Hess Midstream Q2 2024 Earnings Call Transcript

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July 31, 2024

There are 8 speakers on the call.

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2024 Hess Midstream Conference Call. My name is Gigi, and I will 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 Q2 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 are 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 2024 Conference Call. Today, I'll discuss our 2nd quarter performance and review Hess Corporation's results and outlook for the Bakken. Jonathan will then review our financial results and guidance. In the Q2, throughput volumes averaged 419,000,000 cubic foot per day for gas processing, 126,000 barrels of oil per day for crude terminaling and 124,000 barrels of water per day for water gathering.

Speaker 2

Throughputs increased across all segments of our business with gas processing and oil terminating volumes increasing by approximately 7% and 8%, respectively, from the Q1, primarily driven by strong Hess performance. System availability remained high across our midstream assets and gas capture was particularly strong in the Q2. Now turning to Hess upstream highlights. Earlier today, Hess reported 2nd quarter net production for the Bakken averaged 212,000 barrels of oil equivalent per day, which was above the high end of their guidance range of 195,000 to 200,000 barrels of oil equivalent per day. Approximately 1 third of the increase is from volumes received under percentage proceeds contracts, which do not impact Hess Midstream's throughputs or revenues.

Speaker 2

Hess anticipates Bakken net production will be in the range of 200,000 to 205,000 barrels of oil equivalent per day in the 3rd quarter, reflecting lower anticipated volumes under percentage of proceeds contracts and planned maintenance at the Little Missouri 4 gas plant. Hess reiterated its plans to run a 4 rig program in the Bakken in 2024. Turning to Hess Midstream guidance, which was included in our earnings release this morning. With Hess' continued strong Bakken production and our focus on gas capture, we're raising our gas gathering and processing throughput volume guidance for full year 2024 to average between 425,000,000 435,000,000 cubic foot per day and between 405,000,000 and 415,000,000 cubic foot per day, respectively. This implies approximately 3% growth at the midpoint for the second half of the year and includes our expectations for roughly flat volumes in the Q3, which incorporates Hess upstream guidance and lower midstream throughputs due to a planned week long maintenance outage at the Little Missouri Ford gas plant.

Speaker 2

Consistent with prior guidance, we continue to make excellent progress on our 2024 capital plans and are focused on supporting Hess and third party development in the Bakken. The progress of our multi year projects to build 2 compressor stations and associated gathering pipelines continue as planned. We expect to spend more in the second half of the year as we continue construction activities. In summary, we remain focused on executing our operational priorities and safely delivering our growth strategy, which will continue to drive sustainable cash flow generation and the potential to return additional capital to our shareholders. 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 financial strategy that prioritizes return of capital to shareholders with a demonstrated track record of differentiated shareholder returns. Since the beginning of 2021, we have returned $1,750,000,000 to shareholders through accretive repurchases that have reduced our total unit count by nearly 25 percent. In addition to the combination of our 5% targeted annual distribution growth and 8 distribution level increases following each repurchase, we have increased our distribution per Class A share by approximately 48% over this period and by over 10% in 2024 year to date on an annualized basis. As a result, our total shareholder return yield is one of the highest of our midstream peers.

Speaker 3

Furthermore, our leverage of approximately 3.2 times 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. In January, we announced that we expect to generate greater than $1,250,000,000 of financial flexibility through 2026 for incremental shareholder returns, including potential unit repurchases. Utilizing this capacity in June, we completed our 2nd repurchase transaction in 2024 of $100,000,000 That was accretive on both an adjusted free cash flow per Class A share basis and an earnings per Class A share basis. As we have done in the past, our quarterly distribution increase included our targeted 5% annual growth per Class A share and an additional increase utilizing the excess adjusted free cash flow available for distributions following the repurchase. As a result, on an annualized basis, our distribution per Class A share growth of over 10% is significantly above our targeted 5% annual growth through 2026.

Speaker 3

Following the unit repurchase, we expect to continue to have more than $1,250,000,000 of financial flexibility through 2026 that can be used for continued execution of a return of capital framework, including potential ongoing unit repurchases. Turning to our results. For the Q2, net income was $160,000,000 compared to $162,000,000 for the Q1. Adjusted EBITDA for the 2nd quarter was $276,000,000 compared to $275,000,000 for the Q1. The increase in adjusted EBITDA relative to the Q1 was primarily attributable to the following: Total revenues, excluding pass through revenues and a one time $8,000,000 reduction in 2nd quarter revenues related to the setting the 2024 tariff rates for certain subsystems increased by approximately $26,000,000 primarily driven by higher throughput volumes, resulting in segment revenue changes as follows: gathering revenues increased by approximately $15,000,000 processing revenues increased by approximately $9,000,000 and Terminalling revenues increased by approximately $2,000,000 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 primarily due to higher seasonal operating and maintenance activity, resulting in adjusted EBITDA for the Q2 of $276,000,000 at the midpoint of our guidance range.

Speaker 3

Our gross adjusted EBITDA margin for the 2nd quarter was maintained at approximately 80%, above our 75% target, highlighting our continued strong operating leverage. 2nd quarter capital expenditures were approximately $73,000,000 and net interest excluding amortization of deferred finance costs was approximately $47,000,000 resulting in adjusted free cash flow of approximately $156,000,000 In May, we issued $600,000,000 a 6.5 percent senior unsecured note due 2029 in a private offering. We used the proceeds from the offering to repay the borrowings on our revolving credit facility, and therefore, we had no drawn balance on our revolving credit facility at quarter end. Turning to guidance. For the Q3, we expect net income to be approximately $160,000,000 to $170,000,000 and adjusted EBITDA to be approximately $280,000,000 to $290,000,000 Compared to the 2nd quarter, this reflects relatively flat volumes net of the 8,000,000 cubic feet per day impact from the maintenance at the Little Missouri 4 gas plant as well as stable operating costs with continued seasonally higher maintenance activity in the Q3.

Speaker 3

We also expect CapEx to increase in the 3rd quarter, consistent with seasonally higher activity. In the 4th quarter, we expect increasing revenues, ongoing volumes and seasonally lower maintenance activity, resulting in higher EBITDA compared with the Q3. For the full year 2024, we are updating net income and adjusted free cash flow guidance to include the impact of an incremental $15,000,000 of interest expense resulting from the $600,000,000 notes issued in the quarter, partially offset by lower interest on the revolving credit facility. The updated net income guidance also includes the impact of an incremental $10,000,000 of income tax expense resulting from ownership changes following the secondary equity offerings and Class B unit repurchase transactions completed this year. As a result, we now expect net income of $650,000,000 to $700,000,000 We are also maintaining our adjusted EBITDA guidance range of $1,125,000,000 to $1,175,000,000 implying growth of approximately 9% in adjusted EBITDA at the midpoint in the second half of the year.

Speaker 3

With total expected capital expenditures of 250 dollars to $275,000,000 we expect to generate adjusted free cash flow of approximately $675,000,000 to $725,000,000 With distributions per Class A share targeted 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 2024. Looking ahead through 2026, we continue to expect approximately 10% annualized growth in gas and oil volumes, supporting a greater than 10% growth per year in adjusted EBITDA. With stable CapEx through 2026, we expect adjusted free cash flow to grow greater than 10% per year in excess of our 5% targeted distribution per Class A share growth that together with capacity as our leverage falls below 2.5 times adjusted EBITDA supports greater than $1,250,000,000 in financial flexibility that can be utilized for continued unit repurchases. In summary, we are very pleased to have delivered additional incremental return of capital to Hess Midstream shareholders and 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 of capital to our shareholders. This concludes my remarks.

Speaker 3

We'll be happy to answer any questions. I will now turn the call over to the operator.

Operator

Our first question comes from the line of Doug Irwin from Citi.

Speaker 4

Thanks for the question. I just wanted to start with the growth outlook beyond 2024. If I just look at the updated volume guidance and think about 10% growth a year for gas beyond 2024. You start to get pretty close to your processing capacity by end of 'twenty six, if not above it. I just wanted to get your thoughts around whether processing might become a constraint more quickly than anticipated, just given some of the gas capture you've seen.

Speaker 4

And if so, what options you might have ahead of additional processing capacity in 20 27?

Speaker 2

Yes. Thanks for the question, Doug. Yes, from our perspective, we feel like we have sufficient capacity. We've been working on the process and expansion activities for some time now. We've got a really strong partnership with the upstream and we're planning the infrastructure and the well plans along the needs for processing.

Speaker 2

So from our perspective, the gas processing capacity will be available when the upstream needs it. So again, it's kind of that symbiotic relationship we've got between the upstream and midstream that kind of drives that integrated development planning activity that gives us some confidence that we've got the right infrastructure plans for the upstream development.

Speaker 4

Great. Thanks. And then my follow-up is kind of along similar lines, but more just around the basin as a whole. There's several kind of long haul NGL expansions underway in the Bakken. Just curious to get your take on what that means just in terms of the incremental gathering and processing capacity that might be required around the basin to supply the volumes for these projects and then kind of if that means any potential opportunities for SM beyond the current backlog?

Speaker 2

Yes. It's a great question. I think as you can probably tell from the North Dakota Petroleum Council's pipeline authority forecast, I mean, gas production is growing from about 3.5 Bcf towards the 5 Bcf to 6 Bcf range. So there will absolutely need to be additional processing for that additional gas forecast. And again, it's all going to be activity driven on what actually materializes from a gas production perspective.

Speaker 2

I think having additional export capacity out of basin, it helps everybody. I think it makes there's it allows to have more flexibility for takeaway options. And my guess is like we are going to be expanding processing in 20 27 that there will be other providers that will also be expanding. The other thing that we continue to look at is opportunities smartly capture additional third party volumes into our system. And we have the flexibility to add additional capacity over the long term, if the gas becomes available and it's something that we feel like that we can provide that support.

Speaker 2

So we do anticipate the basin to continue to grow from a gas perspective and we expect that the capacity will be there. And I think again having the export capacity out of the Bakken is going to be critical to making sure that that works and that we're able to actually support the producers as the volume comes online.

Speaker 4

Great. Appreciate all the detail. I'll leave it there.

Speaker 2

Okay. Thank you.

Operator

Thank you. One moment for our next question. Our next question comes from the line of John McKay from Goldman Sachs and Company.

Speaker 5

Hey, thanks for the time. Maybe I'll pick up on that last one a little bit. I mean, if we're thinking about kind of a shift in the competitive environment in the Bakken, I guess I would just be curious your thoughts on what that can mean for your 3rd party business. I mean, is it good because you can offer more outlets and don't have to depend as much on one other party? Or do you think you actually have a handful of other companies up there kind of trying to step it up on the commercial front now?

Speaker 2

Yes. I mean, I don't think I can really speak to some of the other companies, but I definitely think that as the basin continues to grow in other parts of the field, there will be providers that will offer capacity to them. I think from our perspective, the 3rd party opportunities become those operators that are around and near our strategic footprint and where we can actually extend our footprint to provide support to those other operators. As far as the export goes, again, I think the more flexibility there is to get out of the basin, I think just commercially, it's going to create more competition for those volumes. From our perspective, flow assurance has always been really critical, making sure that we have flow assurance all the way from the well pad to export and ultimately to end customers.

Speaker 2

That's a priority for Hess. And I think from our perspective, we've looked at that to make sure that we actually have capacity for that flow assurance. But again, as export options open up, it gives us a chance to look at different commercial opportunities as well. So again, I think it's a net positive for the basin. I think it's a net positive for Hess Mid Stream, Hess and other operators in Midstream companies in North Dakota.

Speaker 5

I appreciate that. That's helpful. Maybe just shifting to the capital return story, you guys have been extremely consistent on the repurchase side. I guess I'd just be curious, is there room for that to start moving up a little higher on an annual basis given the size of the EBITDA base now, the growing free cash flow, etcetera?

Speaker 3

Yes. So right now, our leverage, as I said, is 3.2 times EBITDA. Our target leverage is 3 times. We have been willing to continue to do do repurchases being slightly above our target when we have visibility as we do now, as we've talked about through 2026 growth, more than 10% growth per year in EBITDA. So that gives us confidence to continue.

Speaker 3

So for this year, we feel as if we're going to be limited to stick to that target, which we as you know is a big focus for us in terms of balancing shareholder returns, but also balance sheet strength. But as we go forward, certainly, we'll continue to have 1,250,000,000 dollars of capacity still available. We'll continue to calibrate that relative to our growth. But certainly, for this year, we'll focus on staying slightly above. By the end of the year, we expect to be just at 3x.

Speaker 3

And then as you go certainly into next year, we'll certainly, as we've talked about, delever well below 3 times less than 2.5 times by the end of 2025. And then also we have, of course, free cash flow after distribution. So building that cash balance as well, that can also fund additional return on capital to shareholders.

Speaker 5

All right. That's clear. Appreciate the time. Thank you.

Operator

Our next question comes from the line of Naomi Marfatiya from UBS.

Speaker 6

Hey, good morning. Maybe to touch on the guidance update. Curious if you could help us understand the moving pieces around the discrepancy between throughput and EBITDA guidance. I know you guys mentioned about planned maintenance on Hess' assets. Is there any other noise around it that you would like to point to?

Speaker 3

Yes. So I'll start with the mechanics and then I'll let John talk about maybe the underlying drivers. I mean, if you look at our EBITDA guidance for the year, we've maintained our EBITDA guidance, that's a 9% increase in EBITDA in the second half. And the driver of that is primarily volume growth across our gas and oil system. We had a really strong volume growth in the Q2.

Speaker 3

I mentioned in my remarks, dollars 26,000,000 in additional revenue just in the quarter on volumes alone. And that allowed us also is consistent with increasing our gas guidance just slightly but by 10,000,000 cubic feet per day on a full year basis. As we go into Q3, we expect flat volumes with Q2, but that includes, as I mentioned, that 8,000,000 cubic feet per day impact from the planned maintenance at LM4, the gas plant. So really what that means is that we're that implies that we see continued growth around outside the maintenance in the quarter. And then as we go into Q4, we're really expecting higher revenues on growing volumes and then of course lower seasonally OpEx as we usually have in the 4th quarter and that will support accelerating EBITDA into the Q4.

Speaker 3

So that's really how it kind of all fits mechanically. Let me just turn it over to John, he can talk about what's happening behind that in terms of the business driving all of that.

Speaker 2

Yes. Thanks, Jonathan. It's a really good question. I think at the end of the day, Hess has been performing exceptionally well. I think their D and C function and bringing wells online has been outstanding.

Speaker 2

The overall deferred production, the availability of the system has been extremely high. Partnered with the Midstream, our system availability has been very high as well. And then from a just well planning and infrastructure planning perspective, they're really marrying up really nicely from the standpoint of when the wells come on, the gas infrastructure is there to take that away. And that's what has enabled us to bump up our gas guidance slightly as a result of just that gas capture. I mean in the Q2, we were above 97% total gas capture across the entire field.

Speaker 2

When you look at it on a routine flaring basis, we're getting very, very low from a for routine flaring. So basically, as the wells are coming online, the infrastructure is in place to capture that gas. And I would say the 2nd quarter both from an upstream delivery side, but also midstream availability and ability to have the infrastructure in place right when it was needed was exceptionally strong in the Q2. We expect that to continue into the Q3, but as Jonathan mentioned, there is some planned maintenance activities, routine planned maintenance activities at LM4, which is going to keep volumes relatively flat from Q2 into Q3.

Speaker 6

Thank you. That's helpful. Maybe as a follow-up, seems like your water volumes are growing fast. Are there any trends that you'd like to call out?

Speaker 2

Yes. Water has been and I think we've talked about this previously, but water has been a very strong story. As we've talked about on prior earnings calls, the water infrastructure has been an underinvested area. And this is something that we've been over the last several years have been aggressively investing in. And the water capture as far as getting trucks off the road and getting it captured into pipe into our gathering system has been really good.

Speaker 2

The operational teams and the infrastructure teams building the infrastructure would We would expect to start to see water trend closer to oil. So I would say that the really aggressive growth and being able to capture the water is materially behind us. And now the growth that's going to continue into the future is going to look a lot more like oil growth. As you bring on new wells, the total fluids both from an oil and a water perspective will be now captured on pad and that will go into our system. So we do expect to continue to see growth.

Speaker 2

We just won't be we won't expect to see the growth rate we've seen over the last several years.

Speaker 6

Great. Thank you. I'll leave it there and enjoy the rest of your afternoon.

Speaker 2

Okay. Thank you so much.

Operator

Thank you. One moment for our next question. Our next question comes from the line of Praneeth Satish from Wells Fargo.

Speaker 7

Thanks. Good morning all. Maybe just on Hess, Hess' Bakken production, so it's now running at 212,000 barrels per day, higher than kind of the long term target of around 200,000 barrels per day. I mean, I know you mentioned I guess I'm just trying to translate this into the impact for Hess Midstream. I mean, I know you mentioned some of that outperformance is related to POP, but how sustainable do you think this is?

Speaker 7

And does that provide any kind of tailwind to your volume projections into Q3, Q4, maybe 2025?

Speaker 2

Yes. No, I mean, I think it's a good question. Q2, again, I mentioned this before, both from midstream side was just phenomenal. I think the overall performance on well delivery and infrastructure availability was exceptionally high in the Q2, which was great. I mean gas capture above 97%, almost 0 routine flaring essentially is just phenomenal.

Speaker 2

As you mentioned, a big piece of the second quarter about a third of that total volume beat was related to POP. And that really doesn't translate to additional throughputs or revenues for us. As we've been looking at the uncertainty of wells and as they come on in the future, we expect the performance to continue to be very high. But we are comfortable with where our guidance ranges are. We've set our long term MBCs and I think we see 10% growth rates going into the future.

Speaker 2

I think we feel very comfortable with where that is. Again, that relationship between our upstream and midstream and that flow assurance focus that we've got is really important to us. So as we're doing well planning, we're doing infrastructure planning at the same time. And if there's opportunity to capture upside, we will absolutely do that, and look for the wells to perform better, then we'll make sure that the infrastructure is sized to accommodate it. But again, I wouldn't say it's going to be a material change in anything we've seen and it's something that we're going to continue to partner with the upstream on.

Speaker 2

And we just feel really good about Hess' long term growth trajectory. They're going to run 4 rigs through 2024 and we expect to continue to see that growth trajectory that's translated into our MVCs and the implied volumes, growth volumes that go into the MVCs.

Speaker 7

Got it. Thanks. And maybe this question is for Jonathan. Historically, you've run the business at around a 3 times leverage ratio, kind of doing buybacks to keep that leverage ratio at 3 times as EBITDA grows. But the business has become at least a little bit more incrementally risky with the expiration of the cost of service contracts.

Speaker 7

So do you think 3 times is still the right leverage target, kind of over the next few years? Or could you look to trend that down over time?

Speaker 3

Yes. So I think we feel very comfortable at 3x. We feel 3x leverage is conservative, but it's not constraining to our strategy in any way. So on a relative basis, if you look at 3 times EBITDA, it's one of the lowest leverages in the sector and certainly consistent with our objective of stable cash flow and distributions. I think at the same time though, if you look, it doesn't we've demonstrated our ability to utilize that capacity and together increasingly more so as we go forward with free cash flow after distributions building, but still leveraging that capacity to really as I talked about more than $1,750,000,000 in buyback since 2021, really just amazing.

Speaker 3

And really that highlights what I said in my comments, which is we have our total shareholder return yield is one of the highest of any in the midstream sector. At the same time, our leverage is one of the lowest. And so really, we think that balance is correct and really highlights our ability to really deliver differentiated shareholder returns, but also maintain our balance sheet strength.

Speaker 7

Got it. Thank you.

Operator

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

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