Hess Midstream LP

NYSE:HESM

Earnings Call Transcript 2022-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Third Quarter 2022 Hess Midstream Conference Call. My name is Shannon, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this 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, Vice President, Investor Relations]

Thank you, Shannon. Good afternoon, everyone, and thank you for participating in our third 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 and our transcript of today's prepared remarks.

With me today are John Gatling, President and Chief Operating Officer; and Jonathan Stein, Chief Financial Officer. In case, there are audio issues, we will be posting transcripts of each speaker's prepared remarks on www.hessmidstream.com following their presentation.

I'll now turn the call over to John Gatling.

[John Gatling, President & Chief Operating Officer]

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's third quarter 2022 conference call. Today, I'll review the progress we're making on executing our strategy, discuss our operating performance and capital program, and review Hess Corporation's results and outlook for the Bakken. Jonathan will then review our financial results and guidance.

Beginning with Hess Upstream's results, today Hess reported third quarter Bakken net production of 166,000 barrels of oil equivalent per day, which was above their guidance range of 155,000 to 160,000 barrels of oil equivalent per day, reflecting strong execution and recovery following challenging weather conditions in the first half of the year. Hess anticipates fourth quarter Bakken net production to be in the range of 165,000 to 170,000 barrels of oil equivalent per day and full year 2022 Bakken net production to average approximately 155,000 barrels of oil equivalent per day, which is at the high end of Hess' previous guidance range of 150,000 to 155,000 barrels of oil equivalent per day.

Hess' fourth Bakken drilling rig commenced operations in July, supporting Hess' planned production ramp to approximately 200,000 barrels of oil equivalent per day in 2024, which drives long-term volume growth for Hess Midstream.

Looking ahead, we expect all our systems to be above MVC levels in 2023 and 2024, primarily driven by Hess' planned production growth and its goal of achieving zero routine flaring by the end of 2025.

Turning to Hess Midstream results. Our third quarter throughput volumes recovered strongly, growing approximately 20% on average from the second quarter. Third quarter volumes averaged 110,000 barrels of oil per day for crude terminalling and 83,000 barrels of water per day for water gathering. Reflecting strong gas capture, third quarter gas processing volumes exceeded MVC levels, averaging 354 million cubic foot per day, contributing to third quarter adjusted EBITDA, up $254 million, which was above the top end of our guidance range.

We anticipate fourth quarter gas, oil and water volumes to be relatively flat compared to third quarter, driven by planned maintenance activities deferred from the third quarter.

Now, moving to Hess Midstream guidance, which was included in our earnings release and is available on our website. We've updated our volume guidance to reflect third quarter performance and now expect full year 2022 gas processing volumes to average approximately 330 million cubic foot per day, crude terminaling volumes to average approximately 105,000 barrels of oil per day and water gathering volumes to average approximately 75,000 barrels of water per day.

We continue to make excellent progress on our 2022 capital program, with activities primarily focused on flare reduction due to the continued expansion of our gas gathering infrastructure. In September, we brought online the second of two new compressor stations planned this year. In aggregate, the two stations provide an additional 85 million cubic foot per day of capacity and can be expanded up to 130 million cubic foot per day in the future.

Additionally, the stations were safely completed several months ahead of schedule and below budget, demonstrating the benefits of our lean approach to standardized compression design. We're proud of our team for outstanding execution, amid a challenging inflationary cost environment.

As previously announced, we expect to initiate construction on a third compressor station in the fourth quarter, which would provide an additional 65 million cubic foot per day of capacity in 2023 to further support Hess and third-party production growth. We expect full year 2022 capital expenditures to total approximately $235 million, comprised of $120 million in compression expansion, approximately $105 million in gathering system well connects and $10 million of maintenance activity.

In closing, we continue to execute our strategy, focus on safe and efficient operations, preserving cost discipline through our lean-driven standard design and build philosophy, allowing us to efficiently grow throughput, sustainably generate cash flow and return capital to our shareholders.

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

[Jonathan Stein, Chief Financial Officer]

Thanks, John, and good afternoon, everyone. As John described, we are making good progress in executing our strategy, and we are excited to support Hess' development in the Bakken, while continuing to deliver on our strategy of consistent and ongoing return of capital to our shareholders.

Beginning with our results. For the third quarter, net income was $159 million, compared to $152 million for the second quarter. Adjusted EBITDA for the third quarter was $254 million, compared to $243 million for the second quarter. The change in adjusted EBITDA, relative to the second quarter was primarily attributable to the following. Total revenues, excluding pass-through revenues, increased by approximately $19 million, primarily driven by a combination of higher MVC and throughput volumes that exceeded our MVCs and gas processing and one of our gas-gathering subsystems, resulting in segment revenue changes as follows. An increase in processing revenue of approximately $5 million and an increase in gathering revenue of approximately $14 million.

Total costs and expenses, excluding depreciation and amortization, pass-through costs and net of our proportional share of LM4 earnings, increased by $8 million as follows. Remediation expenses for a produced water release of approximately $6 billion, inclusive of both actual costs incurred to date and estimated total future expenses, higher operating and maintenance activity of approximately $2 million in our gathering segment that was seasonally higher compared to the second quarter the lower than anticipated as a result of the deferral of some maintenance activities, until the fourth quarter, resulting in adjusted EBITDA for the third quarter of $254 million, above the top end of our guidance range.

Our gross adjusted EBITDA margin for the third quarter was maintained at approximately 80%, highlighting our continued strong operating leverage. Third quarter maintenance capital expenditures were approximately $1 million, and net interest, excluding amortization of deferred finance costs, were approximately $38 million. The result was that distributable cash flow was approximately $215 million for the third quarter, covering our distribution by 1.6 times.

Expansion capital expenditures in the third quarter were approximately $59 million, resulting in adjusted free cash flow of approximately $156 million. At quarter end, debt was approximately $2.9 billion, including a drawn balance of $43 million on our revolving credit facility, representing leverage of approximately three times adjusted EBITDA on a trailing 12-month basis. We expect to decline below this target in 2023, with increasing adjusted EBITDA providing flexibility for incremental return of capital to the shareholders.

Consistent with our return of capital framework, earlier this week, we announced our third quarter distribution that increased 5% on an annualized basis and represents a 10% increase compared to the third quarter of 2021, including our distribution level increase earlier this year.

Turning to guidance, we anticipate fourth quarter net income and adjusted EBITDA to be approximately flat compared to our higher third quarter results, reflecting the combination of the following. Stable revenues for the majority of our systems with throughput below MVC levels, downtime from planned maintenance activity that was deferred from the third quarter driving expected lower throughput volumes and revenues at our gas gathering system operating above MVCs and lower total OpEx in the fourth quarter, with the produced water remediation expenses in the third quarter.

Reflecting these fourth quarter expectations and our strong third quarter results, we have updated and raised our full year financial guidance relative to the midpoint of our prior guidance. We now expect net income to be approximately $630 million, and adjusted EBITDA of approximately $990 million, representing 9% growth compared to full year 2021 results.

Maintenance capital and cash interest are projected to total approximately $150 million for the full year 2022, and distributable cash flow is expected to be approximately $840 million resulting in an expected distribution coverage of greater than 1.5 times. We expect to end the year with leverage at our conservative three times adjusted EBITDA leverage target.

Looking forward, in January, we will release our 2023 operational and financial guidance including 2025 MVCs. We expect to continue to execute our financial strategy over the coming years as we have clear visibility to expected revenue and adjusted EBITDA growth, supported by organic growth above MVCs in 2023 and 2024.

Emphasizing this visibility to continued growth in adjusted EBITDA, our current MVCs in 2023 and 2024 reflect continued organic growth in gas processing and gathering throughput, driving increasing gas revenues that excluding pass-through revenues comprised approximately 75% of total affiliate revenues.

As a result, we anticipate continued growing adjusted EBITDA and stable CapEx and expect growing adjusted free cash flow, sufficient to support our growing distribution and incremental financial flexibility allowing for continued return of capital to shareholders, consistent with our financial strategy.

In closing, we are very pleased with the progress we are making in our business 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.

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] Your first question comes from the line of Michael Lapides with Goldman Sachs. Your line is now open.

[Michael Lapides, Goldman Sachs]

Hi. Thanks, everyone. Thanks, John and Jonathan, for taking my questions. Actually, I have a few, one kind of more near-term, one lot longer term. On the near term, Jonathan, you used the word stable when referring to CapEx going forward. Does that imply that future CapEx or growth CapEx or expansion CapEx looks a lot like 2022 levels, or should we be thinking, given the amount of new compression you added in 2022, that future CapEx may even be a little bit lower than this year's?

[Jonathan Stein, Chief Financial Officer]

All right. So, why don't I -- I'll just start and give kind of the overview. Maybe, just a general talk on where we think direction is going on guidance and I’ll turn it over to John Gatling to give a little bit more detail.

Look, in terms of CapEx, specifically, we've really said that we expect CapEx for 2023 to be stable, as I said, at or below levels of this year. John Gatling can break that down, but it will continue to be well connected and compression.

So with that stable capital, and as I talked about in my remarks, we expect growing EBITDA that you can see visibly through our current MVCs, of course, we'll update those MVCs, including our 2025 MVC that we expect to show and demonstrate the visibility of our continued growth.

But remember, with that stable capital that we'll have next year and then growing EBITDA, that means we'll also have significant financial flexibility in terms of leverage. As I mentioned, we're at our 3 times target already. And so, as we move into next year with growing EBITDA, we expect that to decline.

And I also mentioned our revolvers, just at $43 million now, so as we move into next year, we'll be generating excess free cash flow above our growing distributions, giving us incremental financial flexibility for our return on capital program as well.

So that's kind of the broad contour is, we'll give more information in January, including our 2025 MVC, as I said. But that's generally kind of the broad direction of where we think things are headed. Let me just turn over to John, if you want to give any more on the CapEx.

[John Gatling, President & Chief Operating Officer]

Sure. Thanks, Jonathan. We've been working towards Hess's production growth to 200,000 barrels of oil equivalent per day in 2024. So we've been kind of targeting that from a CapEx perspective in compression and gathering. We've been continuing to focus on compression.

I would say that the spend -- as Jonathan mentioned, the spend in 2023 is going to be at or below the 2022 level. But from a growth perspective, and you can see it in the implied volumes from our 2023 and 2024 MVCs that we are expecting growth, and we are going to continue to focus on well connects and compression.

But again, we have 500 million a day of total processing capacity and we'll continue to grow towards that capacity as Hess grows its production in the basin.

[Michael Lapides, Goldman Sachs]

Got it. And then one kind of longer term question kind of was several years out, it has really achieved its zero flaring goal. Outside of the kind of the production growth volume, how should we think about what that incremental -- like getting some current flaring to zero flaring needs for you?

[John Gatling, President & Chief Operating Officer]

Yes, I mean we see -- we definitely see the Zero Routine Flaring commitment from Hess as a positive. It's definitely a catalyst for the midstream. Hess is doing actually very, very well. I mean, they're well above 95% gas capture currently. They made the commitment to Zero Routine Flaring by the end of 2025. We're on track to support Hess' growth towards Zero Routine Flaring by the end of 2025.

I think as Hess has demonstrated in its sustainability report, it's committed to continuing to improve emissions reduction activities in the basin. And we're -- I think we're well-positioned to help support and grow that. So, from a plan perspective and MVCs, and as I mentioned, at the implied 2023, 2024 volumes, and we'll give 2025 MVC guidance in January, that -- the gas capture component of that and Zero Routine Flaring commitment is built into those forecasts. So, we feel good about it. Again, it's underpinning our growth and we're here to support Hess' objectives from a climate and emissions reduction perspective.

[Michael Lapides, Goldman Sachs]

Got it. And then one last one, and this may be one for Jonathan. How should we think about the move in interest rates? And, A, what that means for financing costs for you, including doing things like using the revolver. But B, kind of, thinking more two to three years, using incremental debt issuance as a mechanism or a tool in kind of the broader return of capital to shareholders' process?

[Jonathan Stein, Chief Financial Officer]

Sure. So, great question. Let's just start. In terms of currently where we sit right now, really only our bank facilities, which we just recently renewed through 2027 and are exposed to floating interest rates. The rest of our debt is fixed. So that leaves us with just 15% of our debt is floating.

As I mentioned on our revolver -- $1 billion revolver, we only have $43 million drawn. And with the extension of the bank facilities, we really have no debt maturities until 2026 at this point. So we have, with that, means significant flexibility to execute our repurchase program from a leverage point of view as we talked about as we go into next year in terms of delevering, but also, we're also going to be generating now excess free cash flow beyond our growing distribution really without any ongoing balance on the revolver to pay down just working capital. So, that creates additional cash flow to fund our internal capital program.

On, an overall basis, our weighted average cost of debt, just looking at the fixed above 5%, very good there. So, we're really in a great spot. We don't have any pressures in terms of short-term maturities or any pressures there. We have a lot of flexibility in terms of using a revolver to be able to optimize as necessary and we have cash flow that will support the leverage as well for our repurchases.

So, we're really in a good spot. We don't see anything that is going to -- in terms of the interest rate environment, we don't see that as an obstacle in terms of us being able to continue to execute our return on capital program.

[Michael Lapides, Goldman Sachs]

Got it. Thanks guys. And sorry to hog up the beginning of the call. Much appreciated.

[John Gatling, President & Chief Operating Officer]

Thanks Mike.

[Operator]

Thank you. Your next question comes from the line of Stephen McGee with JPMorgan. Your line is now open.

[Stephen McGee, JPMorgan]

Hi. Good afternoon. I guess just starting out with the volume increase there. Does this kind of flow through into 2023 for you guys? And then with that, do you see all systems above MVCs next year with this? And then is that for all four quarters, or is that more of an average?

[John Gatling, President & Chief Operating Officer]

Yes. Why don't I'll hit the volume question, and then I can hand the MVC question over to Jonathan. So, on the volumes, from Hess’ perspective and the volume growing to 200,000 barrels of oil equivalent per day by 2024, we've built that into our forecast. Again, we'll update guidance going into January as far as the 2025 MVCs. So that'll give you an indication of where volumes are heading.

But from our perspective and looking at the implied 2023 and 2024 volumes from the MVC based on the implied nomination from Hess, we definitely see growth going into 2023 and 2024. And from an MVC perspective, we're definitely going to be in good shape, but I'll hand it over to Jonathan for a little bit more detail.

[Jonathan Stein, Chief Financial Officer]

Yes. So I think in terms of MVCs, just as a reminder, MVC is just three is in advance. So 2022 is really called the last MVC from prior to the downturn, what has reduced the number of rigs. And as we move into 2023 and 2024, we're really going to be -- these are MVCs which are set based on above the more current plan. As a result, we expect to be above MVCs, which were set at 80% of the current plan in 2023 and 2024.

What I think is gives us confidence in that growth is, as John said, with Hess continuing to be moving towards 200,000 net production goal, 200,000 BOE per day as well as we just talked about the zero routine flaring goal, all that, as John said, really underpin our growth that we see there. And then as we said, we'll give a new and we see for 2025 that will essentially, we expect to show continued growth as well.

And then in terms of how we think volumes, the way to think about this is to say, look, we're at MVC levels for the majority of our systems this year, as I just said, we're going to be above MVC. So those MVCs were set at 80% of expected throughput. So I think of the growth from this year to next year is being from MVC level this year, to physical growth into physical volume levels next year.

And then 2023 and 2024 will continue to be on a sustained basis now above MVC, and then therefore, what will really be is going from physical volumes in 2023 again to physical volume growth again in 2024 and then so on for 2025. So this year is really as we go to next year, really this year's MVCs levels, to next year's physical level, that's the way to think about our growth as we go into next year.

[Stephen McGee, JPMorgan]

Got it. Thank you for that. And then if one has hit their 200 barrels of oil equivalent per day, how do you gauge third-party interest? How do you determine that on your system? And what is the interest level there from Hess M perspective?

[John Gatling, President & Chief Operating Officer]

Yeah. I mean, obviously, Hess is going to be our primary customer, and that's where we're going to focus most of our efforts. But as we've always done and have been successful at doing, we continue to be focused on capturing any third-party volumes we can in the area to fill any outage that we have in our system. So any available capacity, we're looking to fill it by third parties. Again, this is a very good problem to have, which has us sitting on top of great rock. We're on top of that acreage position. There's other third parties that kind of surround that as well. We're a natural aggregator for those volumes, and we're continuing to look at that. From our perspective, we've assumed approximately 10% oil and gas third parties. We'll continue to -- we're continuing to kind of forecast that. But again, we look for opportunities to capture more volumes as it becomes available. And again, we think our system is strategically positioned to attract additional volumes as we have capacity available on our system.

[Stephen McGee, JPMorgan]

Understood. And then one more, if I could. Just wanted to see what you're seeing in the basin right now as far as ethane recovery rejection and then how you kind of see that progressing, I guess, going forward?

[John Gatling, President & Chief Operating Officer]

Sure. I mean, I think ethane is a bit split. You've got some processors that are actually recovering ethane and taking it to market. Some are rejecting the ethane and including in the residue stream coming out of the basin. I think it's really going to depend on market and kind of what the value of ethane is. It's also going to -- it's also going to depend on export capacities for both ethane, residue and NGLs ultimately. So I think from our perspective, from Hess' perspective, we're extremely fortunate that we've got full fractionation capability up to 250 million cubic foot per day at the Tioga gas plant plus another 150 million a day of Y-grade capacity at the gas plant. We've got reliable takeaway for both -- for all three streams, residue, ethane and NGLs, both fully fractionated NGLs but also Y-grade. So I think from our perspective, we've got the export solved. We're going to continue to work on how do you optimize between ethane recovery and other NGLs and even reject into the residue stream. At the end of the day, it becomes an economic and ultimately, an export capacity question.

[Stephen McGee, JPMorgan]

Got it. Appreciate it. Thanks guys.

[John Gatling, President & Chief Operating Officer]

Yeah. Thanks you.

[Operator]

Thank you very much. This concludes today's conference. Thank you for your participation. You may now disconnect, and have a great day.