ARC Resources Ltd

TSX:ARX

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the ARC Resources Limited Q1 2022 Earnings Conference Call. [Operator Instructions] Also note that the call is being recorded on Friday, May 6, 2022.

And I would like to turn the conference over to Dale Lewko. Please go ahead.

[Dale Lewko, executive]

Thank you, operator. Good morning, everyone, and thank you for joining us on our first quarter earnings conference call. Joining me on the call today are Terry Anderson, President and Chief Executive Officer; Kris Bibby, Chief Financial Officer; Armin Jahangiri, Chief Operating Officer; Lara Conrad, Chief Development Officer; and Ryan Berrett, Senior Vice President, Marketing.

Before I turn it over to our executive team to take you through our first quarter results, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP and other financial measures with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars unless otherwise stated.

Finally, the press release, financial statements and MD&A are available on our website as well as SEDAR. And following our prepared remarks, we'll open the line for questions.

With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

[Terry Anderson, executive]

Thanks, Dale, and good morning, everyone. Today, I want to take a moment to review 3 items related to our financial and operational results and how we are progressing our business.

As it relates to the quarter, ARC delivered on our strategy. We profitably invested in our assets and capitalized on elevated commodity prices to reduce debt and accelerate returns to our shareholders. Since closing the Seven Generations acquisition a year ago, ARC has sustained production at greater than 340,000 BOE a day and generated over $1.6 billion of free funds flow equivalent to about 15% of our market cap today. In Q1, we allocated 2/3 of our free funds flow to our shareholders through the base dividend and share repurchases and the remainder to debt reduction.

Since initiating the buyback program in September last year, we have invested and retired approximately 6% of our shares at an average price 30% lower than today. Retiring our shares below intrinsic value has proven to be a great use of capital and an effective way to grow our per share metrics. So we'll continue to use the tool to complement the base dividend as long as it is good returns for our shareholders.

In addition, we announced a 20% dividend increase in the quarter. This further demonstrates our commitment to shareholder returns as we grow our business. Importantly, the dividend is sustainable through the cycle. We can sustain the business and fund the dividend with cash flow at $40 WTI and $2 AECO.

Arc is an ESG leader and very proud to have one of the lowest emissions intensities in North America. We are pleased to announce that we have achieved certification of our Northeast BC assets under Equitable Origin Standard for Responsible Energy Development. This is the second certification we've achieved, the first at our Kakwa asset, which means approximately 95% of our operations is certified. As a result, ARC now holds the largest volumes of independently certified production in Canada.

We're also excited to announce another LNG supply agreement. This is an important next step in our market diversification and market expansion strategy. ARC will supply 140 million Btu per day or about 12% of our current gas production to Cheniere beginning in 2027 or possibly sooner. In exchange, ARC will receive JKM link pricing net of shipping costs and liquefaction fees. Our scale, strong financial position and leading emissions profile were all important factors in securing this transaction. And it supports our broader strategy to expand margins by gaining access to markets where demand for our products is strong and growing.

We continue to explore additional opportunities to insert ourselves and own more of the value chain. There is growing demand for low-cost, low-carbon natural gas, and ARC has a deep, deep inventory and expertise to responsibly develop it.

Finally, our priorities for the balance of the year have not changed. We will remain disciplined with our capital. We'll focus on costs and operational efficiencies, given the inflationary pressures, and will resume investment in BC growth projects like Attachie and our Sunrise expansion once the regulatory environment is supportive. Our plan yields an attractive return for our shareholders. At strip pricing, we expect to generate free funds flow of approximately $2.5 billion in 2022 or approximately $3.70 per share.

ARC has a significant commodity and geographic optionality to help us manage risk. We are capitalizing on that optionality today as we await clarity and resolution on the regulatory environment in BC. ARC is starting to receive incremental development permits from the BC Oil and Gas Commission, which is a very encouraging step towards establishing a foundation for future investment in the province. The most efficient operating plan for ARC currently is to redirect activity to Kakwa as we await more clarity.

At this time, there's no change to our overall capital spending plan or production guidance. The economic incentive in Kakwa are high, given the condensate fundamentals and prices are very strong. And we have improved efficiencies at the asset level and are able to leverage existing infrastructure to profitably deliver growth. The optimal production for Level 4 Kakwa is between that 180,000 to 200,000 BOE per day, approximately 15,000 BOE per day above what we produced in the first quarter. This is the appropriate production level that optimizes free cash flow and returns by balancing capital, inventory and available infrastructure.

With that, I'll turn it over to our CFO, Kris Bibby, to go through our financial results.

[Kristen Bibby, executive]

Thanks, Terry, and good morning, everyone. I'll be brief so we can leave some time for questions. As Terry said, we delivered a strong quarter, generally in line with expectations. ARC once again demonstrated capital discipline and commitment to shareholder returns by distributing 65% of our free funds load to shareholders through the dividend investing in our shares. The balance was reduced -- used to reduce debt, which is also a form of returns that accrues to shareholders. If you know ARC well, you know that we are a balance sheet first company, and we adhere to that guiding principle in the first quarter.

At the end of the quarter, we had $1.6 billion of long-term debt, of which $1 billion is through our investment-grade senior notes. This equates to a debt to cash flow ratio of roughly 0.6x. We will continue to reduce debt with any excess free funds flow after dividends and share buybacks.

Terry alluded to our market diversification strategy as it returns to LNG and internationally linked pricing. This is complementary to our long-standing diversified portfolio of pricing points across North America, which continues to benefit us today. ARC realized a natural gas price of $6 an Mcf in the quarter, which is $1.40 above the AECO benchmark in Western Canada. We have exposure across 5 different markets in North America, including delivery to the U.S. Gulf Coast and retain considerable flexibility through our company-owned infrastructure that allows us to capture value, especially in periods of commodity price volatility.

Capital allocation remains top of mind in conversations with investors. We put forth the framework to return 50% to 80% of our free cash flow to shareholders last year and continue to deliver on that. We have allocated approximately 65% of our free cash flow to shareholders since its adoption last year through a growing base dividend and by repurchasing 6% of our shares to date. With their shares continuing to trade below intrinsic value, we intend to continue down this path. Our shares trade at approximately 3x free cash flow on an unhedged basis at strip, and we can sustain that for decades on existing inventory.

I will caveat that this is based on a strong commodity price environment, however. Through a different lens, our shares are discounting at commodity price below our mid-cycle prices of USD 60 in WTI and below where other assets are transacting in the public market that are both lower duration and not underpinned by our owned and operated infrastructure. To summarize, we are confident in attractive risk-adjusted investment for our shareholders.

To front run the question I know is coming. If we continue to allocate 65% of our free cash flow to shareholders over the balance of the year and the remainder of the debt. Net debt would likely be below our $1 billion investment grade outstanding. In that scenario where there's excess free cash flow beyond the needs of the business, we would logically return more profits to shareholders.

As it pertains to our outlook, capital and production guidance were unchanged. Certain cost guidance items increased due to a combination of factors. Taxes increased due to higher commodity prices than we had budgeted, so a good thing, while higher pipeline tolls and fuel gas charges increased transportation, again, linked to higher commodity prices. But we are facing inflationary pressures like all other producers. So far, we have been able to mitigate most of it on the capital side through lasting efficiency improvements.

Drilling efficiencies in the Kakwa region are best-in-class. We reduced drilling days per well by roughly 15% and increased drilling meters per day by over 10% over the past 18 to 24 months.

With that, I'll give it back to Terry for some closing remarks.

[Terry Anderson, executive]

Thanks, Kris. I'm so excited about where ARC is heading. We are early in demonstrating an inflection point in profitability at a time where there is strong demand for responsible resource development. ARC has the attributes to grow and continue to lead in this regard. We have scale in world-class assets that is opening up numerous opportunities to get our product to key demand regions. We have one of the lowest emission profile and a path to improving it, all made possible by our team of high-caliber and motivated people. ARC has been in business for over 25 years, and the future has never looked brighter.

With that, I'll turn it back over to the operator.

[Operator]

[Operator Instructions] Your first question will be from Michael Harvey at RBC Capital Markets.

[Michael Harvey, analyst]

So just a couple of quick ones. I guess, first on this Cheniere deal, maybe for Ryan. Do you have any sense for -- or maybe you can give us some color on the available firm transport on Great Lakes or otherwise, just to get your gas there? Or do you still have to kind of sort that out?

And the second one would be just more modeling based, and that's just focused on your royalties. You've got a bunch of moving parts that are kind of tougher for us to model, drilling credits rolling off, more Alberta drilling, just higher prices. So maybe you can give us a sense for where you would see your royalties going later this year kind of at a strip pricing scenario.

[Ryan Berrett, executive]

Mike, it's Ryan. Thanks for the question. Cheniere, obviously, we're really excited to enter into the Cheniere transaction. Cheniere has a proven track record of delivering LNG to the world, and we're really excited to be a part of that.

Specifically to your question on transport, we are utilizing our Alliance pipeline capacity, and we are delivering in Chicago to Cheniere. And Cheniere takes our gas from there on their proprietary pipeline. This gives us -- and one of the specific attributes to this deal, this preserves our NGPL capacity. So ARC still retains our capacity to the Gulf Coast that we can utilize for NYMEX exposure or future LNG exposure.

[Kristen Bibby, executive]

And Mike, it's Kris here. On the royalties front, yes, you saw obviously a higher royalty sprint this quarter given the high commodity prices. If we look forward at strip is probably the easiest way to just talk to it. We see relatively stable royalties in that 14% range for the remainder of the year. You are right that there are some moving parts in terms of some different changes underneath. And then as you look out a bit, again, if you're using strip is kind of just to center it, it's reasonably stable. It kind of ticks down about 1% and then stabilized kind of in that 13% range going forward based again on existing strip pricing.

[Operator]

[Operator Instructions] And at this time, I would like to turn the call back over to Mr. Anderson.

[Terry Anderson, executive]

If that's all the questions, then thanks, everybody, for your time. We appreciate the time this morning, and we look forward to the next quarter. Appreciate it.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good weekend.