Hess Midstream Q2 2023 Earnings Call Transcript

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July 26, 2023

There are 8 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2023 Hess Midstream Conference Call. My name is Gigi, and I'll be your operator for today. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded for replay purposes.

Operator

I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

Speaker 1

Thank you, Gigi. Good afternoon, everyone, and thank you for participating in our 2nd Quarter Earnings Conference Call. Our earnings release was issued this morning and appears on our website, www.hessmidstream.com. Today's conference call contains projections and other forward looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements.

Speaker 1

These risks include those set forth in the Risk Factors section of Hess Midstream's filings with the SEC. Also on today's conference call, we may discuss certain non GAAP financial measures. A reconciliation of the differences between these non GAAP financial measures and the most directly comparable GAAP financial measures can be found in the earnings release. With me today John Gatling, President and Chief Operating Officer and Jonathan Stein, Chief Financial Officer. I'll now turn the call over to John Gatling.

Speaker 2

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's Q2 2023 conference call. Today, I'll discuss our Q2 performance, demonstrating continued focus on the safe execution of our operational strategy and our financial priorities, including returning capital to our shareholders. I will also review Hess Corporation's results and outlook for the Bakken. Jonathan will then review our financial results and guidance.

Speaker 2

In the Q2, we continued to grow our business in a safe, efficient and cost effective manner, which has enabled us to increase our 2023 gas processing and gathering throughput volume to guidance. Additionally, in the Q2, we executed another accretive share buyback and increased our distribution level for the 2nd time this year. We remain focused on executing our strategy, which positions us for further anticipated growth in throughput volumes, net income and adjusted EBITDA through 2025. Now turning to Hess Midstream's operations. In the 2nd quarter, throughput volumes Averaged 358,000,000 cubic foot per day for gas processing, 108,000 barrels of oil per day for crude terminalling and 87,000 barrels of water per day for water gathering.

Speaker 2

Gas processing throughputs increased by 6% from the Q1, mainly driven by the number of wells brought online by Hess and continued increase in gas capture. Now turning to Hess upstream highlights. Earlier today, Hess reported strong second quarter results with the Bakken net production averaging 181,000 barrels of oil equivalent per day, which was above their guidance range of 165,000 to 170,000 barrels of oil equivalent per day. Approximately half of the increase was due to the strong operational and development performance and the remainder from higher production entitlements under Hess' percentage of proceeds or POP contracts. As a reminder, POP volumes do not impact Hess Midstream's throughput volumes or revenues.

Speaker 2

Hess anticipates Bakken net production will increase to approximately 185,000 barrels of oil equivalent per day in the 3rd quarter and as a result of expected continued strong performance, raised their full year 2023 Bakken net production guidance by 10,000 barrels of oil equivalent per day to 175,000 to 180,000 barrels of oil equivalent per day. Hess plans to continue to operate a 4 rig drilling program and bring approximately 110 wells online in 2023. Furthermore, Hess continues to forecast Bakken net production to grow to an average of Approximately 200,000 barrels of oil equivalent per day in 2025, which implies approximately 10% annualized growth rate in throughput volumes across all Hess Midstream systems from 2023 to 2025. Additionally, Hess expects to hold production at Approximately 200,000 barrels of olequem per day for nearly a decade. Turning to Hess Midstream guidance, which was included in our earnings release this morning.

Speaker 2

With Hess' Bakken production guidance increase and our continued gas capture success, we're raising our gas processing and gathering throughput volume guidance for full year 2023, which implies approximately 8% growth at the midpoint for the second half of the year. Now turning to our 2023 capital program. We continue to make excellent progress on our 2023 capital plans and are focused on supporting Hess and third party development in the basin. We have an active maintenance program in the 3rd quarter, including seasonally scheduled maintenance at several of our compressor stations. In addition, construction continues to progress on schedule for 2 new compressor stations and associated infrastructure that when brought online later this year will increase our gas gathering and Throughput capacity by approximately 100,000,000 cubic foot per day.

Speaker 2

For full year 2023, capital expenditures remain unchanged and are expected to total $225,000,000 which is comprised of $210,000,000 of expansion activity and $15,000,000 of maintenance activity. In summary, we remain focused on safe, reliable and efficient operating performance and project delivery that continues to drive increased volumes through our systems, which in turn has enabled us to increase our 2023 volumes guidance. Additionally, we continue to anticipate substantial throughput volume growth through 2025, which is expected to result in I'll now turn the call over to Jonathan to review our financial results and guidance.

Speaker 3

Thanks, John, and good afternoon, everyone. We continue to execute a unique and differentiated financial strategy, prioritizing consistent and ongoing return of capital to shareholders. In June, we completed another unit repurchase and recently announced another distribution level increase, which continues our track record of shareholder returns. Since the beginning of 2021, we have returned $1,350,000,000 to shareholders through accretive repurchases that reduced our total unit count by approximately 18%. In addition to the combination of our 5% targeted annual distribution growth and 4 distribution level increases following each repurchase.

Speaker 3

We have increased our distribution per Class A share by approximately 33% over this period. As a result, our total shareholder return yield continues to be one of the highest of our midstream peers. Furthermore, our leverage of approximately 3.1x adjusted EBITDA is one of the lowest among our peers, highlighting our differentiated ability to deliver significant shareholder returns, while also maintaining balance sheet strength. Earlier this year, we announced that we expect to generate greater than $1,000,000,000 of financial flexibility through 2025 for potential incremental unit repurchases. Utilizing this capacity, we executed our 2nd repurchase transaction this year of $100,000,000 That was accretive on both a distributable cash flow per Class A share basis and an earnings per Class A share basis.

Speaker 3

Supported by the repurchase, we recently announced a further return of capital to our shareholders through an immediate 1.5% increase in our quarterly distribution level beyond our targeted 5% annual distribution per Class A share growth. As we have done in the past, with reduced share count following the repurchase, this distribution level increase maintains our distributable cash flow at approximately the same amount as before the repurchase. From this new higher distribution level, we will continue to target at least 5% Annual distribution growth per Class A share through 2025 with expected annual distribution coverage of at least 1.4 times. Following the recently completed unit repurchase, we expect to still have more than $1,000,000,000 of financial flexibility through 2025 for potential future unit repurchases that can be executed multiple times per year over this period. In addition, in May of this year, Our sponsors completed an approximate $345,000,000 underwritten secondary public offering of Class A shares that supported continued increasing liquidity in our shares.

Speaker 3

Following the unit repurchase and secondary offering transactions, Public ownership of Hess Midstream on a consolidated basis has now increased to approximately 24%. Turning to our results. For the Q2, net income was $148,000,000 compared to $142,000,000 for the Q1. Adjusted EBITDA for the Q2 was $248,000,000 compared to $239,000,000 for the Q1. The change in adjusted EBITDA relative to the Q1 was primarily attributable to the following.

Speaker 3

Total revenues excluding pass through revenues increased by approximately $80,000,000 primarily driven by higher throughput volumes, including continued increased gas capture, resulting in segment revenue changes as follows: gathering revenues increased by approximately $9,000,000 Processing revenues increased by approximately $8,000,000 and terminaling revenues increased by approximately $1,000,000 With physical volumes growing as more wells come online, we expect continued growth in revenues through the rest of 2023. Total costs and expenses excluding depreciation, amortization, pass through costs and net of our proportional share of LM4 earnings increased by approximately $9,000,000 as follows: higher seasonal maintenance activity of approximately $6,000,000 Higher operating G and A, property taxes and other costs of approximately $3,000,000 resulting in adjusted EBITDA for the Q2 of 2023 of $248,000,000 at the high end of our guidance. Our gross adjusted EBITDA margin for the 2nd quarter was maintained at approximately 80%, highlighting our continued strong operating leverage. 2nd quarter maintenance capital expenditures were approximately $4,000,000 and net interest excluding amortization of deferred financing costs were approximately $42,000,000 The result was that distributable cash flow was approximately $202,000,000 in the 2nd quarter, covering our distribution by 1.4 times. Expansion capital expenditures in the 2nd quarter were approximately $48,000,000 resulting in adjusted free cash flow We had a drawn balance of $198,000,000 on a revolving credit facility at quarter end.

Speaker 3

Turning to guidance. For the full year 2023, we are updating our guidance based on strong year to date operational performance. We are updating net income, distributable cash flow and adjusted free cash flow guidance to include the impact of an incremental $10,000,000 in interest expense on borrowings under our credit facilities used to fund the Class B unit repurchase transactions in 2023. The updated net income guidance also includes the impact of an incremental $5,000,000 of income tax expense resulting from ownership changes following these previously completed Class B unit repurchases and the recent secondary equity offering transaction. As a result, we now expect net income of $595,000,000 to $625,000,000 Supported by strong volume growth in the first half, Together with continued expected throughput and revenue growth across all of our systems, as well as lower than expected operating costs in the first half of the year, We are updating our adjusted EBITDA guidance to $1,000,000,000 to $1,030,000,000 representing an increase at the midpoint of our guidance.

Speaker 3

As implied in this updated guidance, we anticipate adjusted EBITDA in the second half of the year to approximately 8% higher at the midpoint relative to the first half. With total expected capital expenditures of $225,000,000 we expect at the midpoint to generate adjusted free cash flow of approximately $625,000,000 with distributions per Class A share Tired to grow at least 5% annually from the new higher distribution level, we expect to be free cash flow positive after fully funding distributions for 2023. For the Q3 of 2023, we expect net income to be approximately 145 to $155,000,000 and adjusted EBITDA to be approximately $250,000,000 to $260,000,000 reflecting higher volumes offset by seasonally higher operating costs, including the active maintenance schedule at several of our compressor stations that John discussed earlier. 3rd quarter maintenance capital expenditures and net interest excluding amortization of deferred finance costs are expected to be approximately $50,000,000 resulting in expected distributable cash flow of approximately $200,000,000 to $210,000,000 delivering distribution coverage of approximately 1.4 times. In the Q4, we expect continued adjusted EBITDA growth relative to the Q3 on higher volumes and expected lower seasonal OpEx.

Speaker 3

In summary, we are very pleased to have delivered additional incremental return of capital to Hess Midstream shareholders I look forward to a visible trajectory of growth in our operational and financial metrics that underpins our unique and differentiated financial strategy with a focus on consistent and ongoing return on capital. This concludes my remarks. We'll be happy to answer any questions. I will now turn the call over to the operator.

Operator

Thank and wait for your name to be announced. Please standby while we compile the Q and A roster. Our first question comes from the line of Brian Reynolds from UBS.

Speaker 4

Hi, good morning, everyone. Maybe to touch on the guidance update, curious if you could just provide some additional thoughts around raising The lower end versus the whole range given year to date performance and specifically if you could just comment a little bit more around second half well connect cadence versus the original guidance expectations?

Speaker 3

So John, Maybe I'll just talk a little bit about the financial, then I'll turn it over to John to talk about the well connects. In terms of the guidance for the rest of the year And in terms of raising the guidance, we've had strong performance, particularly on the gas side. As we talked about, particularly gas capture has been extremely strong and therefore together with the growth that we expect to see through the rest of the year And John can talk more about that. He talked about that as more wells come online. We do have some seasonality to the rest of the year.

Speaker 3

We do expect in the Q3, We seasonally have higher OpEx in the second and third quarter compared to Q1 and Q4. In the Q3, we expect it to be Even higher relative to the Q2 as a result of the maintenance compressor stations that John described. So what we see really going from here is really going to be increasing revenues as we capture more on the volume side that in the Q3 that will be offset by increasing OpEx, but still increasing EBITDA. And then in the 4th quarter, expect EBITDA to go up even more from the 3rd quarter as we still have Revenues but expect lower seasonal OpEx. That still represents, as I said, 8% increase relative to the first half.

Speaker 3

And so that all of that was taken into account in terms of lowering really the taking bringing up the lower end of our guidance range. Really the way to look at that is we're really just moving the midpoint expected midpoint of our guidance really up as a result of that. So Let me turn over to John to talk about the WellConnects.

Speaker 2

Yes. On the WellConnects, we ended the year with some weather challenges that carried into early Part of 2023, that was resolved in the Q1, and we've seen the level of well count Flatten out from Q2 and we expect it to be relatively flat through the balance of the year. So we expect the pace of new wells coming online to be Consistent for the balance of the year.

Speaker 4

Great. Thanks for that. And maybe as a follow-up, just talking on Basin rig count Hess reaffirmed its 4 rig count cadence, but we have seen rigs decline in the basins to the mid-30s from the low-40s early in the year, where we typically see a seasonal pickup. So just kind of curious of how we should think about any risk to a rig reduction at this point? And if you could discuss Perhaps how Hess rig levels are contemplated in Hess Midstream's 4, 2024 and 2025 outlook?

Speaker 4

Thanks.

Speaker 2

Sure. So maybe I'll address your second part of Question first and then I'll go back to the overall basin rig count. The first part of your question, Hess has Been consistently saying they're planning to run 4 rigs for the foreseeable future. Our plan is Consistent with that and actually builds on Hess' plan. So that's part of the integration between the upstream and the midstream is working together on the development plans and Ensure that the well activity, the wells coming online, that the infrastructure is in place to make sure that the production Can get to export and get to market without any holdup and I think we've demonstrated that through our continued increase in gas capture.

Speaker 2

As far as your the first part of your question regarding the basin rig count activity, we have seen the rig count Drop off like you said from the low 40s down to kind of say the mid-30s, but we've continued to see oil production in the basin continue to grow. So I think it's just a function of timing for different operators that's driving that. I don't think that there's any anticipated Real material slowdown in activity in the basin. I think it's rig shifting between operators sometimes depending on how the rig count is counted. From that it can fluctuate rigs, a handful of rigs here and there.

Speaker 2

So again, I don't think we've seen anything from an overall activity perspective in the And that would change the trajectory for where we think production in North Dakota is going.

Speaker 4

Great. Appreciate the color. Enjoy the rest of your morning.

Speaker 2

Sure. Thank you.

Operator

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

Speaker 5

Hey, thanks for the question. Maybe just to start with buybacks and maybe a 2 part question here. I guess, first around kind of the outlook and guidance. We started the year with over $1,000,000,000 of Financial flexibility as you framed it. And then we've seen $200,000,000 of buybacks since then and you're still guiding to over $1,000,000,000 of flexibility.

Speaker 5

So I guess, first, just curious if that's kind of an indication of an improved outlook there? And then second, just wondering if you could maybe talk a How much of that flexibility is attributed to kind of spare revolver capacity versus maybe excess free cash flow going forward?

Speaker 3

Okay, sure. So yes, in terms of the $1,000,000,000 let's start there and the plan going forward, Right. As we have said at the beginning, we have more than $1,000,000,000 If you really think about what we've talked about is talk about EBITDA growth of more than 10% and free cash flow growth also more than 10%. So we have significant capacity, Financial flexibility to be able to execute and as we've highlighted, historically we had done in 2021 and 2022, one large buyback per year. Now going forward, we intend to do multiple buybacks per year on an ongoing basis through 2025 using that flexibility.

Speaker 3

So we're really in a great spot there, In terms of funding that and capacity going forward, really highlight first, I would say just to highlight that When we said at the beginning, we had explained that really about 40% of that $1,000,000,000 at least we expect to be funded From excess free cash flow as our free cash flow positive after distributions. And then the remainder would be funded With that and relative our leverage capacity as we fall below our targeted 3 times leverage target. So where we are now is we've basically funded the first To honor revolver, we still have $800,000,000 left on the revolver together with the fact that 40% of the flexibility of the financial capacity we have will be funded with free cash flow after distribution And that $800,000,000 we have for the revolver, we have significant capacity there and really no pressure in terms of that. As we have done in the past, certainly, we have the option to term out those borrowings on the revolver, and we can look at that and have optionality to If and when we do that, whether it makes sense relative to the market and our own capital structure.

Speaker 3

But I think right now, we have significant flexibility, whether it be on the eight Of excess free cash flow that we will generate over the next 3 years, two and a half years, all that provides significant financial flexibility for us to continue to execute our return on capital program on an ongoing basis with multiple buybacks per year through 2025.

Speaker 5

Got it. That's all helpful. Then my second question is just around taxes, which seem to have an impact on the net income guidance this quarter. Can you just remind us when you expect to be a cash taxpayer? And then could you maybe just quickly kind of walk through some of the implications of how the buybacks and the Increased Class A ownership might impact the tax profile going forward.

Speaker 3

Yes, sure. So yes, as I described in my comments as we described in So we did have an impact to our net income adjusted net income to reflect The higher tax expectations as a result of the secondaries primarily as well as the repurchase. First, I'll highlight 2 things. First is to say that we will have no that's only on really on, I'll call it, a book tax basis or tax expense, but We do not expect to pay material cash taxes for the next couple of years based on the shield that we have, which includes coming partially from The second area is that we do. And the second thing I would highlight is as we highlighted, the repurchases are extremely accretive on a DCF per share basis as well as on an EPS basis as well.

Speaker 3

In terms of what's happening in terms of mechanics of that, Hess Midstream LP is treated as a corporation for federal tax purposes. That allows us to be able to issue 1099s rather than K1s, Which has been very positive in terms of increasing our investor base. But as we do the secondaries and more Ownership is owned in that entity, then since it's treated as a corporation for federal tax purposes, it impacts our tax expense there. But again, those secondaries also provide contribute to the tax yield that as I said, that means that we're not paying any material Hash taxes, we expect for the next couple of years.

Speaker 5

Got it. That's all for me. Thank you.

Operator

Our next question comes from the line of Puneet Satish from Wells Fargo.

Speaker 6

Thanks. Good morning. Maybe just staying on buybacks, I guess, how do you differentiate between Doing more buybacks versus doing M and A. If we look at the stock, it trades at 10 times EBITDA. And Generally, you can buy assets at a much lower multiple than that.

Speaker 6

So just curious how you compare and contrast the 2 when looking at your $1,000,000,000 of flexibility?

Speaker 3

Right. So in terms of cap allocation, I think 2 things. First is I think on the M and A side, Both John and myself have been clear. We're not interested in any large scale corporate M and A. We've done as we've done in the past.

Speaker 3

We're certainly open to Bolt ons or things like that, but those are things that would have a high bar and they would have to fit within our In terms of our physically within our system as well as from a risk point of view not to dramatically change our risk profile. So with that, really our financial flexibility therefore and our financial strategy as a result really includes prioritizing return of capital. And therefore, that has come through that $1,000,000,000 of flight still flexibility that we've talked about being really It was buybacks, which have been, as I talked about in my comments, approximately 18% of our shares have been bought back together with the Related dividend increases, 33% increase in our dividends just over the past 2.5 years. And with $1,000,000,000 if that was all allocated to buybacks that would be another 10% to 15% potentially of our share count, total share count. So, really that's our focus.

Speaker 3

We have a clean story, Very much visible growth as we've talked about able to give I think differentiated forward visibility towards 10% Greater than 10% EBITDA growth as well as greater than 10% free cash flow growth. And so therefore, we're going to stay focused on that. And certainly return of capital therefore is a priority within our financial strategy.

Speaker 6

Got it. And then looking at ethane prices, they've come up quite a bit here in July. And I'm just wondering if you've seen any more ethane recovery at your plants, whether there's any Constraints on that side or any kind of just, I know you don't have the price exposure, but any other kind of implications from this?

Speaker 2

No, I think we're uniquely positioned with our Tioga Gas Plant that we've got deep cut ethane extraction capability at the plant. It's running at full capability, and we're going to continue to look at our joint venture plant with Target Resources Down south, south of the Missouri River to look to optimize that for our customers. So from our perspective, we really don't see any constraints On ethane recovery. Got it. Thank you.

Speaker 5

Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Jeremy Tonet from JPMorgan Securities LLC.

Speaker 7

Hi, good afternoon.

Speaker 2

Hey, good afternoon.

Speaker 7

Just wanted to, I guess come back to the EBITDA trajectory for the 2nd half of the year and as you talked about the midpoint of the guidance implies 8% uplift back half versus front half. And wondering If you could break this down for us a little bit with regards to how much of that is kind of seasonality or other factors or how much does that portend to I guess 2024 EBITDA growth strength maybe being a bit higher than previously expected.

Speaker 3

Well, I think the way to think about the rest of the year is like I said, we're really going to have we've given guidance therefore for Q3 That implies a slight step up even more so into Q4. Again, that's really expecting continued growth In revenue, that should be relatively consistent with the 4 rigs and continued gas capture operating. So really then it's really going to be OpEx, which is going to create this kind of seasonality to EBITDA with the higher OpEx going up in Q3 and then seasonally coming down in Q4, so that will also create some more EBITDA. In terms of 2024, We certainly have a lot of great momentum coming through this year. Really there's really no change to what we've said, which is to continue growth in net income and EBITDA more than 10% through 2025.

Speaker 3

Obviously, in January, we'll give an MVC for 2026 And that will also imply what our expected continued growth is there. So really no change to 2024, just have some great momentum Looking for that to continue through the rest of the year to go on the revenue side and then continue into 2024 and on to 2025. Got it. That's helpful. I'll leave it there.

Speaker 3

Thanks.

Operator

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.

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