Hess Midstream LP

NYSE:HESM

Earnings Call Analysis

Hess Midstream Q2 2024 Performance and Guidance

Hess Midstream's Q2 2024 performance showed increased throughput across all segments, with gas processing and oil terminaling volumes up 7% and 8%, respectively. Hess upstream production in the Bakken topped their guidance, averaging 212,000 barrels of oil equivalent per day. Consequently, Hess Midstream upped its 2024 gas gathering and processing throughput guidance to 425-435 million cubic feet per day and 405-415 million cubic feet per day, respectively. Financially, net income was $160 million, while adjusted EBITDA reached $276 million. The company reiterated its commitment to shareholder returns, projecting over $1.25 billion in financial flexibility through 2026.

Revenue and Earnings Performance

In the second quarter of 2024, Hess Midstream reported net income of $160 million, a slight decrease from $162 million in the first quarter. Adjusted EBITDA showed minor growth, rising from $275 million to $276 million. This performance was mainly driven by increased throughput volumes across all segments, with segment revenues rising by $26 million. The company's strong operational leverage was evident, maintaining an impressive gross adjusted EBITDA margin of approximately 80%, above the 75% target.

Operational Highlights

The company's throughput volumes saw significant increases, particularly in gas processing and oil gathering, which grew by approximately 7% and 8% respectively from the first quarter. System availability remained high, and gas capture was particularly strong, achieving over 97% gas capture across the Bakken field. This exceptional performance is attributed to Hess Corporation's effective well delivery and infrastructure planning alongside high system utilization.

Guidance and Future Expectations

Hess Midstream is projecting net income between $160 million to $170 million and adjusted EBITDA of $280 million to $290 million for the upcoming third quarter. Capital expenditures are expected to rise due to seasonally higher activities, but operating costs should remain stable. For the full year 2024, the company expects net income to fall between $650 million to $700 million, adjusted EBITDA to be within the range of $1.125 billion to $1.175 billion, and capital expenditures to be between $250 million to $275 million. The guidance includes a projection of approximately 10% annual growth in gas and oil volumes through 2026, and free cash flow expected to grow by over 10% per year.

Strategic Initiatives

The company continues to execute its strategy focused on returning capital to shareholders. Since 2021, Hess Midstream has returned $1.75 billion through repurchases and increased its distribution by approximately 48%. The recent issuance of $600 million senior unsecured notes due 2029 helped to pay off the revolving credit facility, maintaining financial flexibility. The company plans to maintain a target leverage ratio around 3x adjusted EBITDA, ensuring a balance between shareholder returns and maintaining balance sheet strength.

Investment in Infrastructure

Hess Midstream is making significant investments in infrastructure, including the construction of two compressor stations and associated gathering pipelines. These projects are crucial for supporting ongoing developments in the Bakken region. The company anticipates spending more in the latter half of the year to continue these construction activities, aiming to enhance system availability and operational efficiency.

Shareholder Returns

Hess Midstream has been consistent in increasing shareholder returns, evidenced by a recent $100 million repurchase transaction which was accretive on both free cash flow per share and earnings per share. The company expects to continue its policy of 5% annual distribution growth, with actual growth significantly above this target due to excess free cash flow. Over the next few years, the company plans to leverage over $1.25 billion of financial flexibility for ongoing unit repurchases and incremental shareholder returns.

Earnings Call Transcript 2024-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2024 Hess Midstream Conference Call. My name is Gigi, and I'll be your operator for today. [Operator Instructions] Please be advised that today's conference is being recorded for replay purposes. I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

[Jennifer Gordon, executive]

Thank you, Gigi. Good afternoon, everyone, and thank you for participating in our second quarter earnings conference call. Our earnings release was issued this morning and appears on our website, www.hessmidstream.com. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements.

These risks include those set forth in the Risk Factors section of Hess Midstream's filings with the SEC. Also on today's conference call, we may discuss certain non-GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the earnings release.

With me today are John Gatling, President and Chief Operating Officer; and Jonathan Stein, Chief Financial Officer. I'll now turn the call over to John Gatling.

[John Gatling, executive]

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's Second Quarter 2024 Conference Call. Today, I'll discuss our second quarter performance and review Hess Corporation's results and outlook for the Bakken. Jonathan will then review our financial results and guidance. In the second quarter, throughput volumes averaged 419 million cubic foot per day for gas processing, 126,000 barrels of oil per day for crude terminalling and 124,000 barrels of water per day for water gathering.

Throughput increased across all segments of our business, with gas processing and oil terminaling volumes increasing by approximately 7% and 8%, respectively, from the first quarter, primarily driven by strong Hess performance. System availability remained high across our midstream assets and gas capture was particularly strong in the second quarter. Now turning to Hess upstream highlights. Earlier today, Hess reported second quarter net production for the Bakken averaged 212,000 barrels of oil equivalent per day, which was above the high end of their guidance range of 195,000 to 200,000 barrels of oil equivalent per day. Approximately 1/3 of the increase is from volumes received under percentage of proceeds contracts, which do not impact Hess Midstream's throughputs or revenues. Hess anticipates Bakken, net production, will be in the range of 200,000 to 205,000 barrels of oil equivalent per day in the third quarter, reflecting lower anticipated volumes under percentage of proceeds contracts and planned maintenance at the Little Missouri 4 gas plant. Hess reiterated its plans to run a 4-rig program in the Bakken in 2024.

Turning to Hess Midstream guidance, which was included in our earnings release this morning. With Hess' continued strong Bakken production and our focus on gas capture, we're raising our gas gathering and processing throughput volume guidance for full year 2024 to average between 425 million and 435 million cubic foot per day and between 405 million and 415 million cubic foot per day, respectively. This implies approximately 3% growth at the midpoint for the second half of the year and includes our expectations for roughly flat volumes in the third quarter, which incorporates Hess upstream guidance and lower midstream throughput due to a planned weeklong maintenance outage at the Little Missouri 4 gas plant.

Consistent with prior guidance, we continue to make excellent progress on our 2024 capital plans and are focused on supporting Hess and third-party development in the Bakken. The progress of our multiyear projects to build 2 compressor stations and associated gathering pipelines continue as planned. We expect to spend more in the second half of the year as we continue construction activities.

In summary, we remain focused on executing our operational priorities and safely delivering our growth strategy, which will continue to drive sustainable cash flow generation and the potential to return additional capital to our shareholders.

I'll now turn the call over to Jonathan to review our financial results and guidance.

[Jonathan Stein, executive]

Thanks, John, and good afternoon, everyone. We continue to execute a financial strategy that prioritizes return of capital to shareholders with a demonstrated track record of differentiated shareholder returns. Since the beginning of 2021, we have returned $1.75 billion to shareholders through accretive repurchases that have reduced our total unit count by nearly 25%.

In addition to the combination of our 5% targeted annual distribution growth and 8 distribution level increases following each repurchase, we have increased our distribution per Class A share by approximately 48% over this period and by over 10% in 2024 year-to-date on an annualized basis. As a result, our total shareholder return yield is one of the highest of our midstream peers. Furthermore, our leverage of approximately 3.2x adjusted EBITDA is one of the lowest among our peers, highlighting our differentiated ability to deliver significant shareholder returns while also maintaining balance sheet strength.

In January, we announced that we expect to generate greater than $1.25 billion of financial flexibility through 2026 for incremental shareholder returns, including potential unit repurchases. Utilizing this capacity in June, we completed our second repurchase transaction in 2024 of $100 million that was accretive on both an adjusted free cash flow per Class A share basis and an earnings per Class A share basis.

As we have done in the past, our quarterly distribution increase included our targeted 5% annual growth per Class A share and an additional increase utilizing the excess adjusted free cash flow available for distributions following the repurchase. As a result, on an annualized basis, our distribution per Class A share growth of over 10% is significantly above our targeted 5% annual growth through 2026.

Following the unit repurchase, we expect to continue to have more than $1.25 billion of financial flexibility through 2026 that can be used for continued execution of our return of capital framework, including potential ongoing unit repurchases. Turning to our results. For the second quarter, net income was $160 million compared to $162 million for the first quarter. Adjusted EBITDA for the second quarter was $276 million compared to $275 million for the first quarter. The increase in adjusted EBITDA relative to the first quarter was primarily attributable to the following: total revenues excluding pass-through revenues and a onetime $8 million reduction in second quarter revenues related to the setting the 2024 tariff rates for certain subsystems increased by approximately $26 million, primarily driven by higher throughput volumes resulting in segment revenue changes as follows: Gathering revenues increased by approximately $15 million.

Processing revenues increased by approximately $9 million and terminaling revenues increased by approximately $2 million. Total cost and expenses, excluding depreciation and amortization, pass-through costs and net of our proportional share of LM4 earnings increased by approximately $9 million, primarily due to higher seasonal operating and maintenance activity, resulting in adjusted EBITDA for the second quarter of $276 million at the midpoint of our guidance range.

Our gross adjusted EBITDA margin for the second quarter was maintained at approximately 80%, above our 75% target, highlighting our continued strong operating leverage. Second quarter capital expenditures were approximately $73 million and net interest, excluding amortization of deferred finance costs, was approximately $47 million, resulting in adjusted free cash flow of approximately $156 million.

In May, we issued $600 million, a 6.5% senior, unsecured notes due 2029 in a private offering. We used the proceeds of the offering to repay the borrowings on our revolving credit facility, and therefore, we had no drawn balance on our revolving credit facility at quarter end. Turning to guidance. For the third quarter, we expect net income to be approximately $160 million to $170 million and adjusted EBITDA to be approximately $280 million to $290 million. Compared to the second quarter, this reflects relatively flat volumes, net of the 8 million cubic feet per day impact from the maintenance at the Little Missouri 4 gas plant as well as stable operating costs with continued seasonally higher maintenance activity in the third quarter.

We also expect CapEx to increase in the third quarter, consistent with seasonally higher activity. In the fourth quarter, we expect increasing revenues on growing volumes and seasonally lower maintenance activity resulting in higher EBITDA compared with the third quarter. For the full year 2024, we are updating net income and adjusted free cash flow guidance to include the impact of an incremental $15 million of interest expense resulting from the $600 million notes issued in the quarter, partially offset by lower interest on the revolving credit facility.

The updated net income guidance also includes the impact of an incremental $10 million of income tax expense resulting from ownership changes, following the secondary equity offerings and Class B unit repurchase transaction completed this year. As a result, we now expect net income of $650 million to $700 million. We are also maintaining our adjusted EBITDA guidance range of $1.125 billion to $1.175 billion, implying growth of approximately 9% in adjusted EBITDA at the midpoint in the second half of the year.

With total expected capital expenditures of $250 million to $275 million. We expect to generate adjusted free cash flow of approximately $675 million to $725 million, with distributions for Class A share targeted to grow at least 5% annually from the new higher distribution level we expect to be free cash flow positive after fully funding distributions for 2024. Looking ahead through 2026, we continue to expect approximately 10% annualized growth in gas and oil volumes, supporting a greater than 10% growth per year in adjusted EBITDA.

With stable CapEx through 2026, we expect adjusted free cash flow to grow greater than 10% per year in excess of our 5% targeted distribution for Class 8 share growth that together with capacity as our leverage falls below 2.5x adjusted EBITDA supports greater than $1.25 billion in financial flexibility that can be utilized for continued unit repurchases. In summary, we are very pleased to have delivered additional incremental return of capital to Hess Midstream shareholders and look forward to a visible trajectory of growth in our operational and financial metrics that underpins our unique and differentiated financial strategy with a focus on consistent and ongoing return of capital to our shareholders. This concludes my remarks. We'll be happy to answer any questions. I will now turn the call over to the operator.

[Operator]

[Operator Instructions] Our first question comes from the line of Doug Irwin from Citi.

[Douglas Irwin, analyst]

I just want to start with the growth outlook beyond 2024. If I just look at the updated volume guidance, I think about 10% growth a year for gas beyond '24, you start to get pretty close to your processing capacity by end of '26 if not above it. I just want to get your thoughts around whether processing might become a constraint more quickly than anticipated. Just given some of the gas capture you've seen. And if so, what options you might have ahead of additional processing capacity in '27.

[John Gatling, executive]

Yes. Thanks for the question, Doug. Yes, from our perspective, we feel like we have sufficient capacity. We've been working on the process and expansion activities for some time now. We've got a really strong partnership with the upstream, and we're planning the infrastructure and the well plans along the needs for processing. So from our perspective, the gas processing capacity will be available when the upstream needs it. So again, it's kind of that symbiotic relationship we've got between the upstream and midstream that kind of drives that integrated development planning activity that gives us some confidence that we've got the right infrastructure plans for the upstream development.

[Douglas Irwin, analyst]

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

[John Gatling, executive]

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

I think having additional export capacity out of the basin, it helps everybody. I think it makes the -- it allows to have more flexibility for takeaway options. And my guess is, like, we are going to be expanding processing in '27 that there will be other providers that will also be expanding. The other thing that we continue to look at is opportunities to smartly capture additional third-party volumes into our system.

And we have the flexibility to add additional capacity over the long term if the gas becomes available, and it's something that we feel like that we can provide that support. We do anticipate the basin to continue to grow from a gas perspective, and we expect that the capacity will be there. And I think, again, having the export capacity out of the Bakken is going to be critical to making sure that, that works and that we're able to actually support the producers as the volume comes online.

[Operator]

[Operator Instructions] Our next question comes from the line of John McKay from Goldman Sachs & Co.

[John Mackay, analyst]

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

[John Gatling, executive]

Yes. I mean I don't think I can really speak to some of the other companies. But I definitely think that as the basin continues to grow in other parts of the field, there will be providers that will offer capacity to them. I think from our perspective, the third-party opportunities become those operators that are around and near our strategic footprint and where we can actually extend our footprint to provide support to those other operators. .

As far as the export goes, again, I think the more flexibility there is to get out of the basin, I think just commercially, it's going to create more competition for those volumes. From our perspective, flow assurance has always been really critical, making sure that we have flow assurance all the way from the well pad to export and ultimately to end customers. That's a priority for Hess. And I think from our perspective, we've looked at that to make sure that we actually have capacity for that flow assurance. But again, as export options open up, it gives us a chance to look at different commercial opportunities as well. So again, I think it's a net positive for the basin. I think it's a net positive for Hess Midstream, Hess and other operators and midstream companies in North Dakota.

[John Mackay, analyst]

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

[Jonathan Stein, executive]

Yes. So right now, our leverage, as I said, is 3.2x EBITDA. Our target leverage is 3x. We have been willing to continue to do repurchases being slightly above our target. When we have visibility as we do now, as we've talked about through 2026 growth, more than 10% growth per year in EBITDA, so that gives us confidence to continue. So for this year, we feel as if we're going to be limited to stick to that target, which we, as you know, is a big focus for us in terms of balancing shareholder returns but also balance sheet strength.

But as we go forward, certainly, we'll continue we have $1.25 billion of capacity still available. We'll continue to calibrate that relative to our growth. But certainly, for this year, we'll focus on staying slightly above, by the end of the year, we expect to be just at 3x. And then as you go, certainly into next year, we'll certainly, as we've talked about, delever well below 3x, less than 2.5x by the end of 2025. And then also, we have, of course, free cash flow after distribution, so building that cash balance as well that can also fund additional return of capital to shareholders.

[Operator]

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

[Unknown Analyst]

Maybe to touch on the guidance update. Curious if you could help us understand the moving pieces around the discrepancy between throughput and EBITDA guidance. I know you guys mentioned about Hess' planned maintenance [indiscernible]. Is there any other noise around it that you would like to find.

[Jonathan Stein, executive]

Yes. So I'll start with the mechanics and then I'll let John talk about maybe the underlying drivers. I mean if you look at our EBITDA guidance, for the year, we've maintained our EBITDA guidance. That's a 9% increase in EBITDA in the second half. And the driver of that is primarily volume growth across our gas and oil systems. We had a really strong volume growth in the second quarter. I mentioned on my -- in my remarks, $26 million in additional revenue just in the quarter on volumes alone and that allowed us also consistent with increasing our GAAP guidance, just slightly by 10 million cubic feet per day on a full year basis.

As we go into Q3, we expect flat volumes with Q2 but that includes, as I mentioned, that 8 million cubic feet per day impact from the planned maintenance at LM4, the gas plant. So really, what that means is that we're -- that implies that we see continued growth around -- outside the maintenance in the quarter. And then as we go into Q4, we're really expecting higher revenues ongoing volumes and then, of course, lower seasonally OpEx as we usually have in the fourth quarter, and that will support accelerating EBITDA into the fourth quarter. So that's really how it kind of all fits mechanically. Let me just turn over to John, he can talk about what's happening behind that in terms of the business driving all of that.

[John Gatling, executive]

Yes. Thanks, Jonathan. It's a really good question. I think at the end of the day, Hess has been performing exceptionally well. I think their D&C function and bringing wells online has been outstanding. The overall deferred production, the availability of the system has been extremely high. Partnered with the midstream, our system availability has been very high as well. And then from a just well planning and infrastructure planning perspective, they're really marrying up really nicely from the standpoint of when the wells come on, the gas infrastructure is there to take that away.

And that's what has enabled us to bump up our gas guidance slightly as a result of just that gas capture. I mean, in the second quarter, we were above 97% total gas capture across the entire field. When you look at it on a routine flaring basis, we're getting very, very low from a -- for routine flaring. So basically, as the wells are coming online, the infrastructure is in place to capture that gas. And I would say the second quarter, both from a upstream delivery side but also midstream availability and ability to have the infrastructure in place right when it was needed was exceptionally strong in the second quarter.

We expect that to continue into the third quarter. But as Jonathan mentioned, there is some planned maintenance activities, routine planned maintenance activities at LM4, which is going to keep volumes relatively flat from Q2 into Q3.

[Unknown Analyst]

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

[John Gatling, executive]

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

And it's a very, very high system utilization. We would expect to start to see water trend closer to oil. So I would say that the really aggressive growth and being able to capture the water is materially behind us. And now the growth that's going to continue into the future is going to look a lot more like oil growth as you bring on new wells, the total fluids both from an oil and a water perspective will be now captured on pad, and that will go into our system. So we do expect to continue to see growth. We just won't be -- we won't expect to see the growth rate we've seen over the last several years.

[Operator]

Our next question comes from the line of Puneet Satish from Wells Fargo.

[Praneeth Satish, analyst]

Maybe just on Hess' Bakken production. So it's now running at 212,000 barrels per day, higher than kind of the long-term target of around 200,000 barrels per day. I mean I know you mentioned -- I guess I'm just trying to translate this into the impact for Hess' Midstream. I mean, I know you mentioned some of that outperformance is related to POP. But how sustainable do you think this is? And does that provide any kind of tailwind to your volume projections into Q3, Q4, maybe '25.

[John Gatling, executive]

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

As you mentioned, a big piece of the second quarter, about 1/3 of that total volume beat was related to POP. And that really doesn't translate to additional throughputs or revenues for us. As we've been looking at the uncertainty of wells and as they come on in the future, we expect the performance to continue to be very high, but we are comfortable with where our guidance ranges are.

we've set our long-term MVCs, and I think we see 10% growth rates going into the future. I think we feel very comfortable with where that is. Again, that relationship between our upstream and midstream and that flow assurance focus that we've got is really important to us. So as we're doing well planning, we're doing infrastructure planning at the same time. And if there's opportunity to capture upside, we will absolutely do that and look for the wells to perform better then we'll make sure that the infrastructure is sized to accommodate it.

But again, I wouldn't say, it's going to be a material change in anything we've seen, and it's something that we're going to continue to partner with the upstream on, and we just feel really good about Hess' long-term growth trajectory. They're going to run 4 rigs through '24, and we expect to continue to see that growth trajectory that's translated into our MVCs and the implied volumes growth volumes that go into the MVCs.

[Praneeth Satish, analyst]

Got it. And maybe this question is for Jonathan. Historically, you've run the business at around a 3x leverage ratio, kind of doing buybacks to keep that leverage ratio at 3x as EBITDA grows. But the business has become at least a little bit more incrementally risky with the expiration of the cost-of-service contracts. So do you think 3x is still the right leverage target kind of over the next few years? Or could you look to trend that down over time?

[Jonathan Stein, executive]

Yes. So I think we feel very comfortable at 3x. We feel 3x leverage is conservative, but it's not constraining to our strategy in any way. So on a relative basis, if you look at 3x EBITDA, it's one of the lowest leverage in the sector and certainly consistent with our objective of stable cash flow and distributions. I think at the same time, though, if you look, it doesn't constrain our strategy. So we've demonstrated our ability to utilize that capacity and together increasingly more storage as we go forward with free cash flow after distribution building, but still leveraging that capacity to really, as I talked about more than $1.75 billion in buybacks since 2021, really just amazing. And really that highlights what I said in my comments, which is we have our total shareholder return yield is one of the highest of any in the midstream sector. At the same time, our leverage is one of the lowest. And so really, we think that balance is correct and really highlights our ability to really deliver differentiated shareholder returns, but also maintain our balance sheet strength.

[Operator]

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