Civitas Resources, Inc.

Good day and thank you for standing by. Welcome to Civitas Resources second quarter 2024 earnings conference call and webcast. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. At that time, you may press star one on your telephone keypad to ask a question. To withdraw your question, press star one again. Thank you. Please be advised that today's conference is being recorded. I would now like to hand the call over to Brad Whitmarsh, Head of Investor Relations. Please go ahead.

Thanks, Jessica. Good morning, everyone, and appreciate you joining us this morning. Yesterday, we issued our second quarter earnings release, our 10Q, and also provided some supplemental materials for your review. These items are all available on our website, and they may be helpful for this morning's call. I'm joined today by our CEO, Chris Doyle, CFO Marian Alifoski, and COO, Hodge Walker. After our brief prepared remarks, we will conduct a question and answer session. As always, please limit your time to one question and one follow-up so we can work through the list efficiently. We'll make certain forward-looking statements today which are subject to risk and uncertainties that could cause actual results to differ from projections. Please read our full disclosures regarding these statements in our most recent SEC filings. We also may refer to some certain non-GAAP financial metrics. Reconciliations to these can also be found in yesterday's release and SEC filings as well. With that, I'll turn the call over to Chris.

Hey, morning, everyone, and welcome to our second quarter call. Before I address our quarterly results and our improved outlook, I think it's important to reflect on how we fundamentally transformed our business over the past year. This starts with our entry into the Permian Basin, which increased and enhanced our portfolio scale and quality, provided important capital allocation flexibility, and created a more durable and sustainable business. Today, our Permian assets are fully integrated within Civitas and producing more than 185,000 BOE per day. Importantly, production's ahead of plan, oil's ahead of plan, well costs are below expectations, and reduced operating costs are enhancing cash margins, all while maintaining top quartile safety and environmental performance. In a short amount of time, our team's executing faster, and better than we'd planned and certainly well ahead of our underwriting assumptions. At the same time, we continue to deliver exceptional results in the D.J. Basin, recent highlights including completing our non-core asset sales and an accretive valuation, helping to secure a broad-based regulatory agreement that increases development clarity for years to come, and driving exceptional performance from our inventory-rich Watkins area. Simply put, there's no question that Civitas is stronger today. and we're better positioned than ever to drive differentiated returns for our shareholders. And moving to our second quarter results, starting with production, total volumes were above plan as the premium production was up about 12%, oil was up 5%. This is driven by strong oil performance and continued cycle time acceleration, more than offsetting the impact from non-poor asset sales and some temporary third-party facility downtime that occurred in the DJ. Cash operating expenses were 2.5% lower than the first quarter and less than $9 of BOE. Our teams remain laser-focused on driving down our cost structure across all basins. On the capital side, our drilling and completions teams have done a fantastic job delivering efficiency improvements to result in less capex than planned in the quarter. Well-cost reductions are outpacing our initial plan, highlighted by a 10% reduction year-to-date in the Midland Basin. Free cash flow is right in line with our expectation for the quarter as our operating capital cost efficiencies offset the impact of weak natural gas pricing in the Permian. For the quarter, we returned just under $275 million to our shareholders, about 150 of that in dividends, 125 million in share buybacks. A portion of our buybacks during the quarter was utilized to continue reducing concentrated ownership, and the remainder went to open market purchases. So lots of progress has been made over the past year, as evidenced by another strong quarter. I'd like to shift now, however, to three areas that have me really excited about what's to come. Operational execution is absolutely improving the business every single day. Second, our second half outlook reflects the strength of our asset base and our team's capabilities. And third, our enhanced capital return framework will provide additional flexibility to maximize shareholder value. Starting with operational execution and our supplemental materials, we highlight the impact of reduced costs on improving returns and driving down break-evens. A 10% well cost reduction in the Midland Basin drives well returns up 12% and reduces break evens by 7%. Across the Permian, these achievements are increasing the number of low break even locations by 20 to 30% and extending high quality inventory life. Savings are coming from all areas, whether it's optimizing, drilling, completion designs, high grading our service providers and utilizing more efficient equipment, standardizing facilities, for capturing the benefits of having skilled positions in multiple basins. This team is rapidly establishing a strong track record of execution and performance. Now, if we'd said a year ago that within six months of establishing Permian Operatorship that we would be where we are today, I'm not sure that many on this call would have believed it. It's still early days, we get it, but the combination of a culture of continuous improvement and the team focused on the value we can create together has me super excited for the years ahead. Now, leveraging that strong operational execution outlook for the remainder of 2024 continues to improve. Full year CapEx lowered by $50 million. Operating costs decreased by approximately $25 million. We've raised sales volumes expectations 3% from our original guidance, adjusting for asset sales. Looking forward, we expect total volumes in oil to grow quarter over quarter through the end of the year. Recent extreme summer weather in Colorado certainly would Record high temperatures will defer some of that third quarter DJ basin growth into the fourth, but a strong second half of the DJ will be driven by Watkins, where we recently drilled and completed our 13 four-mile wells, the longest laterals ever in Colorado. This is a testament to a talented team that continues to safely push the boundaries of what's possible. Importantly, while it's still early, we're encouraged by the initial productivity, which confirms production contribution across the full laterally. In the Permian, I'm particularly excited to see upcoming production from our first fully designed, drilled, and completed Civitas wells. Productivity to date trends in line with our expectations, but second half 2024 tills will target core zone development and slightly wider lateral spacing than previous operators. The strength of our business and continued execution, we anticipate second half free cash flows of over $900 million, which will be deployed to the balance sheet and to our shareholders. Finally, the true reflection of the strength of our business is our best-in-class shareholder return. Since the beginning of last year, we've returned nearly $1.5 billion to our shareholders via dividends and share repurchases. This represents more than 20% of our current market cap. We remain fully committed to returning 50% of our free cash flow to shareholders after the base dividend. Based on second quarter results, our board approved a $1.52 dividend to be paid in September. In addition, the Board enhanced our capital return program to add flexibility in the way we return the variable component to shareholders. Beginning with the third quarter, the variable return will now be provided through a combination of share repurchases and dividends. As part of this enhancement, the Board also approved a new $500 million share repurchase plan, which replaces the prior program. We will remain disciplined in executing our buyback strategy, but we traded a very compelling valuation when compared to our peers, and when compared to recent asset transactions. At Civitas, we believe that cyclical businesses should be run with low leverage, so we'll continue to execute on our hedging strategy to support the pace of our delivering efforts, and this capital return enhancement will prioritize our balance sheet with the remaining 50% of our free cash flow. Wrapping up, we've made tremendous progress in the first half of the year. Our entire team is excited to demonstrate what our transformed company is capable of delivering. Thank you for your interest in Civitas, operator. We're now happy to take questions.

Thank you. And just a reminder, if you would like to ask a question, press star one on your telephone keypad. To withdraw your question, press star one again. And your first question comes from the line of Kevin McCurdy with Pickering Energy Partners. Kevin, your line is open.

Hey, good morning, team. I wanted to start off by asking about the execution of the newly increased buyback. When deciding the amount of free cash flow to allocate the buybacks versus the variable, what will be the main criteria? Are you looking at recent share price dislocation, NAV, or maybe the low multiple that you highlight in your deck?

Yeah, sure. Thanks for the question, Kevin. As we've said in the past, we view our capital return framework much like any other capital and this is something we discuss regularly with our board. The move to add that flexibility is really tied to exactly what you talked about, and that is a continued disconnect with how we are valued. Look at underlying NAV, look at NAV at various commodity prices, look at how we trade versus peers, and look at the asset market. This is not the asset market that we entered the Permian in. A year after our entry, the asset market is up a full one and a half plus turns, and in some cases, that's for lower quality assets. So the valuation as we see it today does not reflect the quality of these assets and does not reflect the quality of the team and how they are executing. And ultimately, I don't think it reflects the tailwinds that we've seen in terms of regulatory and the DJ. So you've got a business here that's executing on really high-quality assets, trading at a 20% free cash flow yield. That's a super compelling opportunity as we see it. That's driving the change, and we're excited to dig in and allocate money to this business. We're super excited, super proud of what we've built. Hasn't been reflected yet, but it will be. And appreciate the question. And the other thing to highlight on the shareholder return framework is we can protect our equity, but at the same time not lose sight of our delivering targets and maintaining a strong balance sheet. So we're super excited for the adjustment. We think it fully enhances framework and know that this team is fully aligned with shareholders as we go through that calculus.

Great. Thank you for that answer. I think that's what the market wants to hear. Shifting maybe to well costs, when I look at slide 10 in your investor deck, what do you need to do to cut the extra 5% out of well costs in the Midlands? And just to clarify, does the new CapEx run rate factor in the $765 per foot in the Midland Basin, or is it using the $725?

Yeah, good question, Kevin. So, our current forecast for second-half capital assumes our current cost structure of the $765 in Midland. You know, as we look back, again, We took over for established operators in the basin. There are a lot of questions around, can we continue that level of performance? And we knew fundamentally that we would improve upon it, but we'd like to stack some skins on the wall. And I think that's what this team's done for a couple of quarters, just as we've done in the DJ. What has got us to where we are today really is a mix of benefits of scale, driving down service costs. That's probably about 30% of that delta. design changes to how we complete wells, how we drill wells, that's probably 20%. The other half is really just continued optimization and efficiency gains. So what will take us from 765 to 725 is just continued relentless digging in and driving additional efficiency gains. We're not building any additional deflation or any weakness in the service market. This is about the team stepping back, looking for ways to claw back every dollar and every inch. And look, again, very early, two quarters in, but this is a team that has made a living of doing exactly this in the DJ, and we're doing it there in the Permian as well. Appreciate the answer. I might hop back in the queue. Thanks, Kevin.

And your next question comes from the line of Neil Bingman with Truist Securities. Neil, your line is open.

Thanks for the time. Thank you all for the time and nice remarks, Chris. My first question is really just on your anticipated oil production growth. Specifically, it seems that given your non-core sales and oil production reiteration, you're suggesting that production should continue to trend higher. I'm just wondering, could you speak to the potential growth in both plays and maybe factors impacting this for the remainder of the year?

Sure, thanks. Thanks, Neil. I appreciate the question. I appreciate you highlighting the divestments as well. That was, as we announced last quarter, a massive transaction for us, traded at a full turn above. These are non-core assets in the DJ, trading at a full turn above our entire enterprise. So we hit that bid. It did impact our second quarter results, right? 5,000 BOEs a day. two to three thousand barrels of oil a day. So take that, put that back into the mix and you saw quarter over quarter strong oil growth as a company. So I would say as we look at, I would point to the Permian first, you know, second quarter over first quarter we saw oil up. We see both basins into the third quarter growing as evidenced by our reaffirmation of our oil guide. um even taking out the the divestment so we'll see a step up in both uh both basins you know we have uh a a front half loaded capital program about two-thirds of our tills are coming on in the second third quarter and that's going to really support and drive uh oil growth to the back half of the year um you know a couple of things that we'll talk about in the dj or some some headwinds we saw them in the second quarter with some third third-party facility downtime. We're past that. That was temporary. June is the, I think June went down as the second hottest June in the history of Colorado. I don't know where July is going to come out, but it's going to be up there. And so certainly that's impacting some of our operations out there, but that's temporary. You know, the other thing that's going to drive growth into the second half that we're really excited about is the continued outperformance of the Watkins Wells. Whether it's the four milers, Every well that we're drilling down there is really performing exceptionally well against expectations. So both teams are hitting on expectations. We see some real good tailwinds as we head into the second quarter. And, again, evidenced by a reaffirmation of our oil guide. So we are very confident and pleased with how we've set up for the second half.

Great answer, Chris. And then, secondly, I just wanted a question on the OFS cost. You all seem to be indicating maybe a little bit of pressure there, unlike some others that are seeing things flat. I'm just wondering, Chris, is that maybe I want to make sure I understand that right. Are you saying that, you know, some of the costs are lower or maybe you were just seeing reductions based on the efficiencies?

Yeah, so when we entered the year in the Permian, we were running nine rigs. So we rationalized the rig fleet. We rationalized the track fleet. What that allowed us to do was upgrade crew, upgrade iron. That drove efficiency. It also allowed us to capture some of the weakness that we've seen beyond just consumables, but some of the OFS weakness that we've seen. When you look at a top-tier rig a year ago, it was probably – turning fairly close to 40, and it's now in the mid to high 20s. And so there's certainly been some weakness in that market. I would caution, however, you know, I've seen companies that will only focus, in fact, some of the prior operators focus on the day rate and lose sight of how a higher tier rig and much more efficient higher tier crew what they can deliver. And so we are seeing a little bit of softness, and that's good, but we're not planning on that. This is a team that's going to continue to drive efficiencies and claw for every inch. If OFS continues to weaken a little bit, you'll see us peel some more capital out or redeploy that capital.

Thanks, Chris.

Thanks, Neil.

And your next question comes from the line of Scott Hanold with RBC. Scott, your line is open.

Thanks. Good morning, all. My first question is on the Permian Basin, those first designed and drilled Civitas wells, you talked a little bit about obviously modifying the spacing and zone targeting to get better performance. So two questions on that. Number one is what kind of improvement do you think this can make in the performance of the wells? Are we talking like a you know, just give us some scale, like a 5%, 10% or like, what is the size that you're expecting? And just out of curiosity, is that uplift, you know, factored into, you know, your budget and your outlook?

Yeah, great question. Yeah, as I said, you pointed to super excited to get the city design wells online. Yeah, as an example, there was a previous operator that we think we feel like over-drilled one of the pads They're performing as expected, but we know that it wasn't the best cash on cash return development design. And so we take a little bit of a different approach. I think a lot of operators do too, or you look at that incremental well and what that does to overall returns. And so we're super, super focused on cash on cash returns. I would tell you that the uplift there is not insignificant. We've built in what we believe are conservative but attainable results going forward and this is a team again that's even with prior operators have have fully hit our expectations. But you'll see a bit of a step up. Now, ROC changes east, west, north, south. We get all that, and WellMix will change. But we're super excited about what this team can do when we have fully our hands on the wheel.

Understood. Thanks for that. And switching to the asset market, obviously, you guys have been very involved over the last few years. Can you give us a sense of what you're, you know, there's a lot of transactions that continue to go through the Permian. And, you know, give us a sense of how you think about incremental activity in the Permian, along with, you know, how much opportunity you have in your existing assets to swap and trade to expand your inventory.

Sure. And, you know, we pointed, I think, last quarter to really really great trade that was made in the Midland Basin that allowed us to extend laterals, drive for higher returns, really push costs down on a per-foot basis. There are more opportunities like that that the team continues to deliver. What's interesting is with scaled positions on both sides, we've got operator overlap on both sides where we could trade out of Midland into Delaware or Delaware into Midland. seeing those opportunities as well. We'll let value really guide us. In terms of the asset market, again, take us back to where we entered a year ago with the first two transactions and then followed closely by the third transaction. Any of those assets come to market today and you're talking about a much different entry point. So timing is absolutely critical. Now, in terms of are there opportunities we would pursue potentially in the asset market to think about going after, I think we always look for ways to enhance our business. You're going to hear every CEO out there talk about how high the bar is. I will tell you, I would say we probably have the highest bar out there with where we trade and the disconnect. with the quality of what we've got versus what's on the market. Some of the things that we've seen trade, we've looked at. We'll continue to look at deals. But anything that we do has to compete against turning around and buying a business that's trading at three times where the market's one and a half times higher than that. So we have built a strong business. We're ahead of schedule in terms of how that business is executing and super proud and excited about the future ahead for us.

Scott, and also underpin, like Chris was saying earlier, when we look at our buyback proposition, it's obviously an incredibly compelling opportunity. We kind of focus more on intrinsic value. When you look at our business, we have a free cash flow generating machine that over a five-year period equates to our entire market cap, and that's just really hard to not say impossible to find in the market right now, really public or private.

Appreciate those comments.

Thank you.

Our next question comes from the line of Phillips Johnston with Capital One.

Phillips, your line is open.

Hey, thanks for the time. Just to follow up on Kevin's question on the return of capital, is it safe to say that the board wants to be very aggressive on the share purchase program? in the near term. And maybe just a corollary to that, with the prior framework, you've been repurchasing stock in addition to the 50% variable formula. So I guess the total cash return effectively has been greater than the 50%. So I'm wondering if you'll be limiting the total return to the 50% formula with the other 50% earmarked for reduction of debt, or would you

view that as more sort of a minimum 50 promise with the potential to exceed that amount when you see opportunities in the market yeah i'll kick this off here i think the board and management will be super focused on whatever generates the highest shareholder return and strengthens our business now today today specifically and today more generally does that mean we might more heavily allocate that return to buybacks. I think that's probably a fair assessment. I would say on the question of, hey, before we were really limited to the other 50% of the cash flow post the base dividend and post the variable dividend component to buying back our shares, what that didn't allow us to do, and I think the company's done a really good job of of opportunistically working down some of that concentrated ownership at the top. But what it didn't allow us to do was address and accelerate our delivering plan. And so that's why I think this is a really strong enhancement to the overall program where we can protect and lean in on a buyback and at the same time not stretch our leverage and really progress towards our leverage target.

Okay, thanks for that. And then just on the four-mile laterals, sounds like so far so good. Can you maybe talk about what's embedded in your production guidance regarding that fourth mile? Are you giving it some sort of a haircut? And so what are the specifics there?

You know, I'll take us back to the approach we had last year with the three-milers. And that was we were very confident in the first two miles. the third mile we had risked. You saw that play out quarter over quarter towards the end of the year where those wells actually performed in line with the two milers. And so super excited with how those three milers executed. Now it's replaying itself on the four milers. Very strong performance above tight curve expectations, but we are... We are risking that fourth mile still, being conservative as we are. And so that's going to show up, could show up towards the end of the year. I would tell you the high curves that we have on these four milers are quite compelling in terms of returns. And so any type of outperformance, now all of a sudden you've got potential game changers. We're focused on let's watch these things produce. We're focused on upsizing infrastructure in the area. to unleash these wells. And we're super excited, not just from an operational execution perspective, but seeing contribution throughout the lateral. I think the team's just done a phenomenal job of efficiently executing and bringing these things online. And then the results are just, the proof will be in the pudding, but the results are really, really exciting. And so, you know, in terms of going forward, you know, that's some tailwinds. If it plays back, remember the fourth mile on these wells going to some of the best rock. I think interesting, we talked about the ground game in the Permian quite a bit. You know, there's a ground game in the Rockies as well. You've got a team here that I think is a differentiated weapon within the DJ in terms of what we can execute, long-reach laterals, uh and uh and effectively delivering uh oil from four miles away is is fantastic so super excited what the team's done and really excited to see these wells continue to to perform sounds good chris thank you our next question comes from the line of gabe dowd with td cowan gabe your line is not open

Thanks morning, everyone. Thanks for taking my questions. Chris, maybe any thoughts you could share right now on 2025 and just capital allocation across the two plays relative to this year's capital allocation and also capital allocation within the Permian, specifically Delaware versus Midland.

Sure. You know, this is coming into this year. The calculus was was pretty difficult because we didn't know how the team would execute. I think as we look ahead, and certainly it's too early to guide where we're going to be in 2025, but as you look ahead, the challenge that this team's going to have is this is real-time improvements, enhancements throughout the Permian and in the DJ. The game is changing in both basins, and so there are a lot of moving pieces that will drive relative capital allocation between the DJ and the Permian. Keep in mind, we'll also have, again, the tailwinds on the regulatory side with compromise that gives us you know, into 2028, good clarity in developing the asset, and that's going to impact how we think about capital allocation. There's a lot moving. And then in the Permian specifically, as you think about Delaware versus Midland, certainly we're more levered to Midland, both in terms of scale and production and inventory, some of our best returns on the Delaware side. Now, we have, I think we mentioned in the past, a previous operator was looking to develop some one-milers and good returns, don't get me wrong, good returns, but the team is taking the time to say, look, how do we extend these into two-mile developments and drive some additional efficiencies? And so we're working that through the system, really excited to start allocating to the Delaware. Just given the scale and everything, we're going to be more weighted to the Midland. We're super excited about that as well. While it's early for 2025, I'll just take us back to how are we going to run this business? We're going to run this business to maximize free cash flow, keep production broadly flat, and generate as much free cash, get it back to shareholders, get it back to our balance sheet as we can. I think that business model is really interesting because it does a really important thing. It creates capital scarcity, and when you have capital scarcity with two super competitive teams, you start finding ways to improve that capital allocation mix. And so that's what we're seeing from the DJ. It's what we're seeing from the Permian. These men and women are finding more and more ways to improve returns. And so it's going to be a lot of fun as we set up for 2025, but there is a lot of noise in the system.

Understood. Understood. Thanks, Chris. Obviously, a bit too early still for 2025, but that's helpful. And then just as a follow-up, just going back to well design and spacing in the Permian relative to the prior operator or operators, can you maybe just remind us, broad strokes, what are spacing or well protection assumptions in Midland right now? And is that a little bit of a wider spacing relative to the prior operator? Is that embedded in your inventory number?