ARC Resources Ltd

TSX:ARX

Earnings Call Analysis

ARC Resources Q3 Earnings and 2024 Outlook

ARC Resources experienced robust third-quarter performance with production per share over 25% higher relative to Q2 2021, and corporate operating margins exceeded 60%. The company's Attachie project is progressing on schedule and budget, expecting to add 35,000 to 40,000 BOE per day by 2025. The 2024 capital budget is set between $1.75 billion and $1.85 billion, approximately $200 million below initial forecasts and 25% lower than 2023's budget when adjusted for Attachie capital, aiming for average annual production of 350,000 to 360,000 BOE per day. Free cash flow for Q3 stands at $261 million, surpassing analyst expectations by approximately 45%, mainly from lower capital expenditures.

Shareholder Returns and Debt Management

The company has demonstrated a strong commitment to shareholder returns, redistributing 71% of its free cash flow in the form of dividends and share repurchases, using the remainder to reduce debt. Looking forward, they aim to return nearly all free funds to shareholders in both the current year and 2024, underscoring a focus on enhancing shareholder value.

Strategic Production and Capital Efficiency

Forecasting a 2024 production range of 350,000 to 360,000 barrels of oil equivalent per day (BOE/d), the company anticipates a production efficiency derived from a strategic reduction in nonproductive capital, particularly in the Kakwa region. This careful management of capital outlay, proposing an investment of $1.8 billion—a $200 million reduction from the prior year—promises to deliver flat or slightly higher production levels while optimizing capital efficiency.

Cost Structure and Financial Resilience

The company's cost structure is expected to remain stable at approximately $10 per BOE, emphasizing a resilient business model capable of supporting production levels and dividend payments even with a WTI price below $45 a barrel and AECO gas price under CAD 2 per Mcf. This resilience stems from robust infrastructure, quality assets, and diverse markets and commodities, positioning the company to expect a significant cash flow of $3.0 to $3.2 billion and around $1.4 billion in free cash flow for 2024.

Five-Year Growth Outlook

The five-year growth strategy remains consistent with previous announcements, featuring key project investments and share count reduction. A substantial per-share metric improvement is anticipated for 2025, with projections of Attachie contributing to a 10% production increase and an augmented free funds flow by $600 million, equating to over $1 per share.

Long-Term Free Cash Flow Expansion

The company maintains a bullish long-term outlook, aiming to triple free cash flow to approximately $5 per share. This goal aligns with ongoing investments, increased dividend, and share repurchases, catalyzing substantial growth. As the largest Montney producer, the company's leadership is confident in the strategic direction and potential value add over the next five years and beyond.

Earnings Call Transcript 2023-Q3

[Operator]

Good morning. My name is [ Cynthia ], and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Resources Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Mr. Lewko, you may begin your conference.

[Dale Lewko, executive]

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

Before I turn it over to the executive team to take you through our third quarter results and 2024 budget, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP 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. Following our prepared remarks, we'll open the line to 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. I'm going to spend a little time discussing 3 important items this morning: our Q3 results, an update on Attachie and our 2024 budget. I'll then hand it over to Kris, who will provide some additional color on our financial performance.

Beginning with the quarter, Q3 was a lot like the quarters that preceded it. We executed 2 plans and delivered solid performance across all aspects of the business. It's certainly not easy, but delivering this type of consistent execution is a defining characteristic for ARC that has served us well over our 28-year history.

Today, we are realizing the benefits of a balanced capital allocation framework that includes not only a base dividend but also share buybacks at what we deem to be great value. Production per share this quarter is over 25% higher than the second quarter of 2021, the first full quarter following the Seven Generations acquisition.

This investment in our assets and our shares to compound per share growth is a strategy we intend to continue based on where our shares trade today. This quarter, we executed a $400 million capital program and delivered average production of just over 360,000 BOE per day. This represents 5% growth year-over-year and 13% on a per share basis, highlighting the impact of share repurchases.

We had great operational momentum this quarter. Kakwa volumes approach 200,000 BOEs per day driving corporate condensate volumes to 78,000 barrels per day at a time when condensate prices topped CAD 100 per barrel.

As the largest condensate producer in Canada, this has a meaningful impact on profitability as operating margins exceeded 60% corporately. In addition, the team safely and efficiently completed the rest of our planned turnarounds for this year.

Before I go on to Attachie, I want to quickly highlight an example of our commitment to safety. We recently elected to shut-in a few thousand BOE per day of production at Ante Creek to complete some pipeline maintenance on one of our lines.

This was identified by our team as a proactive measure to maintain the safety of our operations. The volume shut-in are mostly natural gas and are expected to be fully restored in Q1 2024. So while it's not material to our overall business, I've said numerous times before, safety is our #1 priority, and this is just a great example of that commitment in action.

Now turning to Attachie. I'm extremely pleased with the progress the team has made to date. Capital costs and timing are both tracking to expectations and what we outlined at our investor update in June. Total cost for Phase 1 start-up remains at $740 million, of which 1/3 will be spent in 2023 and the balance invested in 2024. We expect to be producing between 35,000 and 40,000 BOE per day in 2025 with commissioning volumes coming on by the end of 2024.

Recently, we took the time to tour the site and have a look at the progress firsthand. There are many different projects at multiple stages. But overall, we are about 20% complete on the facilities and infrastructure.

On this slide, you can see some of the milestones that have been achieved to date. The gas sales line is installed, the liquids line is well underway. At the plant site, the tank farm is completed, 75% of the pilings for all the equipment and buildings have been installed and some of the equipment has arrived on site. The plant construction, gathering system and all the other infrastructure is progressing as planned. And over the next few weeks, we'll begin drilling.

We are also on track to fully electrify this facility at start-up further lowering our emissions intensity per BOE while delivering low-cost energy to market.

In summary, we've secured all the long lead items, services and critical permits to execute this project. Attachie will be our 8th Montney infrastructure project, and I'm confident it will be the most efficient project to date. We are in great shape, and I'd like to thank our staff and service providers for their excellent work thus far in keeping the project on time, on budget and ensuring safety is our #1 priority.

Finally, I'd like to move on to the 2024 budget. The priorities are clear: deliver a safe and capital-efficient program while focusing on completing Attachie. The outcome of this will be a step change in our free cash flow per share growth in 2025 and beyond.

Next year, we plan to invest between $1.75 billion and $1.85 billion, and this includes $500 million for the Attachie Phase 1 start-up. The capital program is balanced geographically with a 50-50 split between Alberta and British Columbia, and we'll deliver average annual production between 350,000 and 360,000 BOE per day. This budget is approximately $200 million lower than communicated previously at the Investor Day in June and 25% lower than the 2023 capital budget once you adjust for the Attachie capital in each year.

The primary contributors to lower capital are first, operational decisions to minimize nonproductive capital; second, realized cost savings on certain items; and third, a lower decline rate in 2024. At Kakwa, which is our flagship condensate-producing asset, we are investing less capital and holding condensate volumes flat year-over-year.

The primary drivers of this are twofold: a lower decline rate and a shift back to the condensate-rich areas of the asset. This follows our planned activity in 2023 that focused in areas with slightly lower condensate gas ratios. Longer term, our overall condensate growth will be driven by Attachie, which is 60% liquids, of which 75% is condensate.

ARC reached an important milestone at Kakwa this quarter. We achieved payout for the asset that we acquired in the second quarter of 2021. So in less than 3 years, Kakwa has generated cumulative free cash flow at the asset level of $4.2 billion, which is equal to the purchase price.

And we still have approximately 15 years of high-quality inventory ahead of us. I'm extremely proud of how we've made a world-class asset even better by leveraging the strengths embedded in our company.

Moving on to Northeast BC. We expect to produce near our capacity with modest growth at Sunrise following the facility expansion project completed in 2023. This will increase capacity at Sunrise to 360 million cubic feet per day, which is direct connected to Coastal GasLink and will supply LNG projects off the West Coast of Canada.

To summarize, 2024 will serve as a banner year and set the stage for a step change in our free cash flow per share growth in 2025.

With that, I'll turn it over to Kris.

[Kristen Bibby, executive]

Thanks, Terry, and good morning, everyone. First, I'll touch on the quarter itself. ARC delivered average production of 360,000 BOEs per day and generated funds from operations of $662 million. Both are directly in line with analyst forecast, while free cash flow of $261 million, exceeded expectations by about 45%, primarily due to lower capital expenditures during the quarter.

In terms of capital, we invested $400 million in the quarter, split between Kakwa and in Northeast BC, including approximately $60 million at Attachie. ARC maintained full year guidance for production, capital spending and costs with fourth quarter production forecast to be approximately 355,000 BOEs per day.

When I look back at our financial performance over this quarter, what stood out was profitability and margins and how market diversification and a balanced commodity mix played a key role.

First, as it relates to natural gas. ARC realized $3.16 per Mcf in the quarter, which registered as a 32% premium relative to the local AECO benchmark. This was mainly driven by our transportation portfolio to the U.S. demand markets in California, Chicago and in the U.S. Gulf Coast.

In periods of volatility, we are typically able to capture better margins for our gas, and Q3 was a great example of this. Second, ARC's 360,000 BOEs per day of production included 87,000 barrels per day of crude oil and condensate, which, as Terry already mentioned, averaged greater than CAD 100 per barrel in the quarter.

As a reminder, we are Canada's largest condensate producer, which is structurally short market. Western Canada consumes about 700,000 barrels a day in the oil sands and altogether, the market produces roughly 450,000 barrels a day locally. The 250,000 barrel a day shortfall is imported via 2 pipelines from the U.S., which are operating at or near capacity. So it's structurally a strong market for us long term.

We returned 71% of free cash flow to shareholders in the quarter through a combination of dividends and share repurchases, and the balance was used to reduce debt. As we have stated in the past, we plan to return essentially all free funds to shareholders this year and in '24, implying an increase in the percentage returned over the remainder of the year.

To this end, net debt at quarter end was $1.2 billion, which is the right level for our business, factoring in our asset quality and duration, low cost structure and our low emissions intensity. Combined, these attributes shield our business and ensure we are profitable and sustainable through commodity cycles.

Now looking ahead to the 2024 budget. Our top priority is a capital-efficient program that will provide long-term per share growth. We will achieve this by continuing to invest in our assets and balance that with a meaningful return of capital to our shareholders. This is the optimal way to generate an attractive and competitive total return.

Production guidance for '24 of 350,000 to 360,000 BOEs per day incorporates the anticipated expiry of an ethane sales contract in the second quarter, which will reduce reported NGL production by approximately 5,000 barrels per day on an annualized basis. We plan to reinject ethane into the natural gas stream, resulting in high -- higher revenue from sales of higher heat content gas, offsetting the impact to funds from operations.

In terms of capital, we are investing $1.8 billion in 2024. As mentioned, this is about $200 million less than 2023 once you adjust for the Attachie growth capital, and we are generating the same or slightly higher production levels.

This is driven by 2 things: first, a lower corporate decline in 2024. Therefore, we need to drill and complete fewer wells to offset production declines. And second, a concerted effort to further reduce nonproductive capital in our business. This is particularly true at Kakwa. Next year, we're investing less capital, both capital in facilities and in wells and expect to maintain flat condensate volumes in 2024.

As planned, total production at Kakwa is expected to average 180,000 BOEs per day or 175,000 BOEs per day once you adjust for the ethane contract expiry in the second quarter of next year.

Over the long term, we think this is the optimal production level to maximize free cash flow and asset level returns. In terms of our cost structure, we forecast little change in 2024. Operating and transportation costs are forecast to be relatively unchanged year-over-year at approximately $10 per BOE combined.

To provide some additional context on our cost structure and resiliency of our business, we can sustain production in the 350,000 to 360,000 BOE per day range and fund the current dividend with organic cash flow below a USD 45 a barrel WTI and CAD 2 AECO per Mcf. This is based on our cost structure today, but does not include any deflation that would be expected in a very low commodity price environment.

Beyond our low-cost structure, our competitive strengths also include our infrastructure footprint, asset quality and market and commodity diversification. At strip pricing, the 2024 program is expected to generate $3.0 billion to $3.2 billion of cash flow and roughly $1.4 billion of free cash flow. Free cash flow will once again be returned to shareholders through a combination of a growing dividend and share repurchases given the value of our shares today.

Finally, as we lookout further, the 5-year outlook is essentially unchanged from what we first introduced at our investor update in June. We intend to deliver a balanced program that invests in our best projects like Attachie while reducing the share count to compound that per share growth. The step-change in our per share metrics will first occur in 2025. Incorporating Attachie, we anticipate 10% growth on a production basis and a $600 million increase in free funds flow. This is equivalent to more than $1 per share relative to our 2024 on an unchanged commodity price deck of USD 70 WTI and USD 3.50 NYMEX.

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

[Terry Anderson, executive]

Thanks, Kris. Looking ahead, as the largest Montney producer, I have never had more conviction in our business and where we are headed. We've communicated a 5-year plan that adds significant value through investing in our business, to grow free cash flow, increase the dividend and buy back our shares. This plan will nearly triple free cash flow to approximately $5 per share. As I look forward out towards 2030, ARC will be a larger, more profitable company with expanded reach to global markets through our LNG agreements. At the same time, the build-out of LNG in Western Canada will fundamentally improve the dynamics of our market, providing additional optionality for value creation along the way.

With that, I want to again thank all of our staff for their commitment and contribution towards our success. Thank you. Operator, you can open the line to questions.

[Operator]

[Operator Instructions] Our first question comes from Michael Harvey from RBC Capital Markets.

[Michael Harvey, analyst]

Sure. I just had a couple of questions. The first one is on your natural gas price hub exposure. It looks like your AECO percentage is increasing quite a bit in '25, then '26 and '27. I assume that's by design, but maybe you could just confirm that or if we'll see that be adjusted kind of as we move forward over the next couple of years?

And then the second one was just on the drilling plan at Attachie when you start moving rigs there, I think, later this year. So it's been a few years since you've drilled a well there. Is there anything different you're going to be doing just well design wise, you may have learned from Kakwa or otherwise that you think may impact the recovery profile in that area? And that's it for me.

[Ryan Berrett, executive]

Michael, it's Ryan. Thanks for the question on -- I'll tackle the first question on your AECO pricing hub. Yes, no, you're correct, this is by design. We are increasing our exposure as the buildup of LNG Canada comes on and we start to see those volumes flow in the middle of the decade. So by design, but as you know, we always have a balanced portfolio, and we'll continue to do so.

[Armin Jahangiri, executive]

Michael, this is Armin. In regards to your question about drilling, we're quite excited to go back to Attachie. Obviously, there's been a lot of learning from all the other operations that we are doing in rest of Northeast BC and Kakwa and all those learnings are going to be transferable. We are expecting to be able to hit the ground running in Attachie and incorporate a lot of those efficiencies that we've realized over the last couple of years.

[Michael Harvey, analyst]

Right on. And would there be changes to things like well length, frac design that kind of stuff? Or maybe you're just kind of getting started in that process?

[Armin Jahangiri, executive]

Well, initially, I think it's going to be fairly consistent with where we ended Attachie a couple of years ago, but there's obviously always opportunity for improvement. We look at our well placement and if there is an opportunity to extend the lateral length, for example, to improve capital efficiency, we always do that. So nothing out of ordinary.

[Operator]

Our next question comes from Patrick O'Rourke from ATB Capital Markets.

[Patrick O'Rourke, analyst]

Yes. Can you guys hear me?

[Kristen Bibby, executive]

Yes, we can.

[Patrick O'Rourke, analyst]

Hello?

[Kristen Bibby, executive]

Yes, we can hear you, Patrick.

[Patrick O'Rourke, analyst]

Okay. Sorry, the operator was talking over me there, so I wasn't sure if you could. But I apologize for any miscommunication there. Just kind of wondering and wanted to unpack here with respect to the $200 million improvement in the capital budget, and you guys are talking about nonproductive capital, sort of how durable those improvements are out through sort of the life of the asset?

And then just wondering, are there any sort of analogous improvements that you can see at something like Attachie, where we could see the capital efficiency profile improve and incremental free cash flow from sort of similar type improvements?

[Kristen Bibby, executive]

You bet. Patrick, it's Kris here. I'll take a stab at it. The $200 million does apply across the entire asset base. So it's not really an asset-specific number. And really, what we've done is we've just optimized basically the delivery time of the wells so that we aren't investing as much capital prior to needing some of that production or even facilities. So if you think about it, we would have less invested in basically ducts than we would have otherwise had. And part of the reason we're comfortable doing that, we spent a lot of time working on predictability of results and deliverability of results.

So it gives us the comfort that we can tighten up some of the white space perhaps that we would have otherwise had in some of our safety margin just because we have spent so much time on the predictability to have a very high confidence factor and what the outcomes are going to be.

And so could that lead into further improvements down the road? It's hard to say right now. We're comfortable with this tightening and let us get through the next year-or-so and then we can see where we get to.

[Patrick O'Rourke, analyst]

Okay. And then just kind of maybe shifting gears a little bit here. You talked a little bit about natural gas price exposures, but can you maybe provide a little bit of an update in terms of the timeframes and key milestones for Cedar in particular, but also your Corpus Christi exposure and when we'll start to see the benefit of that?

[Ryan Berrett, executive]

Yes. Patrick, it's Ryan. I'll just dig into both those questions. Obviously, as you know, we signed the Cheniere contract with Corpus Christi about 1.5 years ago. Cheniere came out yesterday and -- or 2 days ago, and talked about their startup of construction on those -- on the Phase III of the expansion.

We're trained 7 of that expansion, and we would expect our service to come into service roughly near the end of 2026. So no real change on that front. On the Cedar front, we continue to work through all the various commercial arrangements. Pembina came out this morning and has talked about potentially a slippage into Q1 of their FID. We are working through definitive agreements on both offtake and on the tolling and would hopefully be in line with Pembina's timing on that.

[Operator]

The next question comes from Jamie Kubik from CIBC.

[James Kubik, analyst]

I have 2 here. So first, capital spending for ARC has come in lower than, I'd say, budgeted for the first 3 quarters of the year. Can you just outline what's driven the savings this year? And how should we think about the full year budget for 2023 based on where you're at today?

[Kristen Bibby, executive]

You bet. Jamie, it's Kris here, again. I would hesitate to call them savings. Really, this is just a timing issue. So we would expect to meet our capital guidance of $1.8 billion to $1.9 billion here by the end of the year, which does imply quite a very active Q4 spend. So I think we are comfortable with it, but we're ramping up activities and Q4 should be in line to get to our full year guidance.

[James Kubik, analyst]

Okay. And then second question, in the 2024 budget, you do have oil and condensate volumes growing relative to the 2023 guidance and you indicate condensate volumes at Kakwa expected to stay flat. Can you just talk about where you expect the growth is going to come from next year?

[Larissa Conrad, executive]

You bet. Jamie, it's Lara. As far as where the condensate comes from, I mean, really, it's going to be our 2 key properties that are condensate-rich, so Kakwa and Attachie. So effectively, as we bring Attachie on in Q4, you're going to see that condensate add coming up. And then the nice part of that, of course, is into 2025 Attachie will add in that capacity and that condensate volume will be consistent for us going forward.

[Operator]

Our next question comes from Travis Wood from National Bank Financial.

[Travis Wood, analyst]

[Technical Difficulty] facility and then through next year, so kind of the key item...

[Operator]

Apologies. Sorry to interrupt, Travis, please do ask your question again.

[Travis Wood, analyst]

Okay. My question is wanting to understand the critical path around Attachie, just getting kind of a timeline for the items that you see the most relevant that you want to check off the to-do list as you get ready for processing at Attachie? So for example, rig mobility for this quarter, starting to drill the wells. You commented on the natural gas line is complete, kind of so what's the timeline for the liquids line and kind of any of the key factors and timeline that can keep us comfortable that everything remains on schedule?

[Armin Jahangiri, executive]

Travis, this is Armin. So we have multiple, obviously, activity of projects underway in Attachie. As Terry alluded to, it's fairly active, and it's going to be over the next 12 months until we get the facility to the commissioning phase.

Obviously, there's the liquid sales line is a major, major project for us that we've already started working on and it's expected to finish around Q1 of next year. The construction of the plant itself is a major task. The plant includes also water recycling hub that is going to be included in it. So that is going to be an activity that's going to continue over the next 12 months-or-so.

Terry also spoke about the electrification. So we've received all our necessary permits to start building the transmission line and substations. So there's quite a lot happening over the next 12 months. In terms of what is on critical path, I mean, obviously, the big project is the plant, and that's the one we need to have up and running. And I see absolutely no reason to be concerned about the timeline. I think the project is going as per the plan, on schedule, on budget.

[Operator]

[Operator Instructions] Our next question comes from Mike Dunn from Stifel.

[Michael Dunn, analyst]

Can you hear me, okay?

[Kristen Bibby, executive]

Yes, we can.

[Michael Dunn, analyst]

Great. A couple of questions for me, if I may. Just on the electrification at Attachie, is that -- the timing of that, is it reliant on Site C completion or is it sort of connected to the grid independent of Site C?

[Armin Jahangiri, executive]

Mike, Armin here. No, it has nothing to do with Site C. That's -- the power for that facility has already been secured through BC Hydro.

[Michael Dunn, analyst]

Okay. And then secondly, just maybe a follow-up from, I think it was Kris' response to Patrick earlier. The 2024 production guidance, are we to infer that there's less margin of safety to meeting the targets than maybe there was in the past?

[Kristen Bibby, executive]

It's Kris. No, I would interpret it that way because of the mitigation items that we talked about in terms of better predictability, understanding white space in the schedule. So I would say no, it's not a higher risk program from a production standpoint.

[Operator]

There are no further questions at this time. I will return the conference back to the speakers.

[Dale Lewko, executive]

All right. Thanks, everyone, for joining. That concludes the call. Have a good day.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's conference call. Thank you all for attending. You may now disconnect your lines.