribution, at least for the period referenced when we increased the distribution and the annual target rate, it was really in relation to the amount of savings that we were able to achieve from the buyback of units as well as the debt reduction. As we start seeing the fruits of our labors and overall leverage reduction, then we'll revisit that mix. But primarily for now, the focus is on getting us to a leverage level that we feel is putting us in an optimal place to be able to return capital to stakeholders and give us greater certainty as to the sustainability of the business going forward.

Got it. That's helpful. And then looking forward to 2022, I know you talked a bit about producer activities, but just wondering what we might be able to extrapolate at this point with commodity prices moving up a bit higher here? Although they've retreated recently, but just what you see for user activity into '22 because it takes six to nine months plus for CapEx to materialize into production? Just wondering if there's any kind of sensitivities that you could provide us for kind of how next year could shake out at this point relative to this year?

Yes. I would just direct a couple of comments related to that. So as we came into 2021, we were on a downward slope as it relates to volumes, so headwinds coming into the year. What we're now pointing to are tailwinds, exiting the year, pretty high growth overall across the portfolio as it relates to exit 2021 over 2020. In addition to that, the increase in capital, if you actually look at where that is being directed, it's toward connecting volumes, direct production-oriented capital, i.e., well connects. There's a material increase relative to what we were expecting in the first quarter. So that is to bring on volumes that we're going to reap the rewards of really in 2022. So again, you're exiting the year with tailwinds relative to the 2020 exit, and the increase in capital is so that we can get volumes online to really enjoy the benefits of that in 2022. So all very positive as we think about the impact on volumes and what we're seeing in the business.

And our next question today comes from Derek Walker at Bank of America. Please go ahead.

Maybe just two quick ones for me. Craig, I think you talked about contribution from private, I think relative to this year, next year increasing. Can you just kind of elaborate sort of how that compares to some Occi commentary from this earnings call where I think it affects a similar production profile to 2021? So I guess do you see privates continue to increase? And does that commentary that you alluded to in 2022 factor in Occi's commentary?

Yes. I mean I think what we've outlined is that the mix of our non-affiliate volume is increasing among the privates relative to our public producers through the uptick in activity that we've seen throughout 2021. As for what to expect in 2022 and beyond, particularly from the public companies that we have tied into our systems, we're really going to need to take a look and see where they come out with their budgets for 2022. We continue to have dialogue with them and stay in those conversations. We've got pretty good line of sight for a number of these private producers who have signaled an increase in activity. Thus, the acceleration of capital, as Michael alluded to, on well connects and with some compression included in that as well to get ready for that growth in 2022 volumes. But as for what that mix will be in 2022 and beyond, we'll really just need to see how the '22 budgets get worked out for the rest of our producers.

Got it. Appreciate it.

Sorry, just one additional comment on that is that Occi obviously has a very attractive and vast portfolio of assets and really only a fraction of that. So when you need to take into consideration when they're making comments related to the totality of their portfolio, we are just a fraction of that. Thus, when you see the impact on us, it's more specific to where they're directing that capital as opposed to the total portfolio.

Thank you, Mike and Craig. I have a quick follow-up regarding the margin commentary. You mentioned that oil is down in relation to higher contributions from equity investments. Additionally, the gas margin saw an increase due to the DJ. How should we view the margin outlook going forward or margin per barrel in the future? With the recent deal in Colorado, can we expect a similar margin on the gas side? And for the oil side, should we anticipate it to be comparable to the second quarter run rate?

Yes. So as it relates to the margin, actually, there was pretty limited variability, frankly, when you look at it quarter-on-quarter. So Q1 for natural gas was $1.19, in the second quarter it is $1.21. Crude oil and NGLs is $2.45, and then $2.40 for the second quarter. So actually, there was pretty limited variability when you look at it, and you're always going to see a little bit of that variance depending on the contribution from equity method investments as well as where the volumes are coming from within our contract portfolio where there are different rates associated with it. As it relates to Crestone, again, we don't actually give specifics related to contracts. The expectation of when those volumes are going to come online is really more 2022 and beyond. So we wouldn't drive any indication as to what that might mean for gross margin in 2021.

And I would just add that going from one year to the next, the cost of service rate resets can have an impact on what those gross margins look like. So I wouldn't necessarily extrapolate too far out into the future. But in the near term, yes, don't expect a whole lot of variability.

And our next question today comes from Shneur Gershuni with UBS. Please go ahead.

Just a few follow-ups to some of the answers that you gave previously. Maybe to start on the capital allocation question. I fully understand that the distribution increase in '21 was sort of a function of the units that you would reduce through the buyback program and that the priority is the next maturity in the tower. But I was kind of wondering what are the other options that you're thinking about? And I guess it's kind of a high-class problem, but it sort of seems like you'll end up at optimal leverage ratio towards the end of next year. Do you consider something similar to what like one of your peers recently did with a buyback from the sponsor as well as a one-time special step-up in the distribution?

Yes, Shneur. It's a great question and highlights the opportunity that we have as we get into more attractive leverage levels. I definitely would concur that at a certain leverage point, the utility of additional debt reduction is actually reduced. Thankfully, we're getting to a place where the leverage is at a very attractive level where those other opportunities are available to us. So the answer is yes. We're definitely open to considering the best ways in which we'll be able to return incremental capital to stakeholders. The good part is that there are a lot of opportunities available to us at that point. The primary focus for us, in the near term, however, is to get to that ideal leverage level wherein we can assess those options. That's been our focus up to this point.

Great. Appreciate the color there. And maybe as a follow-up on the CapEx side for '22. Can you sort of share with us what you're thinking about or what the makeup would be? I understand you can't give us a final number at this point, but do you need to build a new processing plant? Or do you have plenty of capital-light options as well as well connect capital, and that really is the majority of the makeup of how you're thinking about spend for '22?

Yes, it's a great question. For us, we're currently expecting the mix to be pretty similar to the way that you've seen it in 2021. As we've mentioned before, we would first look if we have needs outside of our 100%-owned assets to look for offloads or other arrangements so that we can utilize the capacity that exists in the areas in which we operate. Our current expectation for 2022 would be a similar mix of capital to what we see today. Very quick cycle volume-oriented CapEx that we would expect in 2022 relative to 2021.

So just to clarify, given that you're expecting a similar type of mix, then the delta should just really be a function of what your expected volumes are for '21 versus your expected volumes for '22 and would kind of adjust it that way. Is that kind of a good roadmap?

Yes, very activity-dependent-type structure, exactly. Sure.

And our next question today comes from Robert Mosca with Mizuho. Please go ahead.

Just wondering if you have any early indications of how cost of service adjustments could shake out in the fourth quarter, maybe relative to 2020? You've pointed towards the higher end of the CapEx range and been somewhat deliberate in messaging that volume growth could be more of a 2022 feature. So just curious, the activity in CapEx associated with that growth to be captured in your rates for this year's adjustment or possibly next year?

Yes, a couple of things to consider. We don't have an indication yet, it's too early to tell, and it will definitely be reflective of what activity is expected at the time when those assessments take place. A couple of comments that, as Craig mentioned, the percentage of affiliate for gas, for example, is increasing. Therefore, our non-affiliate gas has increased and is more third-party oriented. As we think about the increase in capital, I wouldn't necessarily draw a straight line as it relates to the increase in capital and the impact on cost of service rates that might occur at the end of the year because a fair amount of that might be activity levels that are not related to the cost of service-oriented contracts.

Okay. Great. That's helpful color. And then in your prepared remarks, I think you said that the Crestone deal should offset some DJ declines in '22. I'm not sure if I heard that right. But just wondering if your base case expectation for the DJ next year is the decline able to see acreage? Essentially, if you could provide more color there, that would be helpful.

Craig, do you want to comment on that?

Yes. Actually, our volumes up in the DJ for next year relative to this year, we see as being relatively flat from where we're going to exit this year. And that's due in large part to the incremental volumes that we'll see in the Crestone deal to help offset what would otherwise be natural declines.

Today's next question comes from Sunil Sibal from Seaport Global Securities. Please go ahead.

Hi. Good afternoon everybody. And thanks for all the color on the call. So, since the start of the year, WES has done a fairly decent job of managing debt maturities and also kind of laying out a plan for debt reduction. I'm just curious, how your discussions with rating agencies have been on that front? And then, do you think you would get some credit from them for the actions you have taken so far?

Yes. It's a great question. So, as it relates to the credit agencies, we maintain a very constant dialogue with them. Obviously, the positive results that we've seen and the debt reduction overall is received very positively, especially as it relates to actual debt reduction and not just EBITDA growth improving overall metrics. As it relates to ratings, however, they've been pretty open with us that there will be some connection of varying degrees, depending on the agency you referred to with Occidental in their ratings. We would expect that would continue despite all the positive debt reduction activities that we've engaged in. I look at us as being very much investment grade in our metrics today, viewing it as an indication of the positive elements of our business, the way that we have been able to reduce debt over time and put ourselves in a very attractive position from a leverage standpoint. But from a rating perspective, it will be somewhat dependent on our largest customer, Occidental.

Got it. Kind of related to that, could you give us a sense of where third-party cash flows would end up in? Or the ballpark would end up in 2021? And it seems like '22, there will be further uptick in the third-party numbers or contributions?

I would not have anything additional to disclose other than what we disclosed in the 10-Q as it relates to affiliate versus non-affiliate volumes, which is in the 60-odd percent range from an affiliate revenue perspective.

So, are you saying that you still expect to be in that ballpark for the next couple of years? Or should we just kind of have to wait out to see how those numbers come out?

Yes. We don't actually provide any specific projection or guidance as it relates to where that ratio will go over time.

Got it. And then last question for me was on the M&A front. There have been some transactions in the midstream space, other kinds of cures. How do you view your asset positioning and some things that might be available around where you guys are?

Yes. I think it's a great question. A couple of comments as it relates to that. We have seen an uptick in an improvement in terms of the attractiveness of assets, like our portfolio. As we think about non-core assets, that puts us in a great position to be able to find opportunities for them as they do exist. From a sales perspective, as it relates to acquisition targets, part of the element of us getting ourselves into the best place from a leverage standpoint is that we would be able to opportunistically look out for those M&A opportunities that would be accretive overall to our operational footprint and to our financial footprint as we look forward. We can definitely see our strong asset base and strong customer relations to achieve some synergies if we see opportunities around where our assets might sit. From a leverage standpoint, putting ourselves in the best position to be able to execute on that has been our goal and will continue to be until we get to that optimal range.

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to the management team for the final remarks.

Thank you very much for joining us for this quarter's call, very positive performance by the team. I'd like to thank the entire employee base for all of their efforts up to this point and look forward to what we can deliver in the future. Thank you all for joining.

This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines, and have a wonderful day.