Whitecap Resources Inc

TSX:WCP

Earnings Call Transcript 2022-Q2

[Operator]

Good morning. My name is Miranda, and I will be your conference operator today. At this time, I would like to welcome everyone to Whitecap Resources' Q2 2022 Results Conference Call and Webcast. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]

I would now like to turn it over to Whitecap's President and CEO, Mr. Grant Fagerheim. You may now begin your conference call.

[Grant Fagerheim, Chief Executive Officer]

Thanks, Miranda. Good morning everyone and thank you for joining us here this morning. Here with me today are two members of our senior management team: our Senior Vice President and CFO, Thanh Kang; as well as Darin Dunlop, Senior Vice President of Engineering. Before we get started today, I would like to remind everybody that all statements made by the company during this call are subject to the same forward-looking disclaimer and advisory that we set forth in our news release issued earlier this morning.

We are pleased to advise that our second quarter results were excellent across the board with successful operations in each of our four business units, paving the way for our record financial results. To give it perspective, our second quarter funds flow of $1.08 cent per share was higher than the $1.06 per share that we earned for all of 2020, what a difference a year and a half makes. The quarter also ended with announcement of our acquisition of XTO Canada on June the 28th. We're very excited about this transaction. We are on track to close it before the end of the third quarter.

In the second quarter, we generated record funds flow of almost $600 million, which was $175 million of it being returned to shareholders through our base dividend and share repurchases. We also ended the quarter with approximately $675 million of debt well below our $800 million target that we were leading set – that we set leading into the end of the quarter. Darin will give a few more details on our operation highlights, but I wanted to touch base on our recent Montney wells that we alluded to in our press release this morning.

Both the initial well results from the 12 to 33 pad and the continued productivity from the 14 to 13 pad validate our assessment of the quality of the Montney opportunity that we have along with the improvement in well placement and associated completion techniques that we have employed. Our ownership in both of these pads and a total of 34 sections at Kakwa will be increasing to 100% working interest once we close the XTO transaction. We look forward to closing the XTO acquisition and putting capital to work on these assets in the fourth quarter.

I will now pass it on to Darin to highlight more of our recent operational achievements. Thank you.

[Darin Dunlop, Senior Vice President of Engineering]

Thanks Grant. Our Q2 production outperformance was driven by one continued identification and implementation of production optimizations on our acquired assets, particularly in Central Alberta and two our Q1 drilling programs significantly outperforming initial productivity expectations. Since taking over operations at Kakwa in mid 2021, we have been utilizing advanced analytics and modeling to proactively optimize the design and implementation of our Montney fracture stimulations. This includes optimizing wellbore placement within the Montney package and refining volumes, rates, entry point design and spacing. As a result, our frac efficiency continues to improve as evidenced by the strong initial rates from the 12 to 33 pad referenced in our Q2 release.

XTO last drilled Montney wells as part of their winter 2019-2020 program and we are excited to implement this optimized well design to our new Montney acreage. Moving on to our other assets. In Southeast Saskatchewan, our 16 Frobisher wells from the Q1 program averaged over 213 boe per day per well over their first 90 days of production. This is 47% higher than our expectation of 144 boe per day. These wells are also declining in a much lower rate than expected, which accounts for some of the outperformance.

In Central Alberta, our four Q1 operated glauc wells now have over 90 days of production for which they averaged 839 boe per day per well with 77% liquids. This is also 57% above our expectations. Lastly, in South West Sask, Saskatchewan, our four well lower [indiscernible] program now has been on for over 90 days and has averaged 245 boe per day, which is 72% higher than our expectations. This program includes a reservoir extension well to the Northeast that will likely upgrade the expectations for 15 to 30 locations.

I would now like to pass it on to Thanh to comment on our financial results and outlook.

[Thanh Kang]

Thanks, Darin. A record funds flow in the second quarter, driven by excellent operational results and strong commodity prices with WTI averaging over $108 per barrel and AECO over $7 per Mcf in the quarter. Tight differentials and a weak Canadian dollar further improve the high benchmark pricing that we realized. Funds flow of $677 million or $1.08 per share and free funds flow of $589 million or $0.94 per share were all up over 150% from Q2 of last year. And further, we continue to generate strong returns to shareholders by returning a total of $176 million in the quarter through base dividends and share buybacks.

Second quarter gross capital spending was $88 million relative to our forecast of $75 million. Our budget assumes the $13 million pipeline costs at Wapiti would be net against its subsequent disposition, but under IFRS we have to separate the costs from the disposition. Our 2022 standalone capital budget of $570 million is net of the $13 million Wapiti pipeline disposition. Our balance sheet is in great shape with net debt of approximately $675 million well below our target of $800 million and puts us in an even better position to acquire premier Montney and Duvernay assets without issuing any equity into the market.

As a reminder, net debt upon closing of the transaction is expected to be approximately $2.1 billion, which represents only 1.5 times debt to EBITDA at $50 oil. Our net debt milestone of $1.3 billion represents a debt to EBITDA ratio of less than 1x at $50 WTI and only 0.6x at $85 WTI. There is no changes to our capital spending, our production guidance for the remainder of 2022 and our preliminary 2023 numbers. We're excited to bring the XTO assets into the Whitecap portfolio as they generate strong, sustainable free cash flow and will enable us to continue to increase returns to shareholders long into the future.

I'll now pass it back to Grant for his closing remarks.

[Grant Fagerheim, Chief Executive Officer]

Thanks, Thanh. Since the start of July, our teams have been back in the field executing on an active third quarter capital program. We are currently running 10 rigs and will hit a peak of 11 rigs before the end of August. We have secured drilling rigs and completion services through to the end of spring breakup next year to execute on the expanded capital program including the XTO assets being acquired. We remain very positive about the forward commodity price environment and have prudently planned our capital program using a lower commodity price deck.

We are focused on capital allocation decisions that provide the best returns for the company and to our shareholders. Our intention is to continue to build on recent operational success, improved efficiencies through our processes to increase our free cash flow, achieve our net debt milestones and continue to increase returns to our shareholders. To reiterate, our return of capital framework once our first net debt milestone of $1.8 billion is reached, we will increase our dividend by 25% to 30% and then again by 25% to 30% once we achieve our next milestone of $1.3 billion for a total annual dividend of $0.73 per share.

Once this final net debt milestone is reached, our intention is to return up to 75% of our free cash flow back to our shareholders through dividends and share buybacks. Lastly, I would like to thank our employees and service providers for their continuous dedication, our board of directors for their guidance and to our shareholders for your ongoing support.

With that, I will turn the call over to operator for questions. Thank you.

[Operator]

Thank you. [Operator Instructions] Your first question today is coming from William Damien [ph] with – who is a Private Investor. Please go ahead.

[Unidentified Analyst]

Good morning, everyone. My question is regarding the XTO asset purchase. It looks like we're increasing CapEx by $500 million in order to achieve 40,000 barrels of oil equivalent per day in production at a cost of $1.7 billion for the acquisition. I'd like to see if the panel could expand on that a little bit and how that adds to free cash flow for our investors. Second question I have is the perspective on the web page the beginning of June indicated that 50% of free cash flow would be forwarded to investors throughout the rest of the year. But as I understand this deal was began in January, which would indicate that there was never any intention of forwarding 50% of free cash flow to investors if we were undertaking an XTO deal. Thank you.

[Thanh Kang]

Hi, good morning. It's Thanh here. So I'll answer the first part of the question. I'll let Grant answer the second one here. So the capital program that we've outlined for 2022 we increased that by $50 million in the fourth quarter here. So their current production is about 32,000 boes per day of production. For 2023 on a very preliminary basis, our standalone capital was about $750 million. So, these assets under our commodity price assumption, $85 oil and 450 gas here would generate about $0.5 billion in cash flow. The capital required on this asset to grow it from 32,000 boes per day to 36,000 boes per day, which is 16% growth is about $250 million, so about $1 billion in total that we're spending next year to grow production per share, 23%.

So you can see that this asset here, this high quality asset with the inventory that it brings forward is already generating free cash flow today. $500 million of cash flow, approximately $250 million of capital that we'll spend in 2023 there. So it does improve our sustainability, but it also brings more free cash flow per share. And you can see that when we look at the accretion numbers, our free cash flow per share accretion is 20% per share.

[Grant Fagerheim, Chief Executive Officer]

Just regarding your second question, whether it was our intention to return capital, 50% of our cash flow back to our shareholders. We actually had intended and we're actually into the future going to be returning more back to our shareholders than the 50% that we were talking about earlier. And we – as far as our intention was concerned, the bids were due on the – you're referencing back to January are the bids were due on this first – on the XTO were due in mid-March. There was a process that took us through to the end of April before we were even advised that we were going to be the selected party to negotiate a firm transaction. So our intentions have actually improved, have not been reduced from where we were at previously from returning share – returns back to – are increasing our returns back to shareholders. Thank you.

[Thanh Kang]

Yes, the only thing I would add to that, Grant, is certainly when you look at the quality of this type of transaction, what we're always trying to do is improve the long-term sustainability of the business, which means improving that free cash flow profile so that we can actually return more back to our shareholders. And so, you're referencing the 50% being returned back to shareholders and what we want to do through this transaction is increase that to 75%. But again, once we reach our debt milestone of $1.3 billion, which we think is going to be some time in the first half of 2023 here. So we need to balance looking at our business on a long-term basis versus a short-term basis. And we think that's a very fair trade off in terms of going from zero leverage to low leverage and bringing in such a high quality asset that improves our free cash flow profile and improves our ability to return more capital back to our shareholders.

[Unidentified Analyst]

Okay. But when I look at the early June perspective, it's indicating that we can expect $600 million – or there was $411 million due to come back to shareholders through the final four months or six months of the year and that disappeared and instead we got an increase of $50 million for the rest of the year. So instead of $411 million being returned to shareholders on the plan on June 1, we got $50 million for the rest of the year. And if you change that plan now, how do I know that you don't change that plan later? And I do note that you said up to 75%.

[Thanh Kang]

Yes. There's definitely a trade off for sure. And we're trying to run this business on a long-term basis here. So, when you look at the moving the timeframe from a return of capital perspective and look – we're looking at six to nine months here. We're not years away from being able to achieve 75% back to shareholders here. We think this is hugely beneficial for our shareholders. So it is a medium to longer term trade off in terms of more free cash flow for short-term – for short-term improvements, I would say, from a balance sheet perspective here. So that's something that there was a conscious decision made to ensure that we continue to improve our business from an inventory, from a free cash flow, from a production standpoint here. So there is no question that there is a bit of a deferral here. We agree with that. We think the trade off is immensely beneficial to our shareholders.

[Unidentified Analyst]

Thank you.

[Operator]

Your next question would be coming from Jeremy McCrea with Raymond James. Please go ahead.

[Jeremy McCrea, Raymond James]

Yes. Hi guys. Just with this – the – maybe a bit of a follow up question here as well too. Just with the XTO asset, I know it's really probably high graded your asset base here. Does it give you pause here to maybe look at some, maybe more non-core dispositions just to enhance that free cash flow? And if so, what would those non-core dispositions potentially look like? And then you guys have been very busy on the M&A front here. Does this XTO assets give you pause in terms of M&A? Or are you still looking here pretty proactively?

[Grant Fagerheim, Chief Executive Officer]

Sure. Thanks Jeremy. Just regarding your first question on non-strategic assets, we are in the process of going through an evaluation of assets to put into the market that are non-strategic to that we – non-strategic to Whitecap on a go forward basis because we haven't applied capital and we will not be applying capital to those into the future. We could produce them out assets, but it's somewhere between 9,000 to 12,000 boe per day of production that we're doing detailed analysis on including updated engineering with – along with the rest of our assets. But we are looking to the potential to put into the market – assets between 9,000 to 12,000 boe per day.

The option being that we could monetize them if they're sufficient bid appetite or we could just continue to produce as we have. We haven't applied – we've looked at this over the last period of time, if we haven't applied capital to them or expect to project to apply capital to them into the future that was our criteria that we're looking at our assets on. Your second question on M&A pause, for sure we're going to pause at this particular time. There's – this acquisition – we're very, very excited about with the XTO acquisition. And we want to make sure that we fully integrate not only the assets, but the personnel that will be joining us as well and ensure that through the 2023 year and into the future that we can demonstrate strong results as we have 2022.

[Jeremy McCrea, Raymond James]

Yes, perfect. Thanks, Grant.

[Operator]

[Operator Instructions] Your next question is coming from Travis Wood with National Bank Financial. Please go ahead.

[Travis Wood, National Bank Financial]

Yes, good morning guys. Two questions for you. One could you help us understand kind of the cadence of OpEx on a pro forma basis as you integrate these lower cost Montney assets and kind of what that that pro forma boe number would look like through next year. And then this – the second question is a little bit of a carry on from Jeremy's there, just in terms of what – what low hanging fruit do you see kind of within the XTO assets that you could start to enhance some margins, improve some kind of operating synergies? And I know Darin kind of alluded to some of those, but could you give us some more color around how you plan on optimizing and potentially improving performance coming out of that asset as well?

[Thanh Kang]

Yes. Hi, Travis. It's Thanh here. I'll answer the first question. From an operating cost perspective, Q2 was higher than normal and that's due to higher turnarounds and workovers that we typically do in the second quarter here, but also with the NAL acquisitions that we did, we did acquire the old gas plant, and we did a turnaround there as well that's typically done every three years. As we move into the third quarter from a Whitecap standalone basis, we'd expect that to trend down to that $14.25 per boe range, but there is a step change with the XTO acquisition and those assets being folded in because they come with a much lower cost structure. So pro forma we're expecting about $13 operating cost per boe in the fourth quarter as well as moving into 2023 as well.

[Travis Wood, National Bank Financial]

Perfect, thank you. And then yes, just some of the opportunities you see within the XTO asset base, where you could start to enhance some margin over and above kind of base plant.

[Darin Dunlop, Senior Vice President of Engineering]

Yes. Travis, it's Darin here. I'll take that. So in the press release what we were talking about with regards to optimization that was primarily down in Central Alberta. And that would – that's a different situation where there's rerouting of production to more efficient plants, lowering line pressures, stuff like that. So a lot of optimization that's happened there by consolidating assets up in the – on the XTO assets, a little bit different, we – that – that wasn't a – I guess wouldn't be considered a core asset for the XTO Exxon portfolio. So a lot – they hadn't been active there since 2000 – since 2019-2020. So one optimization there will be just applying what the learnings on frac design, development design, well spacing, and that that has evolved over the last three, four years in the Montney to those assets on developing them. And as well there are some opportunities for lowering line pressure, optimizing well performance in that, but that being said there's a lot less wells, but there are a lot bigger. So any percentage gains you gain on the individual well will be significant. So a little bit different, but still we see some opportunities.

[Travis Wood, National Bank Financial]

Okay. Thanks very much for the color. That's all.

[Operator]

Your next question is coming from [indiscernible]. Please go ahead.

[Unidentified Analyst]

Good morning guys and congratulations on the quarter and the XTO deal. A question as mentioned by Darin just recently the production activity and by Exxon and Imperial was not – after 2019 kind of stalled and stopped. Where was the production at the peak and given the facilities that they have are they running their plants and facilities where – at 70%, 75%, so that you have a lot of growth potential before you have to spend money on more infrastructure, maybe you can put some color on that just to help me understand what XTO is doing for the last few years and the upside capture for yourselves.

[Darin Dunlop, Senior Vice President of Engineering]

Yes, Joseph, thanks for the question. Yes, so if we – if we're – obviously two different gathering systems with the Montney and the Duvernay, but I'll just talk to Duvernay. So in 2020, they – that's when XTO Duvernay production had peaked. Right now with the recent completion of – by Crescent Point of their 16 docks, we are now reaching close to capacity, but that'll be short term. So in the Duvernay, we plan to live within drilling five to eight wells a year to fill to – to drill to fill on the Duvernay, but our primary growth will be in the Montney where we will be drilling over the next few years upwards of 20 to 25 wells a year in the Montney. And that is – we have a lot of options for takeaway and processing capacity within five different plants there.

[Unidentified Analyst]

Okay. Just going to the – where was the peak production on the two assets in 2019, just to get an idea of the 32 that you're getting now versus what was the peaks that they had prior to stopping spending money?

[Darin Dunlop, Senior Vice President of Engineering]

At the total peak in I'm looking at a graph right now, probably in around 40,000 to 45,000.

[Unidentified Analyst]

Quite a bit of upside there.

[Darin Dunlop, Senior Vice President of Engineering]

Yes.

[Unidentified Analyst]

Mostly on the Montney then.

[Darin Dunlop, Senior Vice President of Engineering]

Yes.

[Unidentified Analyst]

Yes. Great. Thanks very much. Good. Thank you for the color. Thanks.

[Operator]

And at this time, gentlemen, we have no other questions registered. Please proceed.

[Grant Fagerheim, Chief Executive Officer]

Thanks very much Miranda. Thanks to each of you on the call today as we look forward to reporting back to you with the closing of the XTO acquisition in the third quarter here. Until then, I hope everyone has a pleasant remainder for your summer holidays. Thanks very much. Enjoy the rest of your day.

[Operator]

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