Antero Midstream Corp

NYSE:AM

Earnings Call Transcript 2018-Q3

[Operator]

Good day, and welcome to the Antero Midstream Third Quarter 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I'd now like to turn the conference over to Mr. Michael Kennedy, Chief Financial Officer. Please go ahead.

[Michael Kennedy]

Thank you for joining us for Antero Midstream's third quarter 2018 investor conference call. We'll spend a few minutes going through the financial and operating highlights, and then we'll open it up for Q&A. I would also like to direct you to the home page of our website at www.anteromidstream.com or www.anteromidstreamgp.com, where we have provided a separate earnings call presentation that will be reviewed during today's call.

Before we start our comments, I would first like to remind you that, during this call, Antero management will make forward-looking statements. Such statements are based on our current judgments regarding factors that will impact the future performance of Antero Resources, Antero Midstream and AMGP and are subject to a number of risks and uncertainties, many of which are beyond Antero's control. Actual outcomes and results could materially differ from what is expressed, implied or forecast in such statements.

Today's call may also contain certain non-GAAP financial measures. Please refer to our earnings press release for important disclosures regarding such measures, including reconciliations to the most comparable GAAP financial measures.

Joining me on the call today are Paul Rady, Chairman and CEO of Antero Resources and Antero Midstream; and Glen Warren, President and CFO of Antero Resources and President of Antero Midstream. I will now turn the call over to Paul.

[Paul Rady, Chairman and Chief Executive Officer]

Thanks Mike. Thank you to everyone for listening in to the call today. I'll begin my comments with highlights from our recently announced simplification transaction and AR's peer-leading margins. Mike will then walk through our third quarter 2018 results and long-term outlook.

I'll begin my formal comments on slide number 3 titled, simplification transaction highlights, going through the numerous merits of the transaction. As you are aware on October 9, AMGP announced a definitive agreement to acquire in a stack and cash transaction. The transaction was truly a win-win-win across the Antero family. First, the transaction simplifies the midstream structure into one publicly traded entity and aligns all equity holders. New AM will be structured as a C-Corp without IDRs which we believe is the increasingly preferred structure by midstream investors.

We expect the structure to broaden our investor base and importantly position Antero Midstream to be included in major equity indices in the future. In addition to the intangible benefits of structure and governance the transaction is immediately accretive to both AM and AMGP on a DCF per unit basis and averages double digit accretion through 2022 for both entities. AMGP shareholders will receive 42% immediate distribution accretion compared to the status quo 2019 AMGP target and AM public unit holders will receive a premium and will be more than made whole on their previously communicated distributions and growth profiles.

Third, the transaction eliminates the IDRs reducing the pro-forma cost of equity capital. Eliminating the IRRs today helps to ensure that we do not miss out on any future growth opportunities both organic and third party. It allows us to compete for larger scale projects with other entities that have already eliminated their IDRs, structured as a corporation for both tax and governance purposes, the transaction significantly enhances governance and shareholder rights as compared to the MLP structure.

New AM, will have an elected board with a majority of independent directors, pushing it to the forefront of best corporate governance practices in the midstream space. The transaction is also tax efficient with respect to corporate taxes and eliminates approximately $375 million of taxes that AMG P was expected to pay from 2019 through 2022. These tax savings generated by the step up in bases allowed the transaction to be accretive to both AM and AMG P. Lastly, the combination of cash consideration from the announced transaction along with AR free cash flow is expected to fully fund AR's buyback and de-levering program.

Now let's move to slide number 4 titled, Antero's proven integrated strategy. While Antero Midstream's corporate structure is expected to change, our integrated proven strategy will not. We firmly believe in the benefits of integration and unparalleled visibility into the long-term development plan. In our view ownership and control of the midstream build out is critical for sustainable resource development. Our integration and visibility into AR's development plan allows us to deploy just-in-time capital and appropriately size infrastructure to support AR's production growth.

As an example during the third quarter, AM tied in, in line a company record 73 wells into the gathering and compression system, a 100% of which were on time. The precise timing of midstream projects optimizes capital efficiency both for AR and AM. The 73 new wells drove record volumes in the third quarter and are expected to generate significant growth and momentum heading into the fourth quarter of 2018 and into 2019.

On the fresh water delivery side, we continued our 100% timely track record of delivering fresh water for completions even as AR set records for completion stages per day. For that I want to thank all of our employees for the tremendous achievements operationally. Moving to the right hand side of the page, AR and management and sponsors remain highly aligned with our midstream investors and will own 31% and 25% of New AM respectively.

Now let's move to slide number 5 titled, consistent leader in realizations and margins, which illustrate AR's peer-leading realizations and margins. Antero Resources is not a traditional northeast natural gas producer. In fact during the third quarter 43% of AR's revenues were derived from liquids including ethane, C3+ NGLs and oil. Antero's liquids exposure is a key differentiator and is the reason AR can generate attractive and sustainable single well and corporate level rates of return.

As depicted on the left hand portion of the slide AR generated all-in realized pricing of almost $4 per Mcf equivalent during the quarter, which is 41% above the peer average and over $1 of NYMEX natural gas prices. While generating the highest pricing realizations is important, it is more important to generate attractive all-in margins, which ultimately drives the economics supporting the long-term development program. Once again AR generated best in class EBITDAX margins of a $1.68 per Mcfe on a fully burdened standalone E&P basis including full AM fees.

The third quarter exemplified Antero's trend of consistently generating the highest realized pricing and margins in Appalachia and gives us confidence in the long-term sustainable production growth that underpins AM. Looking ahead, the fourth quarter represents an important inflection point for AR, in which it expects to generate free cash flow driven by expanding margins, benefiting from strong NGL pricing. These attractive margins support AR's measured drilling and completion capital budgets through 2022 that are expected to be more than fully funded from cash flow assuming today's strip pricing.

I'll finish my comments on slide number 6 with a macro view of NGL infrastructure in the northeast, as the infrastructure is an important springboard for the development of AR's liquid rich locations. Appalachia NGL fractionation and transportation is differentiated from other shale plays in the US. All Y-grade barrels are fractionated in basin and transported in purity product form, which is a more marketable product for downstream consumption. This allows barrels from the northeast to be insulated from highly constrained fractionation, transportation and storage capacity that's currently down on the Gulf Coast. In fact, there is sufficient fractionation capacity in the northeast and more specifically AR has sufficient running room to continue deliberating peer-leading liquids production growth.

In the short-term, the joint venture between AM and M PLX expects to bring on line Sherwood processing plants 10 and 11 and in fact plant 10 just came on last evening, adding an additional 400 million cubic feet of processing capacity in this fourth quarter of 2018. The joint venture also expects to place the Hopedale 4 fractionation plant into service during the fourth quarter of 2018, adding an additional 60,000 barrels per day of gross fractionation capacity to the basin.

Longer term AM and MPLX will continue planning and executing on additional processing and fractionation capacity customized to AR's growth. This visibility and customize midstream solution is an underappreciated benefit for AR as it is the only E&P in the northeast with direct ownership and control of the midstream infrastructure build out all the way from the wellhead through processing and fractionation.

In summary we believe that we have the right assets, strategy, employees and now corporate structure to continue generating value for our shareholders.

With that I'll turn the call back over to Mike.

[Michael Kennedy]

Thank you, Paul. I'll first touch on the distributions for AM and AMGP for the third quarter beginning on slide number 7 titled, track record of delivering growth. We recently announced an AM distribution of $0.44 per unit a 29% increase year-over-year and a 6% increase sequentially.

The third quarter distribution at AM was the fifteenth consecutive distribution increase since its IPO, all of which have represented growth of 28% to 30% on an annualized basis since 2014, which is an incredible achievement.

AM's DCF coverage ratios average 1.4 times since the IPO, well in excess of the IPO DCF coverage target of 1.15 times. Additionally, AMGP announced a distribution of 14.4 cents per share, a 144% increase compared to the prior year quarter and a 15% increase sequentially. The AMGP distribution was the fifth consecutive distribution increase since its IPO in May of 2017.

As Paul mentioned before the accretion in the simplification transaction allows us to continue this peer-leading growth and more than key poll are AM public you know holders on their distributions on the previously provided growth targets.

Now let's move on to the third quarter operational results beginning with slide number 8 titled, high growth year-over-year midstream throughput. All of our gathering, compression, processing and fractionation volumes represented record highs for AM during the third quarter of 2018.

Starting in the top left portion of the page, low pressure gathering volumes were 2.2 Bcf per day in the third quarter, which represents a 37% increase from the prior year quarter. Compression volumes during the quarter averaged 1.8 Bcf per day, a 45% increase compared to the prior year quarter. Compression capacity was 80% utilized during the quarter.

Joint Venture gross processing volumes averaged just over 600 million per day, a 65% increase compared to the prior year quarter. Processing capacity was over a 100% utilized during the quarter and we expect continued growth as we place on line Sherwood 10 and 11 during the fourth quarter, adding an additional 400 million per day of processing capacity and bringing the joint venture's total capacity to 1 Bcf per day.

Joint venture gross fractionation volumes were nearly 18,000 barrels per day, a 170% increase over the prior year quarter. Fresh water delivery volumes averaged 195,000 barrels per day, a 37% increase over the prior year quarter.

Looking ahead to the fourth quarter, we expect a decline in fresh water delivery volumes as compared to the third quarter due to reducing our completion crews from six in the first half of 2018 to four in the third quarter and to three in the fourth quarter.

Moving on the financial results, adjusted EBITDA for the third quarter was $186 million, a 46% increase compared to the prior year quarter. The increase in adjusted EBITDA was primarily driven by increased throughput and fresh water delivery volumes.

Distributable cash flow for the third quarter was $157 million, resulting in a healthy DCF coverage ratio of 1.3 times. During the third quarter Antero Midstream invested $131 million in gathering infrastructure and $19 million in water handling infrastructure. In addition to gathering and water, AM invested $35 million in the processing and fractionation joint venture during the third quarter.

Moving on the balance sheet and liquidity, as of September 30, 2018, Antero Midstream had 875 million drawn on its $1.5 billion revolving credit facility, resulting in 625 million in liquidity and a net debt-to-LTM EBITDA ratio of 2.3 times. In addition, after quarter end Antero Midstream exercised the accordion feature on its revolving credit facility increasing the borrowing capacity from $1.5 billion to $2 billion.

I'll finish my comments on the outlook for New AM on slide number 9 titled, best in class midstream vehicle. In addition to our premier asset footprint and operations, we believe the recently announced simplification transaction checks all the boxes for current and future shareholders and we remain excited about the future prospects of New AM.

New AM will be a 1099 security with no IDRs or K-1s and substantially shield it from taxes through at least 2024. Our core financial policy will remain unchanged with New AM maintaining its self-funding organic business model, strong balance sheet, healthy DCF coverage and significant liquidity. We remain highly aligned and integrated with AR, which gives us visibility to provide our long-term targets. Organic growth strategy will continue to be focused on just-in-time capital investment, which we believe leads to top tier capital efficiency and high teens return on invested capital.

In summary, we will continue to leverage our visibility into AR's development plan to generate attractive project and corporate level rates of return and deliver value to our unit holders. As a result of the transaction New AM will be one of the top 20 midstream companies by market capitalization, which is highlighted on slide number 10 titled highest dividend growth among top 20 midstream.

In the chart red font indicates midstream companies that are structured to C-Corps and the asterisks indicate companies limited IDRs. Of that peer group, New AM is expected to have the highest distribution growth among the top 20 infrastructure C-Corps and one of the strongest balance sheets with a 27% distribution compounded annual growth rate through 2021 and an initial leverage around three times trailing into the low two times range.

With all of these characteristics, we remain excited about the value proposition New AM presents as shown on slide number 11 titled, yield versus growth implies attractive value. New AM is expected to have the highest distribution growth among midstream infrastructure corporations and entities that eliminated IDRs. In addition New AM's leverage profile is expected to be a turn lower than the peer average at closing and continue to decline until low two times by 2022.

We believe this growth profile and strong balance sheet combined with no equity needs to fund the organic growth capital should result in an attractive value proposition. Based on the market implied valuation yield versus growth New AM has an implied yield of 5% resulting in a pro-forma share value of $25 per share or over 50% upside to today's price.

With that operator, we are ready to take questions.

Thank you. And we will now begin the question-and-answer session. [Operator Instructions] And our first questioner today will be Spiro Dounis with Credit Suisse. Please go ahead.

[John Mackay, Credit Suisse]

Hey guys, it's John Mackay on for Spiro. First one, hi, even talking about getting more involved downstream for a while now, obviously, the MPLX JV was a great first step, but just kind of wondering what the kind of next steps to look at - look like and kind of what the gating factors might be there?

[Michael Kennedy]

Yeah, that's still an objective longer-term, certainly, and I think part of the delay in doing anything there has been the delay in some of the projects and just watching how the takeaway universe comes together for like with, so just hasn't been actionable, I guess, at this point in time and hopefully it will be down the road.

[John Mackay, Credit Suisse]

That's fair. And just a follow-up, on the AR call, talked about kind of upstream consolidation Northeast from midstream we saw Blue Racer this morning, just wondering your thoughts kind of on if we can see any more midstream kind of Northeast consolidation?

[Michael Kennedy]

I think you will continue to see some, I think it will go somewhat hand in hand with the upstream consolidation, we expect to see some more of that. So, yeah, that's something we certainly look at. In addition, to our organic growth also looking at acquisition opportunities, we haven't done anything like that today, but we will continue to launch. Our filter is pretty tight, because we would only want to do something that where our molecules impact the assets on the midstream side and those are a little bit more difficult to find, but we continue to look.

[John Mackay, Credit Suisse]

All right, that's fair. Thanks guys.

[Michael Kennedy]

Thank you.

[Operator]

And our next questioner today will be Tim Howard with Stifel. Please go ahead.

[Tim Howard, Stifel]

Hi. Thanks for taking the question. Can we have an update on the water treatment facility and maybe utilization in 4Q and any 2019 expectations?

[Paul Rady, Chairman and Chief Executive Officer]

Yeah, our design on the water facility has been - that it would be performing at 40,000 barrels a day and we're still in the commissioning phase where it's up and down we've processed as much as 40,000 barrels a day, but we're still working out some of the project.

[Tim Howard, Stifel]

Got it and if that continues into 2019, would it risk any of the gathering and processing business at all or just AR's growth in general?

[Paul Rady, Chairman and Chief Executive Officer]

No, it doesn't have any impact on that. It would just have a slight material impact to the EBITDA in 2019, but doesn't affect any of the gatherings.

[Tim Howard, Stifel]

Okay, got it. And then pivoting to the pro forma entity, how should we think about 2019 distribution growth? Should we anticipate like onetime step up in that ratable growth thereafter for like the first quarter pro forma? Or should we anticipate kind of ratable growth throughout?

[Paul Rady, Chairman and Chief Executive Officer]

No, that's right. So we came out with a $1.24 distribution per unit in 2019 expectations, let's starts from the first quarter with $0.28 per share and then it's the 28% to 30% growth off of that and for total of $1.24.

[Tim Howard, Stifel]

Got it and then last one, coming onto inclusion into major indices following the transactions closed. Are there any other boxes that need to be checked for that consideration?

[Paul Rady, Chairman and Chief Executive Officer]

We check all the boxes, the one I think that we're close on, but it should be there in 2019 as 30% above the float outstanding but we're very close on that one as well. So by the time the indices would consider including us I think we would take all of the boxes.

[Tim Howard, Stifel]

Okay, great, alright. Thanks for taking the questions.

[Paul Rady, Chairman and Chief Executive Officer]

Thank you.

[Operator]

And our next questioner today will be Ned Baramov with Wells Fargo. Please go ahead.

[Ned Baramov, Wells Fargo]

Hi. Thanks for taking the question, maybe just going back on your water business. Could you talk about water usage per well, I think we have been an upward trajectory for this metric since you acquired the business from AR, and I think that's been driven by longer laterals, increases in completion stages, which in turn drives higher usage of proppant water per foot. But are there any lengths or lateral lengths or water usage per foot that could be treated as the limits beyond which returns would diminish based on what you know today?

[Michael Kennedy]

Yeah, you're right, Ned. We've been increasing on that. We're actually fairly consistent in Q3 in that kind of 40 barrel that kind of seems where we've shaken out and that's based on a 2,000 pound of sand completion, the lateral feet has increased as well, we're up an average around the 10,000 feet per lateral that we're actually - the wells we're completing right now. So those are all picked up but our guidance is always based on that 2,000 pound sand per foot and based on the lateral length that AR provides us and its 46 - excuse me, 44 barrels of water per foot on average for the program, and that's been consistent. The other thing I would note is that where we've been on the upper end of the actual number of wells that we service from a freshwater perspective in 2018 our initial guidance range was 150 to 160 wells being completed. We're on the high end of that guidance range, so more around 160 wells for the year. So that's also added to the improved performance and improved EBITDA from the freshwater business.

[Paul Rady, Chairman and Chief Executive Officer]

And Ned, as far - Ned, as your question on - would we - as we go to longer and longer laterals would we change those proportions of sand and water? And the answer is no. We've gone sideways out towards 15,000 feet in the Marcellus and 17,000 in the Utica, but we - from what we've done so far, we've used our same formula, our same designs in terms of sand per foot and water per foot and we've seen productivity that is - that doesn't diminish as you go longer and longer that you also spread [ph] per1000 there the same, so we probably be applying the same design. So the answer is even as we go longer and longer it'll still be about the same amounts of sand and water proportionately.

[Ned Baramov, Wells Fargo]

Okay. That's great. And then maybe looking at 2019 is the 150 to 160 wells still a good number?

[Michael Kennedy]

Yeah, it's very close to that. Yes.

[Ned Baramov, Wells Fargo]

Okay. Thanks. And maybe one more if I may, just talk about the importance of maintaining the integrated upstream and midstream relationship, so given some of your peers have elected to pursue a different route where midstream is an independent operation, would you consider pursuing third-party opportunities a little bit more aggressively?

[Paul Rady, Chairman and Chief Executive Officer]

Yeah, it depends on the opportunity, of course, as Glen was mentioning, we strategically like to think about opportunities where the upstream touches the midstream and of course that's to keep out the volume risk we know from the upstream side how - what the volumes would be through the midstream infrastructure, so we still stick with that. We do have third-party opportunities. So far they're more on the water side, which would be definitely accretive. I'm not sure you'd see us going out there and competing with other third stream - third-party midstream where we're paying high multiples to service somebody else. So we're pretty conscious that it's a highly competitive market and oftentimes midstream companies overpay in order to be able to provide services for people, so we look at it, but we don't see it as quite as attractive as servicing AR.

[Ned Baramov, Wells Fargo]

Great, that's all I had. Thank you.

[Paul Rady, Chairman and Chief Executive Officer]

Thanks.

[Operator]

And this will conclude our question-and-answer session. I would now like to turn the conference back over to Michael Kennedy for any closing remarks.

[Michael Kennedy]

Thank you for joining us on our call today. If you have any further questions, please feel free to reach out to us. Thanks again.

[Operator]

The conference is now concluded. Thank you all for attending today's presentation and you may now disconnect.