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Western Midstream Partners LP
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Good day, and welcome to the Western Gas First Quarter 2018 Earnings Conference Call. [Operator Instructions]. Please note this event is being recorded.
I would now like to turn the conference over to Jon VandenBrand, Director of Investor Relations. Please go ahead, sir.
Thank you. I'm glad you could join us today for Western Gas' First Quarter 2018 Conference Call. I'd like to remind you that today's presentation includes forward-looking statements and certain non-GAAP financial measures. The accompanying slide deck and last night's earnings release contain important disclosures on forward-looking statements as well as the non-GAAP reconciliations. Please see the WES and WGP 10-Ks and other public filings for description of the factors that could cause actual results to differ materially from what we discuss today. Those materials are all posted on the Western Gas website at www.westerngas.com.
I would now like to turn the call over to our CEO, Ben Fink. Ben?
Thank you, Jon. Turning to our first quarter results. We reported adjusted EBITDA and distributable cash flow of $272.1 million and $231.4 million, respectively, and a coverage ratio of 1.05x. This coverage ratio is in line with our expectations, and we still expect distribution coverage to be over 1.2x by the end of the year. While adjusted EBITDA was essentially flat with the prior quarter on a reported basis, we actually experienced 2% growth after adjusting out the onetime payment DBM Water Services received in the previous quarter.
Also as a reminder, we adopted the new revenue recognition accounting standard on January 1 of this year. While this new standard resulted in changes to how we recognize revenues and cost of product for certain contracts, adjusted EBITDA for the quarter was approximately $1 million lower than it would have been under the old standard. Our quarterly results were driven by strong natural gas throughput growth in the DJ and Delaware Basins. We also saw incremental growth behind the Springfield gas gathering system and the Granger straddle plant. The adjusted gross margin per Mcf of $1 was unchanged from the previous quarter.
The growth in our crude, NGL and produced water throughput was driven by the continued growth of our produced water business and higher volumes at the Springfield oil gathering system and White Cliffs Pipeline. The adjusted gross margin for crude, NGL and produced water assets of $1.84 was $0.37 lower than the previous quarter, driven by normalized produced water margins and lower per barrel distributions from White Cliffs and Texas Express Pipeline. In yesterday's earnings release, we announced that we have secured options to participate in 2 long-haul crude pipelines out of West Texas in conjunction with Anadarko shipper commitments. We believe there is a critical need for additional takeaway capacity to serve Permian oil production growth and are delighted to have the opportunity to be part of the solution. I want to be clear that our options to participate in these projects are at cost. We are not paying a promote of any kind of participate. We have the option to take a 20% stake in Enterprise's Midland-to-Sealy pipeline that will provide access to the Houston market. And as of today, we have exercised this option subject to the completion of final documentation.
We also have the option to purchase up to a 15% ownership interest in Plains' Cactus II pipeline, which will link the Delaware Basin to the Corpus Christi market in late 2019. Details about these projects can be found on the operator's investor materials, and I encourage each of you to look at them. We believe that we will spend a total of $300 million to $350 million in 2018 to fund our share of both projects. Accordingly, we've updated our 2018 capital outlook to $1.35 billion to $1.45 billion, and we still intend to fund this capital program without issuing additional equity. Our 2018 run rate leverage ratio should not exceed 4x. And we expect this ratio to decrease in 2019, as we see a full year impact of the anticipated Delaware volume growth. All of our other guidance remains unchanged, and we continue to be focused on executing the plans we have previously communicated.
As always, we appreciate all of your continued support. And with that, operator, I'd like to open up the line for questions.
[Operator Instructions]. And our first question will come from Jeremy Tonet of JPMorgan.
Congratulations on the equity options there. I was just wondering if these options were included in your EBITDA guidance as it stands now. Or is that something that you might adjust in the future whenever things finalize there?
It's Ben. It's probably so that we might adjust for in the future. It depends on how the final accounting treatment shapes up. Let me explain. We expect, if everything goes as it should, everything will close by middle of the year. And then we'll certainly report 0.5 year of adjusted EBITDA. That by itself is not enough to really move our range either way. The question is, what happens to the earnings that are attributable to us for the period from in-service to the time it closes, is that going to be net capital, or is that going to be a growth capital and also reported earnings. So it really just depends. And so we'll know a lot more between now and closing. Does that answer your question?
That's very helpful. I was just wondering, are there other -- is the potential for other, I guess, options as well to materialize in the future? I mean, these are great interests that your sponsor was able to provide for you? Could there be more opportunities like this going forward in the near term? And just any updated thoughts on -- I think, you talked about a Red Bluff equity option previously. Any thoughts that you can share there?
Sure. We've publicly talked about 2 others, although we've made no decisions whether or not to exercise such options. There is an option to take a piece of the Red Bluff pipeline, which will get us from Ramsey to Waha basically. And then there's the Cheyenne Connector pipeline, which comes online in '19 out of the DJ. There are -- there is at least one other that's kind of under negotiation and discussion, and we'll see if we get to the closing line on that one. But this is something we're always looking forward to be able to use or that our sponsor is able to utilize it to leverage as a customer to get an interest in some really great projects.
And then equity earnings seemed like it stepped down a little bit in 1Q versus 4Q '17. Was that just kind of seasonality and timing or anything else we should be thinking about there?
Two things. One, there were lower distributions from the White Cliffs pipeline, which should surprise no one. And then remember, in the fourth quarter, we had the onetime payment at DBM water. So when you normalize for that...
And that helps explain the change to liquids that Ben was talking about. But we also just experienced some normalizing of the cash distribution at several of our equity investment assets, including Texas Express Pipeline and the Front Range pipeline as well as Mont Belvieu. And so as you had a bunch of extra cash cleared out in the fourth quarter, you kind of return to normalized distribution levels.
Yes. Sorry, Jeremy, I was answering question you didn't ask, which is about gross margin per barrel. Sorry about that.
Okay. Well, maybe you could pick up on gross margin per barrels. You want to continue with your thoughts there?
Sure. No, you noted previously that it declined sequentially. And that was basically due to the normalization of the produced water barrels, which as you know is a gathering business, which has lower margins than a long-haul transportation business.
The next question will come from Shneur Gershuni of UBS.
Just wanted to ask a couple of quick questions here. First on the stake that you have in the Midland-Sealy pipe that was disclosed last night. The fact that you're buying into it, do you get a refund of any of the earnings that they made on the pipeline sort of in the last quarter or so in terms of cash flow once you pay in? Or is it -- you just earn the cash flow on a go-forward basis?
Sure, Shneur. Our option is effective as of the date it went into in service, which was November of last year, right? As I said earlier, we're entitled to share those earnings. And the question will be, whether it's accounted for as a net capital number, or will you reflect the gross capital plus the earnings going forward. But we're certainly entitled to our share from the in-service team.
Okay, got it. Well, either city, there's an earnings number was deducted against CapEx, got it. Okay. And then the second question, I'm sure you're sick of it, but I have to ask it, the simplification question. Any tone change from the last conference call? It seems like it's picking up a little bit, and it seems to be a big investor focus as of late and could be argued as the overhang on your equity.
No, I appreciate the question, Shneur, and I understand it. The reason there was no comment in the prepared remarks is we've really nothing new to say. We continue to look at the issue. And if there's something to talk about, we'll make an announcement.
And next we'll have a question from Richard Roberts of Scotia Howard and Weil.
A quick question on the water business. So you've had some success recently on the water side with third parties. I guess, going forward, should we expect any future third-party business is going to go on the WES water assets instead of APC? Or maybe you could talk about just how that gets determined where that third-party business goes?
Our current mode of operation, Richard, is that third-party business will be WES business going forward.
Okay, got you. I'm going to -- I guess, sticking on the water side. I understand that most of the producers are building out their own water systems. So as you try to add more third-party business, are you primarily targeting smaller producers that haven't made those investments? Or are you making any headway with the larger producers kind of migrating some of that spend over to you?
Yes, it's a great question, Richard. If you were to look at our deal pipeline, you'd see some blue chip producers and you'd see smaller guys. It would really run the gamut in terms of size. What we're able to do is by getting out in front of the problem and building a lot of infrastructure that's on dozens of producers' doorsteps. Whether they're large or small, we can offer them a really competitive solution.
Okay, great. And then maybe one more. You mentioned the amount of infrastructure you have going in. So clearly, this year is a pretty big year for infrastructure spend, a lot of backburner infrastructure going in place as you kind of set up for the volume ramp over the next couple of years. And then APC is doing a fair amount of midstream investing too. So just as we think about the next couple of years kind of a cadence of spending from here, do you think we should see kind of a rollover in spending as you start to reap some of the cash flow from these big investments you're putting upfront? Or is there more APC-level spending that kind of migrates down to you, so you stay in that kind of $1 billion-ish range maybe you could share there?
Yes, that's the 500-pound gorilla that we need to address through now and the end of the year. When you look at our portfolio as it stands today, our capital needs for next year should be significantly below this year, right? We're in various stages of 4 processing plants that will all come in service by the end of '19. We're building a lot of trunk line. And once plants and trunk lines are built, they're built. And now you're really looking at well connections going forward. And so the question is, as we look at whether it's acquisition opportunities or what we want distribution coverage to be, how much of the capital that's in Anadarko, we would want to move down to us. Obviously, water is one option and then maybe a couple of other options as well. And that will be the critical decision to be made as we go on to budgeting for next year.
The next question comes from Gabe Moreen of Bank of America Merrill Lynch.
It's actually Deutsche Bank. I had a couple of quick follow-up questions. One was the Midland-ECHO Sealy pipeline. Clearly, there's a bit of open capacity there in terms of lock-up volumes. Can you talk -- I think your operator of that pipeline has talked about hedging out some of the barrels on that pipeline. Can you talk a little bit about what your approach might be to, I think, the exposure you might have to that spread?
Sure, Gabe, and welcome back. Obviously, we don't have a lot of decisions around of that -- around that. And obviously, the option right now is subject to final documentation. What I can tell you is that we'll have 20% share of a JV. We'll have our proportionate profits and losses of that JV. That JV will be involved in marketing activities, but we expect that those activities would be limited to really certain activities that are directly on the pipe.
And then just curious in terms of -- clearly, it's been in service for a while. The decision to hold off, I guess, to closing this for a while, was that just to wait sort of until, hey, you have to exercise the option? Or was there any other thought process behind, I guess, disclosing the stakes here in Cactus?
Those were contractual requirements.
Our next question will come from David Amos of Heikkinen.
Ben, back to the water margin, can you just help us from a modeling perspective think about that liquids margin per barrel line item and how that will change throughout the year as you continue to add water volume to that segment?
Yes. I mean, water gathering is a lower-margin business, a significantly lower-margin business than long-haul transportation, right? I mean -- and so because it's a gathering business, you're seeing lots and lots of volumes, and that impacts the throughput mix of the barrels that we have. And so this decline is no surprise to us, and we would expect that to trend downward from here as those water volumes continue to grow and be a bigger share of the throughput mix relative to the long-haul transportation.
Okay. Maybe any thought about an exit margin per barrel -- liquids margin per barrel? Or just from -- where it is 1Q and where you might exit this year?
No. I mean, I'd say, from where we are, we'll probably trend towards $1.50.
That's helpful. And then sticking on the water business, you had mentioned that you're seeing some change to term on the third-party contracts, that they're getting longer and looking more midstream like. Is that continuing? And do you see that becoming more of a norm as you pick up more third-party business?
Yes. Everything that we're under negotiation for is really looks like a gathering contract, which is 5 years and out MVCs and not particularly discernible from an oil or gas gathering contract when you look at the key terms. Obviously, you're drilling a well at the end of the process. And obviously, the returns are higher, because you're trying to risk adjust for that downhole risk.
The next question comes from Mirek Zak of Citigroup.
Just one quick form from me. What other factors went into initiating or executing those initial purchase options at the WES level versus APC beyond simply what's the scale today, allowing it to fund such endeavors? Or was that the only reason?
I hope I understand your question correctly, Mirek. I mean, this is Anadarko's leverage as a meaningful shipper that is able to negotiate these options. I don't think WES as standalone midstream entity would have the type of leverage to actually get stake in these projects. And Anadarko has done this a handful of times over the years. There has been times they've built it out on their own balance sheet, dropped it to WES. There's been times like these, where they've asked WES to just fund the capital and basically transfer that option to WES. WES' decision to actually fund the project is just a simple risk versus return basis. Our threshold is mid-teens unlevered on any dollar we spend, and these projects exceed that margin quite comfortably.
Okay. And am I right to assume that the execution of these options had been assumed when you previously put out your two-year distribution growth guidance?
No. And I think we're very clear on issued guidance that it did not include any potential exercise of equity options.
And the next question comes from Dennis Coleman of Bank of America.
Yes. Just a couple of quick ones also on this -- the options. First, you mentioned one other potential option that was under negotiation. And I'm wondering, is that of a similar size? Anything you can tell us about the scope of that investment, what it might be?
No, that one is too early. There's really nothing that I can say meaningfully about it at this stage.
Okay. And then just on the accounting treatment in terms of whether it's a net or added at gross, is that a point of negotiation between you and enterprise? Or is that strictly an internal WES decision?
It's internal WES decision in conjunction with our auditors.
The next question comes from Barrett Blaschke of MUFG.
Just a little follow-up on the two announcements about the option exercises with Cactus and Midland-to-Sealy. Where do these sit strategically in terms of as you're looking at your growth for the next two years? I mean, are there other opportunities around you should be able to tack on to these? Or how do you view it?
Great question, Barrett. And I would say similarly to the other options that we've exercised in the past, where we have wellhead exposure and if we can participate in the economics down the value chain, that diversifies our cash flow and helps our full value-creation story. We started in the DJ Basin as simply a gatherer and processer and worked from there to having option in crude takeaway, NGL takeaway and then ultimate fractionation. And I think as the Delaware Basin gets started, we're trying to follow the same model, just as we are in so many other factors, replicating that success we had in the DJ and now in the Delaware.
And next we have a question from Chris Tillett of Barclays.
I guess, two quick questions here. First is on the Cheyenne Connector and Red Bluff options. Can you just remind us what the timing is on those in terms of your decision to exercise or not?
Red Bluff should be by the end of the year, and Cheyenne is a 2019 decision.
Okay. And then separately, I know Anadarko has a fair amount of security in terms of their future product takeaway capacity out of the Permian. But not all the producers there have been kind of that proactive. As you guys continue to build out in the region, are you noticing or anticipating any change in your third-party producer behavior related to some of the infrastructure constraints in the region that people have been discussing?
Too early to say that we've noted any changes. I'll just remind you that back when we got into the basins through the Nuevo Midstream acquisition, one of the things we loved about the acquisition was the high-quality customer base. I mean, these were blue chip customers like Concho, Cimarex, Chevron, Conoco, BHP, et cetera. And those are the types of producers that tend to mitigate this type of risk. But that's just as you've seen with Anadarko. And so that value that we recognized at the time of acquisition is paying off its base today.
The next question comes from Selman Akyol of Stifel.
Most of mine have been asked and answered, but just one quick one just from a modeling standpoint. As you think about going into the second quarter, and I understand distribution coverage in excess of 1.2x for the full year, but just thinking about it, are we seeing the low end of distribution coverage for the year with this quarter?
That's a funny question, Selman. I'll just reiterate our previous guidance, which is first half between 1.0, 1.1 and then second half significantly higher and an exit rate of over 1.2.
And this concludes our question-and-answer session. I would like to turn the conference back over to Benjamin Fink for any closing remarks.
Thank you, everyone. I really appreciate your interest in our quarter, and we look forward to talking to you again in three months' time. Have a great day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.