EQT Corporation (NYSE:EQT) Q4 2023 Earnings Call Transcript
EQT Corporation (NYSE:EQT) Q4 2023 Earnings Call Transcript February 14, 2024
EQT Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to the EQT Fourth Quarter 2023 Quarterly Results Conference Call. [Operator Instructions] I would now like to turn the conference over to Cameron Horwitz, Managing Director of Investor Relations and Strategy. Please go ahead.
Cameron Horwitz: Good morning and thank you for joining our fourth quarter and year end 2023 earnings results conference call. With me today are Toby Rice, President and Chief Executive Officer and Jeremy Knop, Chief Financial Officer. In a moment, Toby and Jeremy will present their prepared remarks with a question-and-answer session to follow. An updated investor presentation has been posted to the Investor Relations portion of our website and we will reference certain slides during today’s discussion. A replay of today’s call will be available on our website beginning this evening. I’d like to remind you that today’s call may contain forward-looking statements. Actual results and future events could materially differ from these forward-looking statements because of the factors described in yesterday’s earnings release, in our investor presentation, the Risk Factors section of our Form 10-K and in subsequent filings we make with the SEC.
We do not undertake any duty to update any forward-looking statements. Today’s call also contains certain non-GAAP financial measures. Please refer to our most recent earnings release and investor presentation for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures. With that, I will turn the call over to Toby.
Toby Rice: Thanks, Cam and good morning everyone. Coming into 2023, I sat down with our leadership team and we set our overarching corporate mission and goal for the year with two simple words: peak performance. I wanted our fourth year since the takeover of EQT to be our best one yet and the crew certainly came through in delivering on that mission. I want to take a few moments to briefly reflect on the incredible accomplishments from this organization that we achieved over the course of 2023. On the operations front, we set multiple drilling world records and achieved our highest completion efficiency pace ever, with 2023 monthly pumping hours per crew up more than 15% year-over-year. Importantly, this incredible operational pace came amid a 22% improvement in our 2023 EHS intensity, which was even better than our 15% target and underscores our unwavering commitment to safety at EQT.
On the financial front, despite a challenging natural gas price environment, EQT generated nearly $880 million of free cash flow in 2023, retired north of $1.1 billion of debt and raised our base dividend by 5%. This financial performance is a clear demonstration of our advantaged position at the low end of the North American natural gas cost curve and highlights that EQT is poised to thrive regardless of where we are in the commodity cycle. On the M&A front, we closed on the strategic acquisition of Tug Hill and XcL Midstream and integrated the assets at a record pace. Our team has wasted no time driving material operational performance improvement on the assets, with the latest EQT operated Marcellus drilling costs coming in more than $200 per foot or nearly 55% lower than Tug Hill operated wells.
This recent performance suggests the potential for even more upside than the $150 per foot of well cost savings we discussed last quarter, which as a reminder, is additive to $80 million of largely infrastructure-related synergies we originally announced with the deal. On the marketing front, EQT’s low-cost peer leading inventory depth and environmental attributes enabled us to sign the largest long-term physical supply deals ever executed in the North American natural gas market with some of the country’s leading utilities. With much stronger than expected power generation growth in many regions of the United States and natural gas providing the ideal low-carbon dispatchable complement to renewable generation, we expect gas-fired power demand will surprise the upside over the coming decade and EQT’s unique ability to meet this demand should result in additional margin capture opportunities moving forward.
We also made material progress executing on our differentiated LNG strategy, leveraging our significant Gulf Coast firm transportation capacity to sign HOAs covering 2.5 million tons per annum of LNG tolling capacity or roughly 5% of our total natural gas production. Our more integrated approach to LNG exposure compared with peers gives us direct connectivity to end users of our gas globally and we have seen strong interest from prospective international buyers. While there has been some noise around LNG permitting of late, the outcome of COP28 demonstrates the world has spoken deeming natural gas as critical in facilitating the energy transition while ensuring energy security. It is abundantly clear that nations around the world currently powered by coal desperately want and need greater access to natural gas and ultimately political posturing will reconcile with this reality if we, as a society, are truly intent on achieving global climate goals.
On the ESG front, we announced a first of its kind public-private forestry partnership with the state of West Virginia, which will create one of the highest quality most verifiable nature-based carbon sequestration projects anywhere around the globe. We have already seen solid momentum on this project to-date and we are incrementally confident in EQT’s ability to become the first energy company of meaningful scale in the world to achieve net zero Scope 1 and 2 emissions. This impressive list of achievements is a showcase of what is possible when you combine a world class asset base with an industry leading digitally enabled team underpinned by a culture of excellence and teamwork. Turning to our reserve report. EQT’s 2023 proved reserves totaled 27.6 Tcfe, which was up 2.6 Tcfe relative to 2022, largely driven by additions from the Tug Hill acquisition.
Importantly, even with the SEC price deck dropping from over $6 per million Btu at year end 2022 to $2.64 at year end 2023, EQT’s proved reserves prior to the impact of Tug Hill were slightly higher year-over-year, underscoring the economic resiliency of our world class low-cost Appalachian reserve base. Within our proved undeveloped reserve category of roughly 8 Tcfe, we have just 417 gross locations booked or roughly 3 years of development, representing only 10% of our derisked inventory of nearly 4,000 gross locations. It’s also worth highlighting that we estimate an additional 2 Tcfe of reserves not captured in our bookings associated with our non-operated position in Northeast Pennsylvania as we book limited PUDs on this asset, given we only have timing visibility out 3 to 6 months.
Additionally, we’ve taken a conservative stance with limited reserve bookings for Tug Hill’s go-forward Utica inventory in West Virginia, which should be a source of reserve upside over time. Using the year end 2023 SEC price deck of just $2.64 per million BTU, the PV-10 of our proved reserves is approximately $12 billion. Assuming recent strip pricing, this value jumps to almost $23 billion. And again, this ascribes credit to just 3 years or 10% of our remaining inventory. I’d also note our reserve valuation is calculated prior to the impact of our firm transportation portfolio to the value accruing to EQT for marketing arrangements like the MVP firm sales contracts we announced last quarter are incremental to these PV-10 values. We see the consistency and economic resiliency reflected in our reserve report as an important channel check for investors that highlights EQT has among the highest quality, lowest cost natural gas asset base anywhere in the world.
Looking to 2024, we are initiating 2024 production guidance of 2,200 to 2,300 Bcfe, which includes some flexibility to curtail volumes should natural gas prices remain weak. Our program contemplates running 2 to 3 rigs, 3 to 4 frac crews and turning in line 110 to 140 net wells. As shown on Slide 6 of our investor deck, this activity level juxtaposed against our large production base underscores the incredible capital efficiency and quality of our assets, as EQT is generating the most gross-operated production per rig of any natural gas operator in the United States by a wide margin. Looking at our spending profile, we are setting a 2024 maintenance capital budget of $1.95 billion to $2.05 billion, including maintenance, land and infrastructure spending.
We have also tactically allocated $200 million to $300 million for strategic growth projects across water infrastructure, gas gathering and land that are opportunistic in nature and highly symbiotic with our upstream operations. Jeremy will give more details later on, but these projects generate the best risk-adjusted returns in our portfolio, derisk our upstream execution, allow us to replenish inventory at extremely attractive costs and facilitate the compounding of capital for shareholder value creation. At the midpoint of our maintenance capital and production guidance ranges, our implied 2024 maintenance capital efficiency equates to $0.89 per Mcfe and our unhedged maintenance NYMEX free cash flow breakeven is $2.50 to $2.60 per million Btu.
With contractual gathering rate reductions, the shallowing of our base decline, improving basis from the firm sales arrangements we announced last quarter and reductions in interest expense, our all-in NYMEX free cash flow breakeven price should be on a glide path down towards $2.30 per million Btu over the next several years. We believe this economic profile is in a class of its own relative to the rest of the industry, where we expect to see upward pressure on cost structure over this period associated with operators shifting to lower quality inventory in both the Haynesville and parts of Appalachia. This differentiation is highlighted by the fact that we project EQT will generate cumulative free cash flow of almost $9 billion over the next 5 years at a natural gas strip that averages approximately $3.40 per million BTU over this period.
This gas price is roughly equivalent to the fully loaded corporate marginal cost of supply in the U.S. required to simply breakeven from a free cash flow perspective, let alone to generate returns for shareholders. Said another way, higher cost natural gas producers will at best generate no shareholder value at the current strip over the next 5 years, while EQT is set to generate more than 40% of our enterprise value and free cash flow over the same timeframe. This stark contrast underscores why cost structure is our North Star at EQT and why we strive not to be the biggest, but to be the highest quality, most resilient company that can generate durable free cash flow both in up cycles and in down cycles. This is the essence of sustainability and value creation in a commodity business.
And we believe our shareholders are uniquely positioned to reap the rewards of EQT’s unrivaled combination of scale, peer-leading low-cost inventory depths and best-in-class emissions profile. I will now turn the call over to Jeremy.
Jeremy Knop: Thanks, Toby and good morning, everyone. I’ll start by summarizing our fourth quarter results, which highlight our operational momentum as we closed out the year. Sales volumes of 564 Bcfe was toward the high end of our guidance range, reflecting continued best-in-class execution from our drilling and completion teams, along with strong well performance. Our per unit adjusted operating revenues were $2.75 per Mcfe, and our total per unit operating costs were $1.27 per Mcfe, which were at the low end of our guidance range driven by lower-than-expected LOE and G&A expenses. It’s worth noting that we outperformed LOE expectations every quarter in 2023 with total absolute LOE coming in $40 million below our internal forecast, driven largely by more efficient water handling facilitated by the investments we’ve made in water infrastructure.
Capital expenditures were $539 million, which were in the lower half of our guidance range, reflecting the operational efficiency gains Toby mentioned previously. Turning to the balance sheet. Last month, we completed several transactions that eliminated debt, reduced interest expense, simplified our balance sheet and established an important 10-year pricing reference point, which is the longest dated bond outstanding of our natural gas peers and underscores the market’s confidence in our inventory duration. First, we retired all outstanding convertible senior notes due in 2026, which eliminated more than $400 million of absolute debt. Recall, our fully diluted share count already included the shares associated with our convertible notes.
We simultaneously liquidated the capped call that we had purchased in conjunction with the issuance of the convertible notes for cash proceeds of $93 million. Pro forma the convertible note retirement, our total debt outstanding is currently $5.5 billion, which equates to a 1.6x leverage when annualizing fourth quarter adjusted EBITDA. Following the convertible note settlement, we executed a highly successful $750 million 10-year bond offering last month, the proceeds of which we used to pay off 60% of the term loan that we borrowed in conjunction with the closing of the Tug Hill and XcL Midstream acquisitions. We saw extremely strong demand from the credit market with a peak order book of almost $6 billion and the bonds pricing at a tight 1.65% spread to comparable U.S. treasury rates, which is similar to credit spreads of many of the highest quality large-cap companies in the broader energy sector.
In conjunction with the bond offering, we also extended the maturity of our remaining term loan from mid-2025 to mid-2026, providing ample flexibility for maturity management moving forward. In terms of capital allocation, we will continue to prioritize debt pay-down until we achieve our $3.5 billion gross debt target. Our capital allocation philosophy is underpinned by an unwavering focus on establishing a fortress balance sheet, countercyclical and opportunistic share repurchases and a steadily growing base dividend. This long-term focused value investing framework has received resounding support from our increasingly high-quality shareholder base, and we will continue to allocate capital in accordance with this first principles framework.
Looking ahead to 2024, we are setting an annual production guidance range of 2,200 to 2,300 Bcfe, which is underpinned by a fully loaded maintenance capital program of $1.95 million to $2.05 billion. Additionally, we are investing $200 million to $300 million into several strategic growth projects in the form of midstream and water infrastructure and infill land capture this year. These opportunistic investments are significantly value enhancing, and I want to take a moment to highlight the merits of each of these. The acquisition of XcL Midstream last year created a full-service midstream platform within EQT. And through this platform, we are already sourcing proprietary opportunities that generate strong risk-adjusted returns and robust free cash flow yields, even superior to those of our core Marcellus wells, while at the same time derisking our upstream operations.
As shown on Slide 10, we are investing in three Midstream growth projects this year, comprised of the Clarington Connector, the OakGate Pipeline and the Pacific Coast Compression project. The combined capital associated with these projects is approximately $115 million. And once fully operational, these projects should generate aggregate annual free cash flow of nearly $50 million in the form of superior price realizations. This implies these investments will generate an aggregate free cash flow yield of nearly 40%, which is extremely attractive given the absence of price risk and the annuity-like cash flow profile over a 20-year asset life. We forecast a total return on investment of roughly 8x and the aggregate net present value of these projects is estimated at $250 million, implying value creation for shareholders equivalent to roughly $0.60 per share.
Despite only having this Midstream business for just 6 months, these initial projects provide a glimpse into the long-term opportunity we see for this new business line. Reinvestment opportunities of this quality only come about because of the symbiotic relationship between our midstream and upstream teams working in alignment together. We believe this approach to growing shareholder value is differentiated among peers, especially in a $2 gas world, and intend to cultivate this platform so that it becomes an even more impactful driver of shareholder value creation over time. Within our reserve development CapEx, we’ve also allocated $80 million to expand our existing water infrastructure assets in West Virginia. As shown on Slide 12 of our investor deck, we expect 2024 investments into our water infrastructure to drive annual savings of $20 million, implying a 25% free cash flow yield on our invested capital.
Our EQT-owned water system has materially increased the amount of water produced that we can recycle, which is having a tangible impact on our cost structure as demonstrated by our LOE coming in below forecast every quarter last year, translating to $40 million more free cash flow than originally forecasted. Turning to land. We have roughly $100 million allocated to opportunistic infill leasehold growth in mineral acquisitions this year. As shown on Slide 13 of our investor presentation, opportunistic leasehold additions organically replenished 65% of the acreage that we developed over just the past year, which is a pace of replenishment that can materially expand our years of inventory when aggregated over time. We believe this ability to organically backfill developed inventory is a unique feature among U.S. shale plays that largely exists only within Southwest Appalachia due to the land configuration and historic development activity.
We are seeing notable opportunities to add to our acreage position at extremely attractive prices this year given the low commodity price environment, which we were able to capture due to our strong financial position. To put into context, the value creation potential of deploying leasehold capital, we highlight a very tangible example on Slide 13 of our investor presentation. In 2022, we infilled leased acreage and increased our working interest by 18% in our Polecat North development located in Greene County, which we brought online last year. The incremental interest we added in this project through organic leasing is projected to generate a 90%-plus free cash flow yield in year 1 alone and nearly 55% of annual free cash flow yield over the first 5 years and a return on invested capital of roughly 7x the strip pricing.
This example highlights why we see these tactical land expenditures as an extremely attractive reinvestment of capital while simultaneously extending inventory duration, which can, in turn, help facilitate additional strategic initiatives such as signing long-term supply agreements. A key point I want to leave you with on these growth projects is whether it’s land capital, infrastructure investments, our acquisition strategy, long-term agreements with utilities or our base upstream business, we are incredibly intentional about aligning these decisions to ensure they symbiotically work together to enhance each other and collectively result in optimal risk-adjusted compounding of shareholder capital in the decades ahead. In essence, this is the definition of terminal value.
And through building a successful track record of these decisions, we expect this to be reflected in our stock price. Lastly, I want to quickly touch on our cost structure guidance given the moving pieces with the imminent startup of MVP. We are guiding full year transmission expense to $0.42 to $0.44 per Mcfe, which is up approximately $0.10 year-over-year driven by the costs associated with MVP. This is partly offset by an accompanying contractual step-down in our gathering rates, which we forecast to be in the $0.52 to $0.54 range for 2024, down from roughly $0.65 in 2023. Within our 2024 corporate differential guidance of $0.50 to $0.70, we conservatively assume EQT flows only a portion of our MVP capacity due to downstream limitations at Station 165.
In the winter months, we should be able to flow at higher rates on MVP and realize a greater premium on downstream pricing. Thus, the cash flow uplift associated with MVP will be seasonal in nature until downstream expansion projects come online. It’s also worth highlighting that we have roughly 500 MMcf per day of our Station 165 pricing exposure hedged through financial instruments and firm physical sales through 2025, which provides downside protection should there be any further price pressure downstream of MVP over the next few years. With nearly 2.5 Bcf per day of upcoming project expansions at Station 165 and significant demand pull from the Southeast region, our ability to flow volumes on MVP and associated realized pricing should progressively improve over the coming years culminating in the commencement of our firm sales contracts in 2027 that are projected to improve our corporate-wide differential by $0.15 to $0.20, driving a $300 million-plus uplift in annual free cash flow generation.
Turning to Slide 11 of our investor presentation. We announced the proposed acquisition of an additional 34% ownership in the EQT operated Seely and Warrensville gathering system in Northeast Pennsylvania for $205 million in cash, and we currently expect the transaction to close in late Q1 or early Q2. EQT currently owns 50% of this gathering system. So our pro forma ownership will increase to 84% based on terms agreed to in the purchase agreement, subject to the potential exercise of certain preferential purchase rights. Recall, this gathering system was part of the Alta acquisition we completed in 2021, which has been a significant source of value creation for EQT. The purchase price implies we are acquiring these assets for a double-digit free cash flow yield, underscoring how this deal allows us to reinvest capital into durable, long-lived infrastructure at an attractive rate of return with near zero execution risk, given we operate both the system and the upstream development underpinning the assets.
Consistent with our broader strategy to reinvest capital into assets that improve our corporate cost structure, our greater ownership in the system will immediately lower our overall free cash flow breakeven price by more than $0.01 per Mcfe upon close. We are currently looking at ways we can shift even more development activity onto this system over the coming years, which could drive additional upside to the transaction. Moving to hedging. We tactically added to the front end of our 2024 hedge position earlier this year, leaning into the price spike that occurred ahead of the winter storm in January. We have now greater than 50% of our first quarter 2024 production volumes hedged with a weighted average floor price of $3.87 per MMBtu, which has derisked a significant portion of our free cash flow outlook for the year.
We have nearly 50% of our second quarter production hedged with a weighted average floor of $3.39 per MMBtu. And roughly 40% of our Q3 production covered at a weighted average floor price of $3.42 per MMBtu. Additionally, we’ve recently added some 2024 winter hedges, taking our fourth quarter hedge coverage up to more than 20% with a weighted average floor price of $3.47 per MMBtu. Turning to Appalachian. Basis differentials were relatively wide during the fourth quarter, driven by an elevated Eastern storage level and rising production associated with multiple operators completing wells that were deferred from earlier in the year. Our strong basis hedge position again paid dividends this quarter, boosting our corporate-wide realized natural gas price by $0.08 per MMBtu.
As it relates to the increase in Appalachian supply, after peaking at just under 37 Bcf per day in December, production in the basin has fallen by roughly 1.5 Bcf per day, and we anticipate further declines in the Appalachian supply through the second quarter. On the local demand side, it’s noteworthy that PJM recently doubled its 15-year annualized load growth forecast from 0.8% to 1.6%. This equates to nearly 7 gigawatts of additional power demand by 2027, in more than 10 gigawatts by 2030, which, if satisfied by natural gas, would translate to nearly 2 Bcf per day of additional local demand by the end of the decade. This trend of increasing local demand juxtaposed against a relatively flat basin supply and the commencement of MVP should provide a structural tailwind for local pricing over the coming years, which we do not believe is currently priced into the basis futures market.
As it relates to Lower 48 supply, it’s worth highlighting that a prominent data vendor revised its year-to-date supply estimates downward by 1 to 2 Bcf per day this week. We had suspected certain data sources were overstating production, and this downward revision validated the market is not as oversupplied as many previously thought. Assuming production simply stays flat at the current revised level and weather is normal through the injection season, end of summer gas storage will be roughly in-line with the 5-year average level. I’ll close by sharing a few philosophical thoughts on what we believe it takes to not only survive but to thrive as a natural gas producer and a macro backdrop that we expect will be characterized by unpredictable volatility for the foreseeable future.
The real long-term winners in this business will not be the biggest companies that gain scale simply for the sake of scale, but will instead be the companies that have a corporate cost structure that is currently and in the future at the low end of the cost curve. A low cost structure is the only competitive advantage one can have in a commodity-driven business, which is why it is our North Star and drives nearly all of our strategic decision-making. While we are believers that future natural gas prices will be higher on average, we do not believe that prices will be stable at the $4 to $5 level, like the prevailing consensus view. And building a business around this assumption of average prices is likely to end poorly. Until we return to a world where we can build necessary domestic infrastructure, we believe we are more likely to see prices either around the $2 level they are today to force high-cost producers to curtail production and activity were materially higher to curtail demand, as pricing becomes the only variable left to balance natural gas inventories.
Said another way, we believe an increasingly fat-tailed distribution of outcomes. That is a critical distinction, and we’re already seeing the manifestation of this dynamic with prompt month pricing at this moment. However, EQT is at the low end of the cost curve and will be moving even further down the cost curve over the next 5 years due to our contractual gathering rate reductions in long-term MVP firm sales agreements. This outcome is by design as our philosophy toward creating value in a cyclical, volatile commodity business has underpinned every one of our strategic decisions over the past several years. The culmination of these decisions has created a unique opportunity for investors, deploy capital into the preeminent natural gas platform that is positioned to generate peer-leading shareholder value through all parts of the commodity cycle over the long-term.
And with that, we will open the call to questions.
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