KNTK - NASDAQ

Good morning, everyone, and welcome to the Kinetic Second Quarter 2023 Results. My name is Chach, and I'll be coordinating your call today. [Operator Instructions]. I'd like to hand you over to Maddie Wagner to begin. Maddie, please go ahead.

Thank you. Good morning, and welcome to Kinetics Second Quarter 2023 Earnings Conference Call. Here with me is our President and Chief Executive Officer, Jamie Welch, as well as Matt Wall, our Chief Operating Officer; Steve Stellato, our Chief Accounting and Administrative Officer; Anne Psencik, our Chief Strategy Officer; Trevor Howard, our VP of Finance; and Chris Kendrick and Tyler Milam, our VP of Commercial. The press release we issued yesterday, the slide presentation and access to the webcast for today's call are available at www.kinetics.com. Before we begin, I would like to remind all listeners that our remarks, including the question-and-answer section will provide forward-looking statements, and actual results could differ from what is described in these statements. These statements are not guarantees of future performance and involve a number of risks and assumptions. We may also provide certain performance measures that do not conform to U.S. GAAP. We've provided schedules that reconcile these non-GAAP measures as part of our earnings press release. After our prepared remarks, we will open the call to Q&A. With that, I will turn the call over to Jamie.

Thank you, Maddie. Good morning, everyone, and thank you for joining our call today. Yesterday, we reported our second quarter 2023 results, in line with our internal budget and slightly better than consensus estimates. The results further build off the momentum of our first quarter. Following record processed gas volumes in April, we continue to experience volume strength during the quarter, processing an average of 1.48 billion cubic feet per day and setting a new company record for quarterly process gas volumes. This represents approximately 10% growth quarter-over-quarter and is attributed to the elevated development activity that typically occurs throughout the second and third quarters combined with encouraging producer well results. During May and June, our processed gas volumes were impacted by record high temperatures experienced in West Texas. The extreme heat affected producers, utilities and service providers alike as they work tirelessly to maintain their mechanical equipment run times and overall production. In fact, this past June in West Texas was the hottest in over 10 years with temperatures consistently exceeding 100 degrees for half the month. Our operations team has gone above and beyond battling the summer heat while endeavoring to ensure smooth and reliable service for our customers. Therefore, despite the weather-related challenges, we still had a record quarter, thanks to our operations team. We remain on track to meet or exceed our 2023 exit rate guidance of 1.6 billion cubic feet per day. This is predicated on our constantly growing customer base, step-ups in contractual volume commitments occurring this summer and the commencement of new contracts later this year. As we enter the second half of the year, 2023 adjusted EBITDA continues to trend towards the high end of our guidance range of $800 million to $860 million. We forecast sustained growth quarter-over-quarter, primarily driven by midstream logistics volume growth and the commercial in-service of Delaware Link and the PHP expansion in the fourth quarter. By year-end, our annualized adjusted EBITDA should be well over $900 million. Our operations team has continued to lead by example, and as a result, our unit operating expenses are expected to decline throughout the remainder of the year and come in below budget. Additionally, current commodity pricing forecast indicate an improved outlook in the second half of the year as compared to the first. Our 2023 capital expenditures are expected to be at the top end of our guidance range, largely driven by incremental capital spend on PHP. It is worth noting our midstream logistics and Delaware Link capital spend is tracking at the low end of our guidance. Our 2024 free cash flow outlook remains robust as we anticipate significant adjusted EBITDA growth year-over-year, coupled with capital expenditures below $150 million. Moving to our growth projects. Delaware Link is ahead of schedule. Construction is progressing well, and we are now targeting mechanical completion in September and commercial in-service on October 1. Once in-service, Delaware Link will directly connect 3 of our processing facilities to Waha, providing enhanced system reliability and flow assurance to our customers. Progress continues on the PHP expansion and the project remained on track for an expected in service of December 2023. Our New Mexico gathering system expansion into Lea County is on schedule and is expected to be mechanically complete in January with the gathering and processing agreement now underpinning that project commencing at the beginning of April. During the second quarter, we executed a gas gathering and processing agreement with a new customer in Lea County supported by a multiyear minimum volume commitment. The contract is expected to commence following the in-service of the pipeline into early 2024. We continue to have constructive commercial discussions with several New Mexico producers, both existing relationships and several new to Kinetics. And we're excited about the opportunities to grow our business in the Northern Delaware. Following the in-service of Delaware Link, the PHP expansion and the New Mexico gathering expansion, we will be able to provide a highly competitive integrated wellhead to Gulf Coast solution to New Mexico producers for residue gas and natural gas liquids. Moving to the Texas side of the Delaware Basin, we identified a handful of commercial opportunities, particularly with private producers. In the second quarter, we executed several gas gathering and processing agreements with new customers that have plans to bring on incremental production later this year and additional development next year. Our commercial team has done a terrific job building partnerships with new customers and meanwhile growing our existing relationships. We have grown our customer base by over 25% following our merger last year, and today, our midstream logistics customer count stands at over 35. We also want to congratulate Chevron on the closing of its PDC acquisition, and look forward to working more closely with them as a major customer within our midstream logistics segment. Finally, we released our 2022 sustainability report last week. Our company has made meaningful progress advancing our sustainability initiatives over the past year. I highly encourage you to take a look at the report if you have not yet done so. I am proud of the progress that we made in 2022 and look forward to our continued improvement and achievements. With that, I'd like to now hand the call over to Trevor Howard, our VP of Finance.

Thanks, Jamie. We reported adjusted EBITDA of $208 million in the second quarter of 2023. Looking at our segment results, our Midstream Logistics segment generated an adjusted EBITDA of $138 million in the quarter, up 15% quarter-over-quarter. This was largely attributed to strong process gas volume growth in the quarter. Regarding the segment's fee-based revenue growth, the second quarter of 2023 was up 10% versus the second quarter of 2022. As Jamie mentioned earlier, operations and the rest of the Kinetic team have done a tremendous job managing costs despite difficult operating conditions and inflationary pressures. The second quarter midstream logistics OpEx came in 3% below budget, and we expect these lower realized costs to carry through in the third and fourth quarters. By the end of 2023, we anticipate unit cost per MCF to decrease by approximately $0.02 from the second quarter as OpEx is effectively flat and volumes continue to increase. Together, we estimate unit cost decreased 8% year-over-year. Shifting to our Pipeline Transportation segment. We generated an adjusted EBITDA of $75 million, up approximately 6% year-over-year. Growth within this segment was driven by volumes and margin expansion at the Shin Oak and Epic Crude pipelines. We remain highly focused on derisking our future earnings potential and our balance sheet. During the second quarter, we reduced our remaining 2023 commodity-linked gross profit to 5% and we will continue to opportunistically hedge our remaining 2023 exposure. We have also shifted our focus to derisking 2024 and beyond. To date, we have hedged over 20% of our 2024 commodity-linked gross profit exposure, much of which took place in July as the market rallied and we were selling into strength. It is worth noting that in 2024, we expect Kinetic's commodity-linked gross profit as a percent of total gross profit to decrease by approximately 10% to 9% as our new growth projects, which primarily carry minimum volume commitments are placed into service later this year and early next. On floating interest rates, we have approximately 90% of our total debt capital either fixed or swapped at fixed rates to at least June of 2025. While we continue to opportunistically derisk our balance sheet, we are currently comfortable with our fixed to floating rate mix. Next, from a capital investment standpoint, total capital expenditures for the quarter were $195 million, $65 million was within our midstream logistics segment and $130 million was at the pipeline transportation segment. We have seen tremendous capital cost control in the midstream logistics segment, which offsets some of the cost increases on our non-operated pipeline side. For the quarter, we generated an adjusted distributable cash flow of $144 million. And turning to the balance sheet, Kinetic exited the quarter with a 4.1x leverage ratio. On July 20, we declared a $0.75 per share quarterly dividend to be paid on August 16. During the quarter, we opportunistically repurchased approximately 112,000 shares or $3.3 million under the previously announced $100 million repurchase program. Year-to-date, we have repurchased approximately 194,000 shares for $5.8 million, leaving $94 million of remaining authorized capacity for share repurchase. The repurchase KNTK Class A shares partially offset share issuances under the second quarter drip in August. And with that, I would like to open the lines for Q&A.

[Operator Instructions]. Our first question comes from Spiro Dounis from Citi.

First question, maybe just to start with growth and some of your available capacity going forward. It sounds like a lot of commercial momentum. So I know in the past, you've alluded to the potential to expand on the processing side. It sounds like that was further away. Just want to get an update on where that stands now? And when you think further downstream from there, do you have enough downstream capacity right now to facilitate all this commercial momentum?

So Spiro, thank you for -- look, as far as on the processing side, I still think as we look at our processing stack going forward, that a decision in the second half of 2024 is the prudent decision point for a new processing facility that would then put it in service most likely towards at the end, the earliest at the end of '25, obviously, depending upon supply chain, logistics and everything else in the world at that point in time or maybe at the latest, it would be the very beginning of 2026. We have enough capacity as it relates to NGLs and the latitude and flexibility that we have. As well as, obviously, with capacity on -- with our capacity on PHP. So I think we feel both comfortable and confident of what we see right now as far as on the customer side going forward. And I think that is not going to change 2 things. It's not going to change how we think about CapEx for next year because even within that $150 million, we've made the assumption that we'll have at least a deposit and probably 1 milestone payment for a box. And that would still keep us under the -- at or under the $150 million level. And I think as far as the rate of pace of growth that we see, look, if it continues to accelerate, we can obviously revisit. We'll obviously try to get everything possible out of our existing footprint. And as you know, we were successful at expanding Diamond Cryo by 120. So I think the guys will -- Matt and his team will try to get everything possible out of Toya, Pecos Bend that they're able to do and still maintain high levels of recoveries and obviously, tremendous customer service.

Got it. Helpful color. Second one, maybe just going to GCX. Looks like you are still exploring the sale there, and I think a lot of us sort of expected maybe a potential deal to close by now, but I know since that last discussion, I guess sounds like KMI is now exploring an expansion of that pipeline, which was not originally in the plan, I suppose. Curious how much of that is sort of impacting the sales process now?

So it's a good -- really good question, Spiro, as it relates to GCX. So yes, we're in the second round. We have a number of parties that are moving through the process. And you're right, as evidenced by Kinder Morgan's discussion on their most recent conference call, where they resumed the topic of an expansion of GCX. I think in part that comes with following the successful FID of next decade LNG. And I think the absolute certain realization that you're going to have almost 12.5 Bcf a day going to Agua Dulce, and you've only got 6 Bcf a day or 6.5 Bcf a day of capacity to get there. So the incremental need is, I think, quite high. The likelihood this gets done, I think, is also pretty high. As an owner and as a responsible owner of GCX and responsible to our shareholders, it's our job to try to get the highest price, including the value for the expansion because we believe much like Kinder-Morgan that it is fairly likely to eventuate in the near term.

The next question on the line is from Neel Mitra from Bank of America.

I wanted to touch on capital allocation going forward. I know the goal is to ultimately get to investment grade as well as turn off the DRIP. So just wanted to understand kind of the order of events here. So it sounds like GCX is still very much on the table. There's likely going to be some sort of expansion and that's probably holding up some things. Then after that, do we look to turn off the DRIP first? Or do we look to keep the DRIP to get to investment grade then turn off the DRIP. I'm just trying to understand which one is the priority first getting to investment grade or turning off the equity issuances?

And Neel, it's a really good question, and it's something we discuss a lot internally. So obviously, the element, obviously, at GCX maximizing the value, particularly with the likelihood of the expansion of that particular pipeline. We intend to reduce to at least the minimum level, if not terminate the DRIP for the remainder of its existing term, which would be 2 quarters, third quarter and fourth quarter of this year. And I think our viewpoint is that the business remains even more robust than we expected. And we do not see a need to continue to have to worrying about the dividend reinvestment plan in order to achieve our 3.5x leverage target, which we think is a controllable outcome. Investment grade is somewhat out of our control because we are reliant on 3 -- 2 or 3 other parties to obviously make determinations on our overall credit -- from a credit standpoint. So we -- within our control, we know what we need to do. And I think it will be -- as we think about the business right now, it is stronger than we anticipated, both for 2023, being at that high end of guidance and '24 being a significant step change as far as EBITDA is concerned. So I think we get a lot of conviction that the dividend reinvestment plan will no longer be required. And I think, Trevor, if I'm not mistaken, we get through this third quarter, we're cash flow positive all the way through from there on out.

Yes, that's exactly right. So as Jamie mentioned, turning off the DRIP or reducing the DRIP meaningfully or turning it off for the third and fourth quarter dividend payments is the plan. And we intend to delever with excess free cash flow beginning in the fourth quarter of this year and 2024 until we hit that 3.5x leverage target. And then thereafter, it will be a mix of repurchase and dividend growth.

Okay. Great. And then maybe a broader macro question. It sounds like on the crude side that there were some just basin-wide processing constraints because of the heat. And you've heard some commentary that some oil producers delayed completions or even shut in some wells during the second quarter due to the midstream constraints because of the heat we've had here in Texas. Did you see any of that with your producers or your underlying growth such that there's a spike in the second half of the year, assuming that we get some relief and heat here in the third quarter?

Trev, do you want to take that?

Yes, absolutely. So we definitely saw -- our business was not immune to the higher temperatures that we experienced in June and then also in July. But what I would say is that as we think about where we were when we last spoke with our first quarter earnings in May, as we think about the second half of this year, we don't really anticipate any changes to our overall volumes for the full year. And while it wasn't included in our press release or slides, I would like to reiterate that we still are expecting to be tracking towards 1.6 Bcf a day of excess process gas -- excess gas process volumes in 2023. So no change to the business that we see at this point in time.

Our next question is from Robert Mosca from Mizuho.

I wanted to ask around your CapEx expectation for next year. And I understand that Shin Oak isn't included in that or expansion of Shin Oak, but is that estimate more like a barebones estimate without any prospective growth projects? I guess I'm just trying to piece out how you can step down to that level and what's currently budgeted.

So Robert, it's Jamie. So good question. I think if you go break down, obviously, our overall guidance, right? So for this year, in midstream logistics, it was $235 million to $265 million. The lion's share of that $235 million to $265 million, on top of what we consider to be regular growth. So to us, maintenance growth will be done with, obviously, with most of our integration CapEx, maybe there's a very, very small amount for the balance of the PB treating that's going to happen in the very, very beginning of '24. But that $235 million to $265 million, which was our guidance, a lot of it related to New Mexico. That will be done as far as the capital is concerned, or I would say 90% of it would be done. We don't have another Delaware link on our chart, on a -- right now on a game board. We don't have another PHP expansion that of itself was $255 million to $275 million. So Robert, when we look at it, we say, it's not barebones that we just had a lot of one-off -- very large one-off items. PHP expansion was one-off, Delaware Link, a New Mexico expansion taking us all the way up into the interior of Lea County. They are not things that we anticipate every year. And when we think about our overall step-up in forecast, that obviously we don't have anything, right, other than what we've got right now. We obviously have the East Toya treating that's already online. We've got PB coming on at the very beginning of next year. That's the remainder, I think, of the integration CapEx that we identified as part of the merger. And so $150 million, as I mentioned, $150 million actually has this decent sized growth. Obviously, there's a component of it related to Apache in one and that second -- and literally sort of the June onwards, when we expect that the Alpine High, will basically be turned in line. There's some incremental capital there. We also can afford a deposit sort of a milestone payment in the context of a new Cryo. So the $150 million, we think, has more than enough room in the context of our continued growth.

That's really helpful, Jamie. And maybe also a follow-up on that capital return outlook. I think it's sounding like that 3.5x leverage is kind of a precondition before you can introduce more buybacks and dividend growth. Is that the right way to think about it? And how early should we expect that to happen? It sounds like the majority of the GCX proceeds will be used to address the DRIP.

So I think our viewpoint is that in 2024, we will certainly -- our expectation is to meet the 3.5x leverage target at some point during the year, whether it's at the year-end or whether it's sort of 12 months from now. Let's just continue to, in fact, count the precincts as we look at the overall forecast for the year. But as I said, the forecast day by day gets stronger. Anne Psencik has done a great job on the hedging side. So as you could see, we've really tried to get ahead of that, and we've got over 20% of our total exposures hedged out through '24. So I think it's going to be in 2024, just can't, with exact precision, tell you exactly what's the date that we're actually going to hit that milestone.

Our next question is from Tristan Richardson from Scotiabank.

Just looking at your slides, can you talk a little bit about your EBITDA target of $1 billion, maybe some of the things that need to happen to achieve that target? And then is that on the asset base you have today with Delaware Link PHP in New Mexico? And -- or does it presume additional infrastructure like a processing plan you've been talking about?

Short answer is, Tristan, it assumes same-store sales. So it's taking what you have and obviously, in the context of our existing asset footprint and actually seeing that be able to maximize the overall cash flow profile that we can actually harvest of that footprint. So it doesn't involve an incremental processing train. That would obviously just be over and above that target. But this is sort of the target that we've got out there that we want to think about in the context of 2024, I mean we see where consensus is sort of in the $950 million or sort of there at $940 million, $950 million, I think, as it is for EBITDA. And obviously, we realize there are some things. I think Matt and the operations team have done a great job. As I said, there are -- the commercial teams doing a great job. There's a really good prospect with some solid fundamentals that we can achieve our targets. So that's our goal. And that's how we think about it. So it doesn't involve anything necessarily further.

Appreciate it. And then maybe just -- can you talk a little bit about the contracting environment in New Mexico? You noted that there's some early discussions with potential new relationships. Maybe just the landscape from the standpoint of Eddy and Lea being buttoned up or there are large packages still to be had, maybe just what you're seeing into Mexico.

Sure. Chris, Tyler, do you guys want to jump on in.

Yes, Tristan, this is Chris Kendrick. Thanks for the question. So -- and then I'll let Tyler chime in. So we see New Mexico as a great growth opportunity. Rig count up there exceeds what we're seeing in Texas. We've been successful filling up the 20-inch line and see some growth out there, both with new and existing customers. It kind of reminds us of the Texas Delaware circa 5 or 6 years ago. There's still a lot of opportunity surprisingly. And the reason we got it there in the first place, there are some constraints. And so we feel optimistic about the continued growth, and we'll continue to pursue those opportunities. Tyler, anything to add on your side?

Yes, Tristan, thanks for the question as well. Yes, this is Tyler. The only thing I'd add is just evidenced through what we announced this quarter with some additional success. We -- the pipeline isn't even in service yet, and we are seeing the need and customers are kind of putting their in where their mouth is for being able to execute on those. So stay tuned. We're excited about the area for sure.

Our next question is from Keith Stanley from Wolfe Research.

First, just a quick follow-up. When you say the GCX sale, you'd look to turn off the DRIP or go to the minimum level for Q3 and Q4. Can you just remind us what the minimum level of the DRIP is?

20% Keith.

20% Okay. And then a second follow-up on New Mexico. Is there any way or any disclosure you can give on a sense of how much volume you've either contracted on that New Mexico pipeline at this point? Or any rough sense or a way to think about how much incremental volume you expect on the system from that line coming on next year and then through 2025?

Really good question. Let me -- we might have to just think about how to do that given within our disclosures. We've not talked about this -- if you recall, Keith, I think in some of our previous interactions, we've talked about, it was $80 million, $90 million and like up 4x -- less than a 4x build. So that gave you a sense that was the original underwrite. And obviously, it has now got better. The new MVC that we have is about 20% of the size of the one that obviously underpinned with the anchor. So that's still a decent size and -- but we know that the anchor was critical to our expansion. We'll think about how to get that disclosure out there so that you guys get a better sense because I do understand that from our standpoint, we're pretty excited about it. And we want to make sure that it's -- we can communicate it effectively.

The next question is from Jeremy Tonet from JPMorgan.

Just wanted to come back, I guess, to the EBITDA trajectory outlook here. Again, as you talked about December 2023, over $900 million there. And then I think you've referenced $950 million Street consensus for '24. And just wanted to see how should we be thinking about that? Is that kind of like it stairsteps into $900 million run rate and there's slight growth over there in the $950 million, 2024 for The Street consensus makes sense? Or I just want to make sure I understood correctly there.

Well, I think what we have said is, yes, it's well over -- it's well over $900 million, right? So let's just start with that. And then I referenced the $940 million to $950 million, I think, is where consensus is and consensus, I suppose, the easiest way to say it doesn't trouble us.

And then, Jeremy, just jumping in there with respect to cadence. Regarding cadence, unlike 2023, where you saw -- where we had trough quarter was 1Q and then we stairstep to a run rate. By the time that we get to fourth quarter, I'd say it's as we think about 2024, it's pretty flattish from there. And so there are some puts and takes when you look at the commodity price curves and whatnot, but I'd say, by and large, it's not like what we saw in 2023, where you had the stairstep quarter-over-quarter sequentially.

Got it. That's helpful. And then -- just wanted to turn to the business for a second here. And if you could discuss some of your larger third-party NGL pipeline and frac commitments and when some of those might start to expire? And once they expire, would you seek to build your own frac or look for other ways to maximize the value of that long NGL position?

Yes, sure. So we have, let's say, shorter-term arrangements on the NGL side with Lone Star. They are plant dedications for East Toya and for Pecos Bend. They roll off in 2026. As it relates to Targa, it's a longer-dated contract out into the early 2030s. And I think they're about a sort of similar time frame, I think, for the enterprise relationship that we have on Shin Oak. And so it's clear to me that we'll think about what to do on how to maximize the value for our producers because at the end of the day, it's obviously all -- our business is keyed off the attractiveness of the netback for our customers. But in the near term, the only thing to play for in the next several years will be sort of that Lone Star roll off and then we'll sort of work out. Anne will then work out what makes sense. As far as investment opportunities, we -- I think our viewpoint is, look, we've got enough on our plate to get through now. We can worry about that at a later point. Obviously, we wait for further updates on exactly what is or what will not happen with Shin Oak. We've got enough capacity on Shin Oak that makes it that we are comfortable as far as what we've got moving on -- from an NGL standpoint, both now and going forward. So I think we are open to outcomes. We'll see what happens, see what comes our way. If it's particularly attractive and compelling, then we'll think about it. But for now, it's not built into our base plan at all.