CIVI - NYSE

Good morning, ladies and gentlemen. Thank you for standing by. My name is Erica and I will be the conference operator today. At this time, I would like to welcome everyone to the Civitas Resources Second Quarter 2023 Earnings Conference Call. [Operator Instructions] At this time, I’ll be turning over everything to John Wren. Go ahead, John.

Thanks, operator, and good morning, everyone and thanks for joining us this morning. I am joined today by our CEO, Chris Doyle; CFO, Marianella Foschi; COO, Hodge Walker; and Brian Cain, our Chief Sustainability Officer. I hope you have reviewed our earnings release, 10-Q and slide deck, all of which are available on our website. We will make forward-looking statements, which are subject to risks and uncertainties that could cause actual results to differ materially from our projections. Please read our full disclosures regarding forward-looking statements in our 10-Q and other SEC filings. We may also refer to certain non-GAAP financial metrics. Reconciliations to certain non-GAAP metrics can be found in yesterday’s release and our SEC filings. After Chris’ brief prepared remarks, we will all be available to take your questions. [Operator Instructions] I’ll now turn the call over to Chris.

Thanks, John. Good morning, everyone. We’ve been extremely busy year-to-date and certainly this quarter, in particular, capturing and now closing two transformative deals in the Permian, while continuing to deliver on our DJ business. You can see that our second quarter financial and operating results are very strong and top consensus estimates for both production and cash flow. In addition, we’re managing our investment and activity levels with capital expenditures under expectations for the quarter and allowing us to reallocate some of our capital savings to value-adding projects in Colorado. Our teams are laser-focused on continuing to build upon our track record of delivering on our promises. Our results continue to prove that an E&P company with high-quality assets can return cash to shareholders through commodity cycles while also maintaining a strong balance sheet. Inclusive of our dividend payment next month, Civitas will return more than $800 million year-to-date to our shareholders, one of the highest dividend yields alongside an active stock repurchase program. When we announced our recent Permian acquisitions, we’ve reiterated our unwavering commitment to a strong balance sheet. We’re well underway with our plans to divest $300 million in non-core assets by mid-2024. The proceeds will allow us to quickly reduce debt while high-grading our portfolio away from assets that simply, are not part of our near-term development plan. Looking forward, we’ll target three quarters of return of leverage at mid-cycle pricing. And again, maintaining a strong capital structure is key to building a sustainable business that can deliver top shareholder returns. Before taking your questions today, let me quickly discuss our recently closed Permian transactions and cover our second quarter highlights. Our new Permian assets are a perfect fit for Civitas and advance our strategic pillars. The new Civitas is scaled, diversified into a platform with duration in 3 of the best oil basins in North America. These deals create instant scale and provide an accretive entry into the Permian. As we’ve said before, scale really does matter in this industry, but we’re not focused on getting bigger, we’re focused on sustainably generating free cash and rewarding our shareholders through the commodity cycle. These deals check those boxes. A diverse asset base provides Civitas with flexibility on how we allocate capital, reduces risk and enhances the certainty of delivering on our metrics. Civitas now has about a decade of high-quality, low breakeven locations across 3 top well basins in the U.S. Our proven business plan matching high-quality assets with scale and a deep inventory provide us with duration and confidence in our ability to deliver value for our shareholders. In today’s deck, we provided production and activity updates for our new Permian assets. Production was in line with expectations, averaged about 107,000 BOE per day, of which 50% was oil during the second quarter. Currently, the assets are running around 100,000 BOE per day in the third quarter, which we’ll look to maintain heading into the fourth and exit the year around 110,000 BOE per day. There are currently 7 rigs running on our Permian assets. When closed, we can now optimize our activity levels and look for ways to best allocate investments across the DJ, the Midland and Delaware Basins. We expect to run about 6 total rigs in the Permian and DJ throughout 2024. For full year 2023, we provided preliminary guidance when we announced the transactions. Today’s materials include the ‘23 outlook for production, capital investments, total cash operating costs, production taxes and oil price differentials. Bottom line, our outlook for Permian production costs are unchanged since the day of announcement. Our full year capital investments, including 5 months of our new Permian assets, are expected to be about $1.3 billion at the midpoint. We are encouraged by some of the recent softening we’ve seen in certain services and consumables include drilling, casing, mud, and sand. It’s early, so we’re maintaining our capital guidance for the combined company. As we said coming into this year, we will be opportunistic and disciplined in how we allocate capital. Any potential savings or efficiency gains on the back half of the year could be allocated back to our development programs or to our balance sheet or back to our shareholders. Certainly too early to model deflation heading into 2024, but we like seeing the market beginning to correct. Since the announcement, we’ve been planning for integration. We have recent experience, obviously, successfully combining companies, and this integration in particular, is going well, be it very early innings. We’re very impressed with the teams behind these assets, and we look forward to building upon our success. We have a 6-month transition service agreement in place with both Hibernia and Tap Rock to ensure a seamless transition. Concurrently, we’re building out the team, looking to identify and retain top talent, align with the broader organization, accelerate the transition wherever we can. Let me quickly summarize our second quarter results. Civitas delivered free cash flow of about $190 million in the second quarter, above consensus expectations and really driven by strong production, lowering expenses and managing capital investments. On production, the team delivered higher-than-expected production of 173,000 BOE per day. So for the first half of 2023, we averaged about 166,000 BOE per day, right at the midpoint or just over the midpoint of our annual guidance. Our strong oil performance for the quarter was primarily driven by increased productivity we’ve seen from our recent 2023 TILs including the Watkins development area. We recently turned in line 3 pads with 3-mile laterals that have significantly outperformed expectations to date. It’s early, but based on our strong performance we’ve seen, we now expect to be around the high end of our DJ production guidance this year and continue to target an exit of 170,000 BOE per day or 280,000 BOE per day when combined with the Permian. On the expense side in the quarter, when we look at the foundation of our cost structure, LOE and cash G&A per BOE, we were down 10% quarter-over-quarter as we got out from under the first quarter winter and returned to normal production levels. Finally, we continue to manage our capital and full year expectations for CapEx are unchanged. Capital investments in the second quarter about $230 million were consistent with the first quarter as our activity levels remained relatively flat. When taken together, higher production, lower expenses and capital inside expectations to get higher free cash flow and higher returns to our shareholders. Finally, we were recently active under our $500 million share buyback authorization and repurchased about $20 million of stock at an average price of $64.55 per share during the quarter. In total, we’ve now repurchased $320 million in stock year-to-date and have $480 million remaining under the buyback authorization through year-end 2024. In closing, let me reiterate today’s key takeaways. First, our legacy DJ business is performing exceptionally well. Our teams continue to find innovative ways to address challenges and safely advance our business and deliver strong results. Second, our recent acquisitions have created a stronger, better and more balanced Civitas. We have options to invest capital across a portfolio of high-return assets in the DJ and Permian. We’re focused on safely integrating those assets and onboarding many of the great employees from Hibernia and Tap Rock once we get past our TSAs. Lastly, we know the importance of a premier balance sheet. We’re advancing sizable noncore asset sales and have a strong outlook for free cash flow. When combined, we expect to return to our optimal leverage ratio of less than 1x in 2024. Thank you for your interest in Civitas. Operator, we’re now happy to take questions.

[Operator Instructions] Your first question comes from the line of Neal Dingmann from Truist Securities. Neal, go ahead.

Good morning. Can you hear me alright?

Yes, we got you, Neal.

My first question on the commodity mix, really, can you all speak to how you’re thinking of the oil cut, both in the new Permian assets and the DJ. I’m just wondering specifically, plus your guide on the new assets assume much change going forward? And then secondly, also on the DJ, does it assume that after that oily quarter you had last quarter that the oil cut goes back to a more normalized level there?

Yes, I’ll start. Thanks for the question, Neal. I’ll start with the DJ. As I mentioned, the pads that came on, a couple of things going on here. One, this is in the Watkins area, which is an oilier area of our development. We love what we’re seeing. Two, these were also our initial 3-mile tests. And so going into the year, we prudently risk both the capital and operational execution, but we also risked the performance of that 3-mile. What we’ve seen through the quarter, early on in the flowback of these pads and they came on last month of the first quarter, so we had a full quarter to look at them. What we’ve seen is the degradation that we had modeled was overly conservative. And so they beat expectations early in the flowback, it’s oilier as well as those wells continue to clean up and we open them up, we will see the gas-oil ratio increase on those pads. And so we’ve got that modeled into the back half of the year. But I’ll tell you, we’re extremely excited about not just the continued performance of this area where about half of our capital is allocated over the next few years, including our two caps. But we’re also excited about what we’re seeing by extending laterals here in the DJ, and we recently just rig released off our first 4-mile well. So good news across the board on the DJ. And in the Permian, I would just point you to the first quarter cut was about 54%; second quarter, about 50%. Guidance indicates we will be in that range somewhere around 52%. You’ll see a little bit of lumpiness as well as come on and off, but we’re comfortable with that guidance going forward.

Great. And then just, Chris, my second, I think I know the answer, but I just want to double check on it. The shareholder return plan, you have any intention of changing this once – I know that the intent is to get this debt paid down initially, then given the free cash flow you showed, you’re certainly going to be able to do that even somewhat early in ‘24. Once you get this debt repaid, do you change that plan? Or will it stay on that kind of 12-month sort of rolling plan.

Yes. I’ll kick this off and maybe kick it to Nella for anything I miss. I really like the framework that was put in place here at Civitas. We’ve not changed the formulation. I like the trailing 12-month calculation. It allowed us to maintain our peer-leading dividend framework as commodity prices moderated from where they were last year. I see us continuing with that plan. And as we get the Permian Basin’s assets integrated, as we’ve guided when we announced, we see some real strength in extending that dividend plan, but also bolstering it from where we would have been without the assets. And then in terms of just how we think about allocating between that and the dividends, the buyback and debt paydown, we’re committed to getting leverage inside that turn, right? We want anywhere between 0.5 turn to 1 turn depending on where we are in terms of deal cycle and commodity cycle. We’re well on our way with the divestments. We think we can potentially accelerate our path to get inside of that. At the same time, and you saw it in the second quarter, as much as we are committed to getting leverage down, you see an opportunity to pick up an equity. And even in a small dose, we will be opportunistic as those opportunities come to us. And so we did that in the second quarter. You could see us do that between now and the end of 2024, where our operation – authorization ends.

Neal, and I would echo Chris’ comments. So the balance sheet is truly going to be the governor to everything we do. We really, really like the last 12 months look at the dividend because it gives some resiliency to the dividend and the shareholder return program. When you look at this plan, it’s at $70 oil or at mid-cycle prices, there is plenty of excess free cash flow after the dividend to hit our balance sheet targets. And we’re further going to complement that with the asset sales. So the asset sales are only going to allow us to reach those balance sheet goals sooner. But we really like it. We don’t anticipate any changes to the plan going forward.

I really like that plan. Thank you all.

Thanks, Neal.

Our next question comes from the line of Timothy Rezvan from KeyBanc. Timothy, go ahead.

Hi, good morning. This is [indiscernible] on for Tim.

Hi, John.

As you mentioned – hey. As you mentioned, your well results in the Southern area looks strong from both an oil cuts and total BOE perspective. How much of your drilling will be in this area before you officially start drilling in the Box Elder CAP? And do you think the recent well results here could be replicated going forward?

So we’re excited about what we see. We will say it’s still early days with the Box Elder CAP and with the Lowry CAP in this immediate area. When you step back and look our capital allocation across or to the DJ, this is an important area for us. Assuming two rigs going forward, which is really underpinning our ‘24 guide, about half of that capital is going to be directed to the south. We will look for ways to enhance our capital allocation, whether that’s within the DJ or to the Midland or to the Delaware. We like having the flexibility of moving capital around and we’re super excited about the results that we continue to see in the Watkins area.

That’s great.

Our next question comes from the line of Phillips Johnston from Capital One. Philips, go ahead.

Hey, guys. Thanks. Just a follow-up on Neal’s question. I think you said the Permian oil mix was 54% in Q1 and obviously fell to 50% in Q2. And then the guidance for the remainder of the year is 53% to 58%. So just wondering what’s moving that mix around so much. It’s a pretty decent base. Obviously, there is some lumpiness, but it is a pretty decent base. So just curious on that.

Yes. I think in the first quarter, with the Hibernia assets, you had some new wells come on oilier obviously, as those continue to open up and clean up, we have gas oil ratio coming up in the second quarter. And then you’ll see that mix range between those two quarters as you allocate capital and as you deploy capital to different areas of both the Hibernia assets and Tap Rock.

Okay, thanks. And you guys mentioned that you no longer expect to pay any cash taxes this year. Looking out into ‘24 and beyond, I think you will be AMT eligible. So can you maybe help us with how we should think about cash taxes in ‘24 and beyond.

Sure. I can address that, Phillips, it’s Marianella. For 2023, the asset sale treatment for tax wiped what we would have otherwise expected. That and a little bit of lower commodity price given the initial guidance we gave was at $80. Going forward, mid-cycle prices, so call it $70 oil, you’ll be looking at about 3% to 6%, 4% to 6% of EBITDA in terms of cash tax going forward. It’s an assumption that’s obviously very sensitive based on oil price because it’s all incremental, but that would be a good assumption at that pricing on the go forward plan.

Okay. Great. Thank you.

Thaks, Phillips.

Our next question comes from the line of Leo Mariani from ROTH MKM. Leo, go ahead.

Hi, guys. Obviously, very strong performance here in the quarter. Can you maybe give us a little bit more color in terms of what inventory is kind of in this Watkins area? Roughly, how many wells do you kind of have left to drill down there?

Yes. If you look at our Box Elder CAP and our Lowry CAP, you’re talking about a few hundred locations in total. We have OGDPs in addition to those two caps. And so it’s a large portion of our go-forward plan. And you look at skyline – if you look you look at the skyline – previous skylines, you can see sort of the split in our southern area, which is really this Watkins area.

Okay. That’s helpful. And then just wanted to ask just around the asset sales. You guys are talking $300 million kind of non-core stuff. Is that all just kind of producing assets? Is there also maybe some midstream there? Just can you provide a little bit more color around kind of what that is? And then just sticking on kind of M&A, I mean obviously, you guys have done a great job rolling up the DJ Basin over time. You are now in the Permian and two of the sub-basins here. Obviously, I think you are focused on integrating these assets. But did you look to kind of employ a similar strategy that you did in the DJ, where you hope to kind of acquire and milk assets for more free cash flow in the Permian over time?

Sure. A lot to unpack there, but thank you for the question. First on the divestment plan, we have selected our bank. We are launching that process. Currently, the first wave of assets are really as I mentioned in my remarks, areas on the right side of the Skyline that just don’t compete for capital when up against Watkins and our Western area and the Midland and Delaware Basins. And so it will include some production as well as some inventory. And then in terms of midstream, we would consider a partial or monetization of our midstream assets. I think with the strength in the commodity, we have a menu of options to hit our target and position us and de-lever us as we have laid out. And so we feel good where we are. We certainly are not going to cut into any muscle. And if we were to consider monetizing anything on the midstream side, we obviously protect our underlying business. But I think the team has shown in the past that we can be creative and that we can be on our front foot to not only to hit our targets, but also surpass them. So, I am excited about the current progress to-date on the divestment plan and look forward to sharing more on that. In terms of M&A, you hit it. I mean our focus really is integrating these two assets. It’s – we will continue to look for ways to enhance our positions in the Midland and Delaware, This question is a year from now, it’s an easier answer than day two of integrating Hibernia and Tap Rock. And so I would tell you that we will continue to look. It would need to be accretive on a number of metrics for our shareholders just as we did with Hibernia and Tap Rock. So, I wouldn’t say that we are completely on the sidelines, but it will have to be quite compelling to have us come back onto the field.

Thanks.

[Operator Instructions] Our next question comes from the line of Nicholas Pope from Seaport Research. Nicholas, go ahead.

Good morning everyone.

Good morning.

I was hoping you guys could talk a little bit about credit facility. I guess credit facility utilization post the close of the deal and how you are kind of planning on managing that where current rates are kind of post the close of this? Just trying to understand how that’s going to get paid down over the near-term.

Sure. Hey Nick, this is Marianella. So, this is something that we, as you might imagine, spend a lot of time as you are thinking of financing these acquisitions, just where rates are, what do we want our balance sheet to look like in terms of fixed versus variable debt, among other items in the balance sheet. But – so where we – and we have a Slide A and B investor presentation. We want to make sure our liquidity was very solid. And in looking through that mix because we know we want to pay down our outstanding quickly, we – essentially it’s a 630 pro forma for the deals. We estimate we will be at $700 million. Again, that’s not as of today, that is a 630 pro forma for that transaction. So, if you look at the pro forma last commitment of 1.85, that gives us very strong liquidity over $1.1 billion. To your point, given where rates are with excess free cash flow after the dividend and with the asset sales, this will likely be the first capital – their first piece of debt that we will pay. And so our goal is to get that down as quickly as possible, continue shoring up our already very strong liquidity. As a reminder, to our current 5% senior notes, that becomes callable as well, the second half of this year, it’s around October. That will be – given the rate on that, that will be lower priority as far as repayment goes, obviously, given where rates are. But hopefully, that helps in terms of how we think about pre-payable versus fixed debt in order of priorities in terms of debt pay down.

That is helpful. And how do you think about balancing that pay down with respect to the share repurchase plan and that variable dividend? Is there any thought about considering rates, I am assuming over 7% on that credit facility, about some sort of balance there, about reducing the share repurchase speed, about potentially looking at the variable component with respect to that current rate?

Sure. From a balance sheet strength perspective, Nick, we feel very comfortable with the leverage and liquidity and where we are headed. We have put our target out there, three quarters of a turn, and obviously, and looking at our profile for the next six quarters by the end of ‘24. We feel very confident that we will get under 1x. That’s after the dividend. In terms of the buyback, and you saw us do $20 million during the quarter. We will continue being opportunistic. When we think about what we need to get to our leverage goals, we will continue executing that prudently. And when you think about what we need to get there, it’s – the generation of this business is still strong that even after the dividend, we feel very comfortable we can get there. But at this point, like you mentioned that the credit facility interest is – it’s up there. It’s just certainly a lot higher than the 5% notes we have outstanding. So, we will be focused on paying that down as quickly as we can with excess cash flow on the asset sales.

Got it. I appreciate the time and answers. Thank you.

Thank you. Our final question comes from the line of Timothy Rezvan for KeyBanc. Timothy, go ahead.

Hi. It’s John again. If I can just squeeze another one in. You reiterated your intent to sell $300 million of non-core Permian assets with the goal of doing that by mid-’24. I am curious how you landed at that 300 figure and how your view would change if, say, if oil prices were to continue to show signs of strength here?

Yes. Thanks John. Glad to have you back on and I want to clarify, the $300 million divestment target that we see currently is primarily in the DJ. And these are assets that we know very well, that are either fully developed or they have inventory that simply does not compete for capital over the near-term. As – let’s say you continue to see commodity prices strengthen, I think that’s a really good day for a lot of folks, including Civitas. That doesn’t necessarily mean that we would sell fewer assets. It could accelerate the process to de-lever, which is great. But this is not just about hitting a number and whatever it takes to get to that number. This is more about how do you strengthen the base and the foundation of this DJ business, which is so strong and competitive across all other basins within North America as evidenced by Watkins, as evidenced by our Western assets. And so I think what you would see is that $300 million with some strength in the commodity price could go up. This is about paring back to a really strong foundation for the go-forward company.

That’s great context. Thanks for that. I will hand it back now.

Thanks John.

That was our final question. I will now turn the call over to Chris Doyle for closing remarks. Go ahead, Chris.

Thanks Erica. Thank you again for your continued interest in Civitas. We look forward to sharing our continued progress on upcoming calls. Have a great rest of your day, and please be safe.