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Chesapeake Energy Corp
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Good morning and welcome to the Chesapeake Energy Corporation first quarter 2021 earnings teleconference. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today’s presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded.
I would now like to turn the conference over to Brad Sylvester. Please go ahead.
Thank you Andrew, and good morning. Thank you for joining our call today to discuss Chesapeake’s financial and operational results for the 2021 first quarter. Hopefully you’ve had a chance to review our press release and the updated investor presentation that we posted to our website yesterday.
During this morning’s call, we will be making forward-looking statements which consist of statements that cannot be confirmed by reference to existing information, including statements regarding our beliefs, goals, expectations, forecasts, projections and future performance, and the assumptions underlying such statements. Please note that there are a number of factors that will cause actual results to differ materially from our forward-looking statements, including the factors identified and discussed in our earnings release yesterday and in other SEC filings. Please recognize that except as required by applicable law, we undertake no duty to update any forward-looking statements and you should not place undue reliance on such statements.
We may also refer to some non-GAAP financial measures which may help facilitate comparisons across periods and with peers. For any non-GAAP measures we use, a reconciliation to the nearest corresponding GAAP measure can be found on our website.
With me on the call this morning are Mike Wichterich, Nick Dell’osso, and Frank Patterson. Mike will give a brief overview of our results and recent events and then we will open up the teleconference for Q&A.
With that, thank you and I will now turn the teleconference over to Mike.
Thanks Brad, and good morning. Welcome to the call. We appreciate you making time for us this morning. Before we go through the quarterly results, I’d like to take a few minutes to discuss our change in leadership and also answer what I’ve been getting as the most common questions. We’ll just take any questions [indiscernible] format.
First question is, was there any action that resulted in this change, and the answer to that I’ve been pretty clear about through both press releases and just in public - there was no action. We like Doug, we thought he left the company in a great position, and we wish him the best.
Second most common question is, is this a change in strategy? The answer is absolutely not. There is no change from the post-emergent strategy. We’re focused on free cash flow, capital discipline, and returning cash to shareholders, and being a good corporate citizen. But we have to put this in perspective - the company has had a huge change in strategy between what it was for the past eight years and what it is today.
The past eight years have been a strategy of value preservation. Today, we’re talking about a strategy of creating value - that is vastly different, and the execution of it is different. The shareholders understood this, which is why they decided to change the board in its entirety with the concept of bringing in a fresh perspective, the company has an opportunity with a new balance sheet and way to create value, and so that perspective knew the change and they made it at the board level. The board has taken several months to get to know the company and decided that management also needed to change and fresh perspective, which is why we made the change.
CEO search - the first question I usually get is, is someone on the board considering interviewing for the job of CEO? The answer is no, no members of the board are currently interviewing for the job and don’t expect it to occur.
Next question is, how long will it take? Of course, this will take several months, we expect it to take several months, and we’ve planned for several months. We’ve formed a search committee, Matt Gallagher will lead that committee. We’re looking for someone who will be accretive to our strategy, not to change our strategy.
With that said, the board was very clear and we have a very clear mandate at the management level - we want change now, we want fresh perspective now, which is why I’m here at the company spending 100% of my time working with the existing management team, working with the existing employees. We make a lot about CEO change, we make a lot of about how important CEO is, but honestly I think too much is made of it. It’s really about the employees and can we execute.
The first order of business for the board was to evaluate staff and get a feeling for where their head was, and truthfully they have every reason to be demoralized after eight hard years and bankruptcy. I can tell you from early observations and my time here that this team is ready to go. It has a chip on its shoulder. I can tell you there’s an energy on campus which is contagious. I think they’re tired of getting punched in the face by a balance sheet and they would like to get away from that cloud and move on to execution.
Now talk is cheap - we get that. We have to have great results, and I think the first quarter is a good start in that direction, so now I’d like to move to the slide deck. We’re going to start on Page 3 of Webex but also on Page 4 of the deck that you saw last night, the Chesapeake value drivers.
The middle of the page is what’s telling the story. Today, we move that number from $2 billion to $3 billion. We think that’s pretty impressive and we’re proud of it. Now, the first action that we’re taking, of course, is returning cash to shareholders. You’ll see we instituted the dividend - that is a fixed dividend we will consider, and we plan on doing additional returns of capital and will make those decisions towards the end of the year, after we have a few quarters under our belt.
To the bottom left, in order to have free cash flow, you have to have financial discipline. We believe in this reinvestment rate. We will continue this reinvestment rate, and that will be one of the keys to our success. Top left corner, the balance sheet is in great shape. Our long term goal is to keep the balance sheet under one time levered. This is a competitive advantage. It gives us optionality that the company has never enjoyed. This will be a big part of how to create value.
Finally ESG - we have goals, it’s part of our compensation structure, we’re taking it serious. It’s not just emissions, it’s also social governance. The company is preparing and making changes every day.
Moving to Page 4 of the slide deck, again let’s go to the first middle section. The company is producing free cash flow. I’ve always said if you have a great company, you also build cash. To the top right, you see we’re building cash on the balance sheet - $340 million. We’re pleased with it. You can see it continues to build, and it’s also driving down our debt, which is exactly what we hoped for, it’s exactly what we modeled, and exactly what our goals are.
Moving to Page 5, a lot of talk about the balance sheet. I don’t think it could be over-emphasized that this is a competitive strength. I know you’ve seen this slide. I would like to reiterate this is our advantage that we plan on taking advantage of.
Page 6, our business is moving to scale, efficiency and cost of capital. Becoming investment-grade is a priority. We think we’re well positioned to get there very soon. This will also help us be competitive.
Page 7, not only is our balance sheet fixed, the management has done a great job in bankruptcy to re-set all of our cost metrics. G&A has decreased, LOE, transportation - of course that’s driving EBITDA. It’s opened up opportunities on assets, this recalibration. We have more opportunities, lower breakevens than we’ve ever had.
Finally I’d like to talk about stuff that’s happening outside of the bankruptcy renegotiation, something that the team is executing on. When you look at Page 8, I focus on costs per lateral foot. In particular, take a look at Appalachia - we’re pretty proud to get to $700 to $750 a foot. In 2019, it was $985 a foot. Now, during bankruptcy, we said the team continues to execute. It’s about execution going forward and I think we’ll continue to execute.
With that, I’ll open it up to questions.
[Operator instructions]
The first question comes from Scott Hanold with RBC Capital Markets. Please go ahead.
Thank you. Great quarter, guys. I guess my first question is the opportunity set that you all set out there to continue to build scale, obviously there was a big transaction that happened in Appalachia. Can you just give us your sense of strategically how you look at these opportunities, what’s out there, the target areas, and if in the midst of a CEO search, is it likely you guys put that on hold until you get somebody permanent?
Sure. I think you’re referring to the Alta transaction. Number one, we love that transaction. If you put it in perspective, Cabot’s told you for years that asset’s great, we’ve told you for years the asset is great, and now EQT is telling you northeast Pennsylvania is great, so in general we like it.
For us to think about acquisitions, we’d have to look at it a little bit different than others, which is one, we can’t break our balance sheet; two, we’re not going to change our reinvestment rate; and three, it’s got to be accretive. At that level, that transaction is not particularly accretive for us and so we’re not going to do that. We have discipline on all of our acquisitions.
Your question on are we going to pause, the answer is absolutely not while we search for a CEO. The team has a mandate, the board is completely aligned. I can tell you being on the board, we’re absolutely ready to move forward, so I do not expect to have any transaction, any action that we’ll take will be waiting for a new CEO. We’re moving now.
Understood, thanks for that. As my follow-up question, it was impressive you guys started your shareholder returns this quick and at a pretty strong 3% fixed dividend yield. Can you give us a sense of what were you looking at to start this initial dividend? I mean, that’s a pretty healthy output initially and it sounds like you guys are going to be holding off on incremental shareholder returns until, as you said, you get a couple quarters under your belt. But first, address setting at 3%, why that rate; and then as you start looking beyond in 2022, what should we expect?
Hey Scott, it’s Nick Dell’osso. We looked at setting a base dividend here that would be sustainable through all cycles, so we ran a lot of sensitivities on this and we thought about good years and bad years, and we stress tested it pretty hard. Now in reality, we still could have increased the dividend beyond this and lived within that stress tested view, but we want to build on our execution and have room to methodically increase this dividend over time, so we looked at where the competitive landscape is in terms of yield, we looked at where we want our stock to be in the coming quarters, what we think is a more appropriate value. We looked at that stress test and we used all of those things to come back and say, what is the appropriate yield for this company to begin.
Now we expect that yield to grow. We expect to have significant cash flow, free cash flow beyond what we’re paying out in dividends, and as Mike noted earlier in the call and as we put in our press release, as we approach year-end and begin to build that cash on the balance sheet, we’ll detail for shareholders other ways that we plan to return capital to our investors.
We’re going to take our return capital to investors very seriously. This is a business that should generate very significant free cash flow, and we expect to be able to deploy that cash flow in our business in a very accretive manner but we also expect to return quite a bit of it to shareholders along the way. We’re not going to just become a cash hoarding machine here, so that cash will be returned to shareholders.
Appreciate it, thank you.
The next question comes from Josh Silverstein with Wolfe Research. Please go ahead.
Yes, thanks. Good morning guys, and Michael, thanks for the comments here.
Based on the forward outlook heading into 2022, it implies that nat gas is growing while oil declines. I’m just curious, why not increase the oil activity if we remain in a $60 environment? Then just on the gas side, I’m assuming that this would--the growth would all be coming from the Haynesville, given that the Marcellus basis differential concerns, so was hoping you could touch on that.
Let me give you a general thought on oil and when we’d react to it. The first thing about oil is we’re looking at programs here, and they have to be big and sustainable, so we’re not focused on the prompt month, we’re focused on the long term rate of oil. We need sustainability and we need programs that can just take a rig program and continue to get the efficiency and scale that we’re looking for.
Assuming you can get all that, it still has to compete with rate of return on our other projects. We have a good inventory in some of the other basins, in particular the Marcellus and Haynesville. We like those returns, so oil has to compete on a rate of return. This is not an oil or gas conversation for us, it’s a rate of return.
Nick, do you have some thoughts?
Yes, so our capital allocation model is very much as Mike has described, and it is not just about the prompt month. As we think about standing up a program, there’s a lot of friction costs in standing up a rig and then dropping that rig in the months of following if prices wobble, so we want to see a strip that goes out at least through the payout of the wells you would be drilling, so call it two to three years from the time you make a decision until the time you’re going to get payout on that activity, that you feel comfortable you’re sustaining an attractive rate of return.
We’re getting closer in South Texas. You may have noticed we added a few wells to our capital allocation here towards the back half of the year. We had a rig running on some obligation drilling and we’ve chosen to keep that rig going for a few more wells that are going to be great rate of return wells. We’ll evaluate that as we move into next year to determine if it makes sense to, again, continue to keep that rig running.
We think about capital allocation in, again, driving for returns, chasing returns, maximizing returns across the portfolio of opportunities that we have, so it takes a few years of price and it takes likely an ability to hedge in some of that price. We believe when you allocate capital, you should de-risk that capital through a hedging program that thinks about how to hedge and de-risk the volumes that are coming online associated with the capital you’ve allocated, so it is a pretty thorough analysis that would drive us to increase capital.
We’re getting closer in some of our assets and we think about that quite a bit, but we will be very methodical in this. We will protect our 60% to 70% reinvestment ratio, which clearly we have quite a bit of room in between here and there, but we’ll also protect our cash flow metrics, we’ll protect our return metrics. We will continue to drive for improving cash return on capital invested as well as return on capital employed, and you’ll see us talk more and more about all of those things as we move through periods and have more history post bankruptcy.
Josh, this is Frank. To answer the second part of your question, yes, Haynesville is where the volumes are going to come to displace that decline we have in assets. We’ve now moved to three rigs in Haynesville. We are seeing really good base production support in all the fields, so we’re working this as a program.
As far as growing the Marcellus, you’re very aware that we have kind of a cap on our volumes there at about 3.3, 3.4 Bcf a day gross, so we would grow that. Those are great rate of return opportunities, but we’re not going to overwhelm our system or the market.
Great, thanks for that, guys. You mentioned strategically you’ll move forward with a potential transaction. Given the free cash flow profile of the company, do you feel like Chesapeake needs to do something right now given the balance sheet will go to a negative net debt position by the end of next year and leverage is already at just half a turn? Why not just run out an asset for its free cash flow profile? Just any sort of strategic thoughts around transactions on the divestiture side.
Yes, this is Mike. Number one, we don’t have to do anything, and that’s a great position. For the past eight years, they’ve had to sell assets. Some companies don’t have enough inventory and they have to buy assets. We’re not in either one of those positions, so I don’t feel like we have money burning a hole in our pocket to get something done, so it’s not our focus. Our focus is internally first.
With that said, we operate in some great basins, and any time we can create value by adding to it or subtracting to it, we’ll do it. That means knowing everything that’s going on in the market, looking at every transaction, staying current on everything, and so although I don’t think that’s our first order of thinking, think about transactions, it definitely always will be there and we’ll always be ready, so when the right one shows up, we’re ready either on the buy side or the sell side.
Nick, do you have more?
No, just very much agree that we expect there’s going to be a lot of continued discussion around consolidation, and the strength of our balance sheet puts us in the center of those discussions. We like the optionality that gives us to be in the center of those discussions, but we will drive for accretion and value in anything that we look at, whether it’s a sale or a purchase.
There’s plenty of work we can do with this portfolio. When you own a large, diversified portfolio, it gives you a lot of options as to how think about creating value for shareholders. We’ll do that. We will buy some stuff, we will sell some stuff mostly likely over time, but we will have discipline with it. We will drive for accretion and we will drive for value.
Great, thanks guys.
The next question comes from Charles Meade with Johnson Rice. Please go ahead.
Good morning Mike. I want to go back to just dig a little bit more, maybe on the same theme. Going back to your prepared comments, it caught my attention when you were talking about the balance sheet and you said, this is our advantage, this balance sheet. I wonder if you could elaborate on that a bit more because there’s two things that immediately came to my mind. Number one is that actually there’s a lot of companies with relatively low balance sheet leverage, so maybe you more meant that’s an advantage versus Chesapeake in the past, or perhaps there’s another way of looking at an advantage in the industry, or versus the industry.
Then second, when I think about--when I heard that comment, my mind immediately turned to M&A. Is that the sense in which you were saying that the balance sheet is an advantage?
Let’s break it down just a bit. Great companies have great balance sheets, absolutely those are the best competitors. We’re happy to be part of that, and I am separating us from old Chesapeake in the past and also just sort of weaker competitors who have strained balance sheets. It gives an option for us to do absolutely nothing or something, and so when you have that choice, then you’re starting to be able to think about it only in value perspective, not in I have to perspective. This doesn’t mean again that we’re absolutely fixated on A&D or divestitures, we’re fixated on making the company better and making value better.
I think ultimately--obviously we don’t want to keep cash on the balance sheet. Obviously we’re not going to sit around and just let it sit. Nick already said that we’re going to return cash to shareholders, so A&E feels second or third.
Got it. That’s helpful, Mike, thank you.
Second question, Nick, you mentioned that--I get the overall message that standing up a rig in an oil asset has to compete against your great gas assets, but looking at those inventory slides that you guys put together, one of the things that I noticed is that it looks like your Brazos value is really where that inventory expands as the oil price moves up. Is that where we ought to think about a rig going back to work, in Brazos if you did see the strip move higher in a sustained fashion?
Hey Charles, I’m really glad you asked about those inventory numbers. We haven’t shown inventory numbers in a couple years, and we’re really proud of them. Frank and his team have worked extremely hard to build a robust inventory, waiting for us to be in a healthier position to prosecute that inventory. There’s a lot more that we believe we will do to enhance this inventory over time just on what we own, and so we’re really excited about this part of our story.
You’re also right to note that our Brazos Valley asset gears around pricing on inventory a little bit more than some others, and so it is something that we’ll pay a lot of attention to if there’s a big run in prices and think about what that could mean for an asset like that. It’s nice to own a big portfolio of assets where you have those options, but that also drives to exactly the multi-year price stability that we talked about from a capital allocation standpoint.
When you see a play that has inventory that scales noticeably at a $5 move near where you are in the strip today, you have a little bit less confidence in driving a program into that basin immediately. You’d like to have a little bit more cushion than that, so I don’t think that’s necessarily the first place, Charles, because of that sensitivity to price right there.
There are some great wells that we can go drill in Brazos Valley today, and we really hope that we’ll have an opportunity with more stable or increasing prices to go drill a bunch of them, but that’s not where we are yet.
Thanks Nick.
Charles, let me add a couple things. If you were looking at Brazos Valley and it was your only asset, that would be one way to look at the world. If you look at the way those graphs kind of fall out as oil price goes up, the entire portfolio goes up, so they are competing against each other, so you’re going to basically look at those graphs and say, okay, if oil went up, where is the first place you would spend a dollar in the oil assets, and it’s South Texas. Then the next place would either be Brazos or Powder River Basin, and that’s the way we look at the world.
It’s not just can we get a rig stood up in a given asset; it’s where do you stand up a rig inside your portfolio as prices go up, and as Nick said, we have to have confidence in our longer term oil price, and we’re moving in that direction now, which is a really positive thing. It gives us a lot of flexibility.
Thanks Frank.
The next question comes from Nicholas Pope with Seaport Global. Please go ahead.
Good morning guys.
Morning.
I was hoping to understand a little bit, it was mentioned in the 10-K from the end of the year, the Williams transaction of assets at the end of ’20, what was the impact of that on production in the Haynesville from that exchange of assets with the midstream restructure?
That area of the Haynesville that we traded for that agreement was a pretty small producing area for the asset, and we can more than make up for that loss with the remainder of the asset. The bigger issue there was in the stack of opportunities in the Haynesville, that acreage didn’t draw fire for a long time, and so the net present value of that acreage to us in our portfolio was relatively low. Moving it into someone else’s hands, it might move higher in their stack, but we have a lot of quality locations in front of that so we were in jeopardy of losing some of that acreage due to loss of production.
It was a really good trade for us. Now we can focus all our effort, all our capital on the best opportunities within the Haynesville.
Got it. The production, it came out in December, is that right?
That’s right. It was not included in any of our first quarter production. It wasn’t a large amount of production, as Frank noted. I don’t have that number right in front of me today, maybe 25 a day.
Got it. I can follow up with Brad.
Yes, yes.
That’s helpful. You mentioned moving assets. You mentioned you have this governor on just your capacity in Marcellus at 3.3 to 3.4 Bcf growth. Where are you guys on a gross rate now relative to that number?
It depends on the market and the day. We have reached--I believe the record right now is 3.38 a few days in the last few months. We’re a little bit behind that today because the market’s just not accepting the gas as far as there’s a lot of construction or maintenance being done on pipelines right now, but we are able to move 3.3 to 3.4 at any time, so that’s kind of where we’re going to float in that probably 3.2 to 3.3 range.
Got it. That’s helpful, thanks guys.
The next question comes from Neal Dingmann with Truist Securities. Please go ahead.
Morning all. Mike, for you or Nick, my first question is just on your overall plans. You guys did a good job of already commenting, but I just had maybe a further question on that.
Other companies, let’s use Pioneer, have a total return target out where they comprise the base dividend, variable dividend, oil growth. I’m just wondering when you or the board or Nick sit and look at this, is that something that--you did talk already, as I mentioned, about the base dividend, which is certainly notable. Would you put out a total return target or something like that?
Of course we’re thinking about those things at the board level and at management. First goal was to get through the quarter, show results, then start the dividend, and then over the next couple quarters, we’ll determine the best way to go about this. But if the answer is are we expecting to do more, it’s a clear yes.
Yes, and Neal, I would just note that what we’re looking at is that there’s going to be incremental cash generated well beyond the base dividend. We expect to return a significant portion of that cash to shareholders and keep some amount of cash on the balance sheet as reserves, if you will, for whatever events may come around to need cash in what still a cyclical business.
That said, the manner at which and the size at which we return cash to shareholders, we’re going to, again like Mike said, take the next couple of quarters to watch the cadence of cash flow generation, continue to monitor the market conditions and how the variable return structures that others are using are being received by investors, and what investors are preferring is going to influence us a bit, and we’ll make a decision. But it will likely be something in a similar neighborhood to what you’ve seen some of our peers do.
We do think that a variable dividend or share buybacks, both play a role in how you think about incremental return, depending on the conditions for that point in time, and I think you’ll hear us talk about somewhat of an all-of-the-above approach where material amounts of cash are returned to shareholders.
So Nick, is the growth versus some others more of a by-product then versus a goal or focus? It’s a question for you or Mike.
Did you say the growth?
The production growth. Is there a certain sort of number you’re targeting there, or is that just more based on--you know, is that more of a by-product?
I think it’s a by-product. We’re just working on value, getting cash flow per share up, so not growth. That’s not our goal.
Okay, and then just lastly on Frank’s comment - Frank, you mentioned in the comments on where you’d sort of stand up the rig, and agree South Texas is still a great asset. My question would be more on PRB. It’s obviously sort of less delineated, but there is certainly high potential there, so I’m just wondering how--I notice you don’t have a rig there now, but how do you tackle that play? Is it just purely about where you can get the best current return, or--because I guess what I look at is the potential is there, but there’s a little more obviously exploitation and exploration to be done in that area, so how do you sort of factor that in?
Neal, this is Frank. We see that as an option, future option for the company. We just put a little bit of capital to it this to complete some ducts. Those ducts are now on. The team continues to work and drive for better outcomes as far as drilling and completion.
The biggest issue there--those are great wells. The biggest issue there is the cost per foot is a little bit high, and we’re working through our teamwork effort, which is what we do in every field to drive costs down. The teams go from the top to the bottom, try to find places that we can drive costs down. We continue to work that. That same effort is going on in Brazos.
Our goal from a team perspective is to get every single opportunity to compete within the portfolio, and that’s what we’re focused on. Powder just does not compete at the current forward strip as well as South Texas, so the first dollar goes to South Texas. Potentially future dollars could go to Powder as we start to evolve and understand the opportunity there better.
Thank you.
The next question comes from Doug Leggate with Bank of America. Please go ahead.
Thanks guys. Good morning. Welcome everybody, I’m glad to be part of the conversation, and appreciate you taking my questions.
Mike, as some of us take another hard look at Chesapeake after the process you’ve just gone through, there are a number of questions that come up from our long history covering this stock. I want to ask you, I’m trying to put this delicately, but I want to ask you why we should be confident in this strategic vision you’ve laid out, because there’s been a lot of strategic visions over the last 10 years and, not to be indelicate about it, some of the management that were party to these decision are still there.
Why did Doug take the fall for this, and does this speak to an outlook for potential M&A that the CEO of the company is the one that’s no longer there?
I don’t think Doug’s taken the fall. I think it’s a change in perspective because you need a fresh set of eyes. You have to turn over every rock and look at everything different, and you don’t want someone burdened with the decisions of the past. I don’t think this is Doug taking the fall, more of just a change.
As far as why you should believe the strategy - well, it’s easy to see that the balance sheet is fixed, it’s easy to see the cost has come down, and really I think even historically, if you looked at the execution on the operations front, the company’s been pretty darn good. You sort of put together the right capital, the right structure, and it should work, and then you come to the quarter here and you’re like, is it working? And I think it’s early, and again you’ll have to see the quarter over quarter to get some confidence, but the answer is it seems to be working and it should build confidence over time. But you’re right - you need to make your own decision about that.
As far as doing M&A or are we going to do something, number one, we believe in scale and we understand the industry has to be efficient at scale, and it’s our job to create value in whatever form that takes. Today we think it’s executing on our existing assets. We think we’ll do a good job of that, we think our quarter results will show up. But if someone has a super value proposition, it’s our job to take it to the board, discuss it, decide if it’s the best course of action, and we’ll do that.
You have a very shareholder-centric board of directors. You have a very shareholder-centric business plan. I think that’s a little bit different. We’re not covering up, we’re showing you everything. Transparency is there, and we think people will make the decision to start looking at us a little harder.
I’d like to jump in on this, if you don’t mind. I want you to think about going back and looking at the history of the company’s cash flow generation. This company has been plagued for my entire history here with way too much debt, and we’ve put the company in a position over the last many years where the assets were generating significant cash flow but not enough to cover the debt service. If you strip away the interest expense, the preferred dividends and some of the excess GP&T, and you look at the history of the cash flow of the company, the cash flow that you’re seeing show up this quarter isn’t new. It didn’t get created out of thin air from an asset perspective, it just isn’t getting soaked up from the balance sheet.
When you think about what Mike talked about in his opening comments about the balance sheet being a competitive advantage, we now no longer have to figure out how to deploy that cash flow in a way that just tries to attack that debt load. We get to deploy that cash flow now in a way that maximizes return for shareholders, so this isn’t necessarily a fundamental shift in the way that we run the company from an operational perspective or an asset perspective, it is absolutely a fundamental shift in the way the company can be run to generate returns for shareholders.
I know it’s not an easy question to answer, guys. I guess what I was really getting at is the decisions that put the balance sheet in that position in the first place, all the complexities--you know, the forward sales, all the complexities that basically got it into that position, that’s [indiscernible]. We all understand what the cash power of the business has always been, but all of the decisions made prior to Doug’s arrival is what I was getting at, and that obviously put you in a bad spot. But I appreciate you answered the question.
My follow-up is real quick, Mike. Creating value, you talked about delivering differential returns. I just wonder if you could define what that is, because there’s a lot of companies doing a lot of the same things as you just described, so what differentiates Chesapeake here? I’ll leave it there, thanks.
Yes, a lot of great companies can create value. We want to be one of them. Number one, I think we actually have assets that are working and we have the inventory to execute, so nothing has to be done. We can focus internally and generate returns. It has scarcity, but not everyone has great inventory every place, and this company has it. It’s had a good subsurface team to be able to identify it, and so I think that differentiates us sort of in general.
Second, we are operating in a number of basins. We did it, we want to build scale in some of those basins, maybe even more, but because of the footprint we get to look at a lot of transactions that could be accretive because, frankly, once you have operations somewhere, there is efficiencies there, so our playbook is open. We are not burdened with only one place. We’re going to use that, and we’ll follow where the value can be driven.
We’re not stuck in one place, we’re not stuck in one basin. I know people like that for efficiency, but if you’re looking for value, you should be looking everywhere. It’s tough to get a lot of value, and frankly I’m a Permian guy. It’s tough to get value when you’re paying six times cash flow for the asset. It’s very, very difficult to do that. Here the playbook is open, we think we have optionality, growing a great balance sheet. It feels like you have something to work around.
Appreciate the answers, guys. Thanks so much.
The next question comes from David Heikkinen of Heikkinen Energy Advisors. Please go ahead.
Good morning everybody, and thanks for taking the questions.
I’ve been thinking about Chesapeake a lot over the last month or so, and as I think about some of the best investment opportunities, they stem from uncertainty, and so I was going through and looking at Chesapeake - you know, you have uncertainty in management, you have some uncertainty in your assets, and you have some uncertainty in your long term shareholders.
First on the management side, what’s the board’s commitment to the remaining management, as many new CEOs want to bring in their own team? Then second, can you define the metrics of accretion that the board looks at and can you define the rates of return and free cash flow assets that secure the 60% of investment? Are there any assets that will 100% be in the portfolio?
Then third, for the shareholder base to move to more natural, long-term shareholders, number one and number two need to be addressed first, so can you think about the timing and path to remove the uncertainty of how the legacy bond holders transition to more natural long-term equity holders?
Sure, thanks for the question. Management - generally we don’t have any plans to change management. We like the team, the board’s working with them, I’m here working with them, so no expected changes.
Two, on the assets themselves, we are hyper focused on cash flow per share. To get cash flow per share up, you’ve got to have returns, and so when I think about accretion, I’m thinking about how to give more money back to shareholders every day - that is the most important metric for us today.
Nick, do you have a different definition of accretion?
No. I think accretion, certainly you’re going to pay attention to cash flow per share, you’re going to pay attention to EBITDA multiples, and you’re going to pay attention to the way you generate returns out of the assets, really just like Mike said. The way we look at returns at the asset level and at the corporate level is on a cash returns on capital invested and return on capital employed. We’ll use both of those, and again we’ll highlight more about how we perform on those metrics as we put a little more space between us and the emergence from bankruptcy.
But on a cash flow per share basis and on an EBITDA multiple basis, we’re actually valued in a way today that’s a pretty high bar to go out and do a deal, so when you think about some of the transactions that have been announced recently, we paid a lot of attention to those deals, we’ll pay a lot of attention to other stuff that’s in the market, and we’ll be very protective over what accretion looks like. Accretion is hard to achieve and so the bar for doing something is high, but we will be very disciplined around it.
Yes. I think your last question is about the overhang of the shareholders and on natural shareholders. Look - we had an opportunity, and this happens in bankruptcy, where the board is elected by those shareholders, they give direct feedback before we emerge. We’ve had a tremendous amount of conversations at all levels. The board and management have also had that ability to talk to the shareholders and learn what they want.
The good news here is although we have what I would consider a few unnatural holders, long term holders, they seem and they’ve told us they’re committed and they don’t have to make any quick decisions, so I don’t think this is a six-month problem, I don’t think it’s a 12-month problem, but I do think once we get past 12 months, 18 months, we have to start finding ways to attract new investors. We have to fight for market share for these investors with results, with action. I believe we’ll get there. I hope it happens before the 12-month mark, and we plan on acting today, but I don’t feel like there is going to a weird announcement where people have to get out or want to get out.
Okay, and then just on the assets, are there any assets that are rate of return and free cash flow 100% part of the portfolio?
You mean, are we committed to holding onto any particular assets?
Yes.
You know, in order to create value, you can’t have sacred cows. You have to be willing to buy and sell everywhere, so I don’t think we have sacred cows here. I’m just trying to create value. If someone walks in and gives us a zillion dollars, we’re going to take it - we’re not dumb, so I don’t think there’s anything particular that we’d say we must keep, no matter what.
Okay.
The next question comes from Jeff Robertson with Water Tower Research. Please go ahead.
Thank you. A question on gathering and processing. Chesapeake made substantial strides during the restructuring process to lower costs, and I’m wondering if there are steps that could be taken post-restructuring to further enhance your gathering and processing agreements to increase the cash generation from some of the existing assets you have, and also maybe make those a part of the capital allocation discussion, or even enhance the value for somebody else to own.
Let me take the macro and I’ll let Nick take a deeper dive.
Generally speaking, pre-bankruptcy you had a very uncertain partner in Chesapeake from a midstream perspective, so your customers. We’ve now gone to a very certain partner, we’ve gone to a very predictable plan, and so when you have that, when you--hopefully we get an investment grade rating soon, now we are a great counterparty risk. Whenever you’re a great counterparty, now you have negotiation ability at the table, and we think just macro we are absolutely figuring out ways to lower transportation.
Nick, you may talk specifics.
Yes, absolutely. We do have a couple of things that are front of mind, that we will go after, and then there are plenty of other things that will evolve. One element of GP&T of course is scale, and as we continue to grow volumes out of our four assets, we’ll have some opportunities to leverage that scale to reduce the per-unit costs.
Another element is that as we emerged from bankruptcy, one contract that stood out as higher cost, that we were unable due to the contractual specifics of it deal with in bankruptcy, was the gas gathering agreement in our South Texas asset. We’ve worked with Williams quite a bit on that. We’ve been able to achieve a number of changes to our contracts with Williams over many years, but in particular in the bankruptcy, that ultimately are going to be good for both companies.
We will continue to work on that with Williams. We believe there is a path to enhance the value of our South Texas asset by working with Williams. We’re definitely not going to sit still on that. We will be working hard on that, and I would expect we’ll have more to say about that as we move through this year. It will be good for both companies. Williams has no need to do something with us that isn’t good for them, and we have no need to do something that isn’t good for us. We’ve been able to achieve that many times in the past, and I think we have an opportunity to achieve that here.
One other technical matter is that there is a pending change to our northeast contract structure, where one of the contracts that we negotiated for a change in bankruptcy rolls off in October of this year, so you’ll see, and you’ve seen in our projections in the back of our investor deck, that our Appalachian business unit will see a reduction in GP&T in ’22 versus ’21.
So we’ll continue to work all of those fronts. There are opportunities there, and then I think the next big leg for us, as Mike noted that we’re really excited about, is how to take our improved credit profile and go and work further downstream through the selling of product. As you think about the LNG markets, as you think about the fact that Chesapeake is having our gas stamped with the RSG seal of certification around being a responsible producer, we expect to continue to advance our efforts there and work with downstream users of our products to enhance the value that we deliver to our shareholders and ultimately we deliver to the buyer community by giving them a higher quality source of commodities that they know is minimizing its impact on the environment.
Thank you Nick.
The next question comes from Eric Seeve with GoldenTree. Please go ahead.
Hi guys, thank you for the update call and strong quarter.
One question I was hoping you could help us with on the modeling front, I’m trying to reconcile your guidance and just trying to understand at the midpoint of your EBITDA guidance, can you let us know what the annual hedge losses are? Just trying to make sure I can square the numbers.
Sure, so Eric, all of our hedge detail is on our Q, which will be filed very shortly and you’ll be able to see that. But our EBITDA guidance is at the strip, and so you can back into a number based on those hedges that’s going to approximate a little under $400 million.
A little under $400 million of hedge losses as of the 4/30 strip, is that correct?
Right - mark to market for 2021.
Okay, and that’s full year? Terrific. Thanks guys, that was my only question. Congratulations on the emergence and the strong first earnings call.
Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Michael Wichterich for any closing remarks.
Guys, thank you for taking the time this morning. We’re here to answer questions, give us a call. We’re excited about going forward. I think our team’s excited about going forward, and so looking forward to good quarters in the future. Thank you.
The conference has concluded. Thank you for attending today’s presentation. You may now disconnect.