Diversified Energy Company plc Ordinary Shares

Greetings and welcome to the Diversified Energy 2024 Interim Results Conference Call. At this time, all participants are on a listen-only mode. A brief question and answer session will follow the formal presentation. If you should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Douglas Criss, Senior Vice President, Investor Relations and Corporate Communications. Thank you. Please go ahead.

Good morning and welcome to our interim results conference call. Joining me here today are Rusty Hudson, our CEO, and Brad Gray, our CFO. For reference, we will make notes and comments around certain non-GAAP and non-IFRS financial measures. All of our disclosures around those are found in our earnings materials or in our earnings release. on our website and also issued via the R&S service. I'll now turn the call over to Rusty Hudson, our CEO. Rusty, please go ahead.

Thank you, Doug. Thank you, moderator, and thank you for everyone that's on the phone today. We're going to go through several slides here, talk a little bit about the first half of the year, talk a little more granularity around a few of those key metrics. And then I'll turn it over to Brad to talk about a few slides on the financial side, and I'll come back and wrap it up. And I'll start here on slide three and really just kind of focus a little bit on some of those metrics that I was referencing in terms of the first half results. Before I do that, I do want to recognize our employees that may be on the phone with us today. or we'll listen to this later, and really just recognize them for their outstanding contributions and their achievements in coming up with these numbers and really just what they do for us on a day-to-day basis. We always talk about them that without them we don't have a company, and they have truly outperformed not only in this first half of the year but over the years, and it shows in these results. Those results of their hard work are highlighted here. A few of those highlights, the free cash flow generation has been 121 million, 38% free cash flow yield. That kind of pairs with the 50% cash margins, which we'll talk about in a minute. We continue to see $108 million of debt principle payments made in our amortizing ABS notes, which is crucial to our overall strategy long term. We are focused on shareholder returns. We've paid around $65 million in dividends and share repurchases through the first half of the year. We'll get into a little more details of that. I think it's really, really important for people to understand that our business, we had a zero percent decline essentially over the last three fiscal But that's a tremendous testing to the work that our guys do in the field, guys and ladies, do in the field on a day-to-day basis in getting additional production and improving, enhancing production on the portfolio. So that's been three straight quarters. I think it's also very, very important to see that since our IPO, we've paid over $850 million of capital in return to our shareholders over a seven-and-a-half-year period, which I think is So, reliable, measurable results, which is what we pride ourselves in. Looking at page four, kind of summarizes our capital allocation framework that we laid out earlier in the year. You can see here kind of a quick update on this, what we call our four pillars. We talk about it, $180 million of debt principal reductions. Our payments, the systematic debt reduction that we talked about, we paid over $55 million in dividends, fixed per share dividends for the first half of the year. We've bought back around 10 million of our shares, 2% of our outstanding shares over the last six months. And then we talked about the growth pillar. We've announced the impressive past acquisition. million worth of accretive acquisitions that will continue to contribute to our future success. So those are our four pillars kind of updating on where those stand for six months of the year. Moving to page or slide five, one of those pillars that we talk about is the growth pillar. And I think you can see here the two acquisitions that either completed or announced that will be completed in the third quarter. It's two great transactions. You know, we have stayed true to our valuation expectations throughout these years. The one thing that we've always said, we're not going to do a deal just to be doing a deal. We haven't compromised our valuation metrics. And you can see here that these two transactions have been in that PD-17 to PD-20 range on just PDP. We still haven't paid for any undeveloped value. in these two acquisitions. The multiples that we paid continue to be under our equity valuation multiples, which is accretive to our shareholders. More importantly, it's adding value for the future and helping to increase cash flows and sustainability of the business model over a long period of time. The way we look at it is we buy good assets. We put our operating procedures and processes in place to operate them better, get more out of them, and it's a big win for diversified. So these two transactions continue that trend that we've set for the last seven years. Moving to slide six, I want to spend the next few slides talking in a little more granularity around a couple of key aspects of our corporate strategy and our business model. Obviously growth is a big aspect, but being capital efficient is also equally important. And what I mean by that is our capital intensity at 10% is significantly lower than most of our peers. And that gives us a big advantage because we have lower CapEx to keep our production profiles, our engineered production profiles, where they need to be to be successful in our going forward forecast. Lower capex to maintain those production means higher free cash flow. And so we have a low decline rate. We have a very low capital intensity. It means higher free cash flow that we can then allocate to those four pillars that we talked about earlier in our presentation. Flipping to page seven. Very proud of this run that we've had. This is since the IPO in 2017. But you can see that we've averaged 50% cash margins over a seven-year period, which I think is pretty remarkable. And that's with a very, very volatile natural gas market, which makes for many years of operations. That's a testament to our ability to acquire good assets and good valuations to replace the production that's rolling off on an annual basis. It shows the effectiveness of our hedging strategy and our ability to have predictability in our production that we can then hedge out and lock in those cash margins for a longer period of time. And then it shows the scale that we've built and our ability to drive down operating costs through geographical concentration and smarter asset management processes. And so that's what's allowed us and given us the ability to be very successful over a long period of time, but more important, not just successful, consistent. And for our business model, that's an extremely important factor. Flipping over to page eight, at the end of the day, You know, you take that low capital intensity that we were discussing, that 10%, you take strong margins, 50% on average, and that equals a high free cash flow conversion rate. And you can see here that we lead the pack as it relates to our peers on the natural gas side in terms of converting EBITDA into free cash flow. And so you can see at a 55%, that's a very, very strong free cash flow conversion rate. And again, it represents free cash flow that can then be allocated to those four capital allocation pillars that result in shareholder returns to all of our shareholders that hold our shares. So very important aspect there. On page nine, this is something I really want to lean into on this call, and I want people to really focus on this because I think it's a very, very important slide and one that I think gets overlooked in the valuation of our company and in our equity. As you look at this, this represents our undeveloped acreage that we've acquired over the years that we've paid nothing for. We have around 8.6 million net acres within our operating footprint, and that includes Appalachia and the central region. All of that essentially is held by production, which means we don't have any time commitments or any reasons to be concerned about losing something because it doesn't get drilled. Of that 8.6 million, 65% of that is undeveloped. It's a large percentage. And you've seen over the last several quarters us leaning into some of those acreage sales. In the first half of this year, we've sold about 15 million of undeveloped acreage sales, potentially mostly in Oklahoma. But if you take that and you look at just Oklahoma alone or the central region, and you take that $1,100 an acre, which is what we've generated on the land sales that we've done so far in 2024, and you apply that across just the central region undeveloped acreage, that's over $800 million of value in Oklahoma alone because we are one of the top one or two acreage holders or acreage positions in the state of Oklahoma. We have value that is being evaluated, and we will, you know, cash in on long term. It gives us the ability. We can do it through monetization. We can do it through organic development or through JV, you know, JV strategic partnerships with others to drill it. But at the end of the day, this is being missed when people look at our company and they take a look at, you know, where's the value in the NAV and all that. We also see this as a way for us to you know, increase liquidity to grow the business long term. As we do these acreage sales, you know, increase or generate liquidity, we can use that to buy PDP and other positions that we can sell the undeveloped acreage down the road. So this is a very overlooked part of our business that I think people really need to take a harder look at on a forward basis. On page 10, You know, we continue to see a discount, our share, you know, our equity value trading at a discount to not only to our peers, but even on a historical basis, you know, where we traded at on a historical average, we continue to underperform our peers in that situation, about a 37% discount to the current peer average. Now, what I see that being is that it's a great, We've only been in the U.S. now about eight months, so we're starting to develop some maturity in trying to get more and more U.S. shareholders involved. We're doing a lot of investor outreach in the U.S. We believe that that trading discount will continue to shrink, and we should see our multiple move up closer to our peers over the next several months as those investors start to to increase in trade in the shares. This is a very important factor and I believe represents a great buying opportunity in the company and in our equity value as we sit here today. And a great opportunity to see multiple expansion moving forward. So with that, I'll stop and I'll turn it over to Brad for a few slides related to some financial metrics.

okay thank you rusty uh as you stated earlier we are very pleased with our mid-year results and i i also appreciate the hard work and efforts of our diversified team members as they continue to perform at high levels during some candidly challenging markets so on slide 11 we're highlighting the favorable impacts of our consistent and disciplined hedging strategy Hedging the prices of our commodities is a fundamental part of our business model as we are committed to protect the robust cash flows of our assets that produce for our shareholders. And as seen on this page, our average full price for the second half of 2024 is $3.34 for NMBTU. which represents a 40% improvement over the corresponding period strip price. And this margin will allow us to continue to deliver almost 50% cash margins that Rusty mentioned earlier. Additionally, as noted in our mid-year results, our hedging program provided $78 million of realized gains during the first six months of 2024. And as we look ahead, we are well positioned, especially compared to our natural gas peers, to protect our cash flows while also having some exposure to the opportunity for higher prices in all three of our product streams, which are natural gas, oil, and NGLs. Moving to slide 12. I've had the privilege of working directly with our information technology teams since 2018. And our technology teams, just like our field teams, are focused on optimization and efficiency. And with our strategy of growing primarily through acquisition, it is imperative that we have the ability to integrate new assets and processes with speed and efficiency. And we take a very data-driven approach using modern technology tools to manage our assets. This process includes that we require common systems, we standardize our data, we provide business intelligence tools to all of our teams, and we are a 100% cloud-based company with no physical servers in our IT or our OT environments. Our systems provide our operators with time series visualization tools that help us quickly see trends and find opportunities for improvements. The systems that we have built also allow our teams to efficiently and cost-effectively manage our assets. Our systems, importantly, are scalable, repeatable, and very cost-effective, which gives us great confidence as we continue to execute on our growth strategy. On slide 13, as Rusty discussed earlier, we are committed to a balanced approach to capital allocation. The strong free cash flow that our assets and our teams produce allow us to create shareholder value through growing our production base with either accretive optimization projects or from new asset acquisitions. additionally systematic and significant debt reduction through our abs structures and returning capital to our shareholders via our fixed quarterly dividend of 29 cents per share along with share repurchases this balanced approach provides us with flexibility to allocate our cash flows to the highest and best uses back to you rusty thanks brad and um you know i think just finishing up and i really want to allow

more time for questions here, but building a strategic resilient energy producer, we really pride ourselves in a differentiated model, one that gives investors the ability to invest in something that's not drill bit focused, with less risk, more price protection and production that's more predictable. So we believe that we are building that business model that's giving people a differentiated look at the energy space. We feel that there's still a lot of opportunity in the market. There's a significant amount of M&A activity that we're seeing on a day-to-day basis, and we believe that we're in a good position to take advantage of that on a going-forward basis. We continue to focus... on our delivering for our shareholders. We talked about those four pillars and leveraging our reliable production and our hedging and our vertical integration to continue to provide a meaningful cash flow to provide to those capital allocation pillars that we can then generate returns for our shareholders. Brad talked about our technology and our ability to really modernize our field management. We continue to put great efforts into that, capital into that, because we believe at the end of the day that that's what's going to drive our synergies and our long-term efficiencies in the business that we can take advantage of and continue to expand the margins. And doing all of this without on our emissions reductions and our technology that we're putting there and our well retirement processes. All of these things makes Diversify the right company at the right time and will continue to execute on this business model on a going forward basis and we believe be highly successful over the long sustainable period. I will stop our comments and I will open it up for questions from anyone that has any.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up the handset before pressing the star keys. We do ask that you please limit yourself to one question and one follow-up. Again, that's star one to register a question at this time. Today's first question is coming from Brett Dons of Truist Securities. Please go ahead.

Hey, good morning, Rusty, Brad, and the team. Thank you for the update. Thanks, Mark.

Good to see you, Mark. Good morning.

Martin, and on the first question, just the Crescent Pass acquisition screened pretty well on our estimates. Could you maybe talk about the depth of opportunities that you have that maybe have similar attributes? Has the volatility in the gas space helped? Like, are more companies looking to unload assets to improve their balance sheets, or is this, you know, maybe the bid-ask spread has widened due to the sharp moves in the strip?

Well, I think that last comment that you just made regarding the strip – You know, we're in a slightly, I would say, you know, contango. I wouldn't call it extreme contango, which we've seen in the past. But, you know, obviously the first 12 months, the price is the lowest that you see in the forward curve. I would say that the multiples on just a pure natural gas deal look a little higher, but that's only because the next 12 months are your lowest prices. And what's really interesting to me, Bert, is as you look at these deals, You know, you may pay a three and a half in the oil pool, but your net cash back to you may only be four and a half because the price gets higher as you go out and bring more cash flow in. So it's really the opposite of oil. You know, oil has the higher prices in the front 12 months and the lower prices in the back. But we're seeing, you know, I think that there's going to be significant asset movements. over the next several months and quarters. We've seen some of the big mergers take place. I think there'll be assets generated or divestments generated out of those as the FTC makes rulings and comes down as to their thoughts around some of these deals. We're seeing a lot of activity. Obviously, we like the Gulf Coast. We believe that that's an area that we can be successful in. It's got the LNG export capacity that we like and gives us a lot of variability there to move gas. But at the end of the day, I think that the valuations are still pretty, pretty good from our perspective. We feel like we can get some pretty decent deals out of it.

Perfect. That's a great update. And then on the well retirements, it looked like you had a higher percentage of non-op activity in the last quarter. Is that indicative of more demand for next-level services, or am I looking into that too much and maybe it's just a one-time data point? And then just any thoughts on, you know, the cost of retirements or any profit margins for the third-party market? Thanks.

Yeah, Bart, so actually the difference between this year and last year's performance in our next level, we're ahead of schedule on plugging diversified wells. The pace of bids or packages coming out with the federal money has changed to the back end of 2024, whereas last The majority of our work in 2023 was on the, I think you called it non-op or we'll call it third party. So we've, just because of the pace of those federal contracts coming out, we have focused more on our internal plugging and we're well ahead of that. We're almost completed for the year on our consent agreement requirements. So we're in a good position there and we're well positioned for the second half of the year to plug for third parties. We have had a fair amount of activity with third party operators and with all of our assets, which includes our wire line, our construction, cementing assets in addition to well plugging. We've been working closely with some storage companies, coal companies, and so that's been some good revenue generation for us there. But we're in a good spot for the year on activity. And from a cost perspective, we really haven't had any significant adjustments up or down that have changed on a year-over-year basis.

That's great. Thanks, Tim. Thank you.

Thank you. The next question is coming from Tim Hurst-Brown of Tennyson Securities. Please go ahead.

Good afternoon or morning, gents. Thanks for the call. Just got a quick question around the underlying production. So since Q4 last year, excluding acquisitions, production has been broadly flat versus the sort of 8% to 10%. rate that you had in 2023. Just wondering whether there are any sort of one-off factors in there that explain why it's flat and what you expect production to do on an underlying basis sort of through the second half of this year, i.e. will it be broadly flat or are we going to go back to the sort of 8% to 10% decline that you've had historically?

uh tim we've had good production results uh in both appalachia and in our central region um we've had um it's been um we've had some opportunities for some marcellus production to come back online that had been impacted from some other operators has been helpful and and overall the optimization projects that our teams in the field work on every day we had we had good results from those So I think that those will continue for the remainder of the year. I do think, though, that you'll see us trend back more towards our engineer declines in that high single digit for the second half of the year. You know, it's in a portfolio of ours to have any quarter over quarter flat is impressive. But to put three together in a row here is a great testament to our team.

And, Tim, just to add one thing there, you know, we did focus a heavy amount of our time and our capital late last year and early this year into oilier projects and fields. Obviously, that was because of price. We've seen some decent oil uplift and NGL uplift from some of those projects in addition to some of the stuff that Brad was talking about. It's really, to Brad's point, a testament to build ops in the way that they're approaching the day-to-day operations of the wells, obviously focusing on those things that have the best payback. but also improving the production as we move forward on some of this stuff that's helped to kind of stave off declines.

That's great. Thanks, guys.

Thanks.

Thank you. The next question is coming from David Round of Stiefel. Please go ahead.

Thanks for the presentation, guys. The hedging strategy, that continues to work pretty well for you. I'm just wondering, though, How do you maintain the right level of hedging when you're acquiring businesses that may or may not come with a hedge book? I mean, Crescent Pass, for example, correct me if I'm wrong, I don't think that did. So are you able to layer on and do you want to layer on hedges in advance just to make sure you're positioned for when that deal completes?

Absolutely. So we've got some provisions in our existing RBL that allows us to to utilize and put on some of you know hedges on acquisitions that have been announced or whatever and so we're able to kind of hedge that prior to closing and lock in some of those uh prices that we've uh that we've uh kind of factored and valued the business on so we do that consistently uh so you know for example on the press pass deal uh you know i would say that you know we're not even closed yet but You know, there are probably already engines on to kind of lock in the value that we strive to the business. So it's something that we've been doing for a long period of time. We don't want to take a lot of price risks. We always talk about that. We don't want to be at the mercy of price. Thank God we haven't been over the last, four or five years, especially as prices have been extremely volatile. So, yes, we do have abilities to lock in gas on these acquisitions prior to closing them.

Okay. Brilliant. Appreciate it. Thanks, Gus. Sure.

Thank you. The next question is coming from Simon Scholes of First Berlin. Please go ahead.

Yes. Hello. Thanks for taking my questions. I've got two. Just on the subject of undeveloped acreage, so you raised $15 million in Oklahoma in the first half. I was just wondering if there's any prospect of you accelerating the disposal rate going forward and what the average tax burden on your remaining portfolio is. And then second, just on the full year volume outcome, If we assume that you go back to the previous decline rate in the second half, am I right in thinking that after the Oak Tree and Crescent Pass acquisitions, average volume in 24 is likely to be slightly below 23, assuming no further acquisitions?

Let me go to the first question, which I think was related to the... I'm sorry, I'm... When we have acreage positions that others are interested in, especially in Oklahoma, that's been a really hotbed of activity there. We obviously will accelerate those and try to get as many as we possibly can. We obviously have a lot of levers to pull there, and so it does take some time to work through those. You've got land investigations and title searches and all those things that the buyer has to go through. So they typically go a little bit at the buyer's pace. but we have a very, very good team on our side that's working those deals and have been highly successful through the first half. We could see some big ones, you know, over a course of time. And so, you know, that's always, for us, that's always a big opportunity set. And, you know, if you can generate a 15 to 20 to $30 million acreage sale, that's a lot of value for us. And so, you know, Definitely are working those every day. Would love to accelerate them, and there's always the opportunity that that could happen. Related to the, go ahead.

Yeah, so, Simon, I believe your question is related to gross volumes for the end of the year. If you layer in the O3 transaction, which, as you know, closed in early June, That adds about a 15% uplift in production. And then you layer on the Crescent Pass will be, you know, additional to that. So we believe that, you know, that's going to effectively offset overall declines for a period of about 18 months. So we should be higher at the end of 24 versus 23 volume. Okay. So above 820 per day.

Did you say above or at? I didn't hear. I'm sorry. Well, yes. I mean, I think the figure for last year was 821 million cubic feet per day.

I mean, I think we exited the second quarter at 865, so Crescent Pass will add to that. So, yes, we should be above that 820 mark.

Okay. Great. Thanks. And how about the tax burden on the undeveloped acreage?

Well, from the tax burden on generating capital gains by selling those, I don't think we're – we have a – we've got a pretty advantaged tax position, you know, with our federal tax rates and the marginal wealth tax credits. So we don't anticipate any significant cash tax burden from even in light of additional land cells that will likely occur.

Okay, thanks. That's very helpful.

Once again, ladies and gentlemen, that is star one if you would like to register a question. The next question is coming from Malcolm Graham-Woods of Hydrocarbon Capital. Please go ahead.

Rusty and the team, good afternoon. Hi, Dan.

Hey there.

How are you? I am very well, thanks. I'm better off having seen a great presentation. Well done. And my question is also about Slide 9, the undeveloped acreage. And to be honest, you have answered a fair bit of my question. But my question was originally, I mean, it is a, you know, I've always said ever since you started that, you know, that this company could go on for 10 years and more without doing anything on the basis of what you have in your portfolio, which is what this, I'm so pleased to see this chart. What I would ask you is what do you think the value – I mean, certainly you asked it about the tax. What's the value of that slide that you can see with regard to all your acquisitions? So if you compare it with what you're paying for acquisitions that you're doing at the moment.

Yeah, that's a great question. You know, I can't put a dollar amount on it, Malky, but I can say that we know there's value across the portfolio. more importantly that value is going to continue to materialize in all areas of the portfolio as time goes by because you know the the inventory of drilling opportunities uh over time will continue to deplete for so companies are going to need additional acreage they're going to need additional opportunities and i think more importantly There could be new formations and new opportunities set underneath the acreage we have that somebody's not even really focused on now. For example, in Oklahoma, we've been selling acreage to some of the producers out there that have been drilling a new formation called the Cherokee. That was never even really that thought of two years ago. But now it seems to be a pretty hot and heavy formation that's being drilled. So there's always new things that come available. And when you have acreage in these areas, it becomes a valuable proposition for some of these producers. I will say this. We have, over time, accumulated a lot of acreage. We've never, and we've been very clear in this, we don't pay for it. We don't pay for that upside. And so for us to continue to, you know, be able to lay into that value, that's value that we didn't pay for, and it's just, you know, a bonus for not only for the first five, but for our shareholders.

Thank you. At this time, I would like to turn the floor back over to Mr. Hudson for closing comments.

Thank you all for joining us today. I would just end the call with very pleased with the first half of the year. We feel like that we're setting ourselves up for some great success moving forward. With our capital allocation strategy, the operations being strong, we'll continue to drive free cash flow and results that will make our shareholders happy over the long haul. So thank you all for joining, and see you soon.

Ladies and gentlemen, this concludes today's event. You may disconnect your line to log off the webcast at this time and enjoy the rest of your day. Thank you.