SM Energy Company

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the SM Energy's second quarter 2023 financial and operating results Q&A. All lines have been placed on mute to prevent any background noise. After the speaker's brief remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Jennifer Samuels, Vice President, Investor Relations and ESG Stewardship. You may begin your conference.

Thank you, Rob. Good morning, everyone. First off, I do apologize for any inconvenience yesterday for the delay in posting all of the quarterly materials. Our third-party web host had technical issues. I guess reporting on the busiest day can overload the system. We may reference those materials today, including the investor presentation and call transcript during today's Q&A call. Thank you for joining us this morning. To answer your questions today, we have our President and CEO, Herb Vogel, and CFO, Wade Purcell. Before we get started, I need to remind you that our discussion today may include forward-looking statements and discussion of non-GAAP measures. I direct you to slide two of the accompanying slide deck, page five of the accompanying earnings release and the risk factor section of our most recently filed 10k which describe risks associated with forward-looking statements that could cause actual results to differ we may also refer to non-gap measures please see the slide deck appendix and earnings release for definitions and reconciliations of non-gap measures to the most directly comparable gap measures and discussion of forward-looking non-gap measures Also, look for our second quarter 10-Q filed this morning. And with that, I will finally turn it over to Herb for a brief opening commentary. Herb?

Thank you, Jennifer. Good morning and thank you for joining us. Before we get started, I just wanted to reiterate a few key messages this quarter. Our return to capital program has been well received with the repurchase of 2.6 million shares in the quarter and 5.3 million since inception of the program last September. Including our sustainable dividend, we have returned $221 million to stockholders since September for a 6% yield over nine months based on the June 30th market cap. Execution was solid in the second quarter, building on a very solid first quarter. We're very pleased to have increased production guidance, reduced capex guidance, and geared up to add a rig in October that will help drive slightly higher oil growth in 2024. People who have followed us know that our ability to build inventory organically really differentiates SM. We've added 29,100 net acres this year to date in the Midland Basin, a 35% increase, and the team is excited with these latest 20,000 acres to target more dean potential, which today has been the producing interval in some of our very best wells in the Midland Basin. I've got to say, this is the best way to add true value to an E&P company. The first half of 2023 puts SM on a trajectory for an excellent year. With that, I'll turn it back to Rob to start taking your questions. Rob?

At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. And your first question comes from the line of Zach Parham from JP Morgan. Your line is open.

Thanks for taking my question. I guess first off, just like cash return, You all have returned a significant amount of free cash flow through buybacks over the last couple of quarters. In the second half of the year, your free cash flow is set to expand as production increases and capex declines. How should we be thinking about your buyback in the second half? Will you continue to utilize 70 plus percent of free cash flow to buy back stock? And maybe just talk about how the stock price plays into how you're thinking about the buyback.

Good morning. This is Wade. Great question. Yeah, you know, I guess all I can say there is, you know, $500 million authorized. We've now used $166 million of that, so $334 million to go. So I think I did say in the remarks that the current price looks very attractive to us. I probably shouldn't speculate any more than that. I think if I were you, I would just kind of model the remainder pro rata the rest of this year and into 2024.

Thanks, Wade. And maybe just one on the new operating position, the 20,000 acres, you know, can you just talk a little bit more about your development plans on that new acreage? I know you've talked about developing the Dean there, but you know, when will you start to initially drill some wells there? When should we expect to see some results?

Zach, this is Herb. So I think we flagged this at your conference in June, but we're picking up a fourth rig in the Permian Basin in the fourth quarter, and we're going to be first going into another part of Rockstar and then moving over to the acreage as soon as we're ready. But we should start drilling on that acreage late in the year, and then we'll continue on into 2024. We haven't budgeted how much of the year we'll be doing that. We'll be doing the normal efficient pad execution in terms of when we put the frack spread on there and how quickly we'll do it. So we're just lining out the plans now. We're really excited about it. You know, this is the sort of play that our best wells have been in the Dean. And so we're really excited to see what we can do up here. We do have a lot of confidence given offset well data, both vertical and horizontal wells. So that's really the plan. No more than that.

Thanks, Herb and Wade. Really appreciate the responses.

And your next question comes from a line of Oliver Wang from TPH and Company. Your line is open.

Good morning, Herb, Wade, and team. Congrats on the strong quarter, and thanks for taking my questions. Just wanted to kind of follow up on the Martin-Dawson acquisition issue. a little bit more. I know you all are very excited about the asset, having highlighted the dean and middle sprayberry sand intervals as key targets. Just any initial thoughts in terms of how you all are planning to develop the asset from a spacing perspective? Also, what's the opportunity set to other zones within the area and any color with respect to HBP commitments that you all might have to carry out, if any?

Yeah, Oliver, so first of all, you know, this is not your usual stacked mud rock Permian play. In this area, we're really targeting much more conventional sands with higher porosity, and it's really oil-saturated rock, and that underpins the prolific wells. The type of characters is a bit different than your normal plays. It's quite good from an economic standpoint. Right now, we're looking at optimizing the lateral length. And as part of that, we'll be putting the spacing in that will optimize our economics. You know, we use the same approach throughout where we really look at the incremental return for the last well assigned to a DSU. So that'll basically be making sure that we achieve great economics on the wells. So that's really the story there. And we'll be getting some well results there. It'll probably be You know, in the first half of next year, we should get some well results from up there. But there's already been quite a bit of offset drilling, too. And just to the southeast of it, we have our best wells ever in the Permian Basin that are in the Dean.

Okay, that's helpful, Culler. And just for a second question, in South Texas, certainly great to see the positive ops update out of there. but just really trying to understand the oil handling project a little bit better. It sounds like it's completed at this point, but just are we now at the point where volumes from the Austin Chalk can be flowed in the most optimal way, or is there still some level of constraint, and how should we think about future investment on this front, or does this all pretty much satisfy any sort of growth that we might see over the next couple years?

Yeah, Oliver, I'm just going to refer back to what we said about a year ago. So we were expanding the pipeline to carry the oil out over a three-year period, progressively synced up with where we were developing. So last year, we did the first part. This year, we did the second part, and we finished that early in the second quarter. And there will be a third extension of that pipeline next year. The constraints are relieved at this time. The only time that we would wind up with constraints is if we put a couple really oily pads on adjacent to each other that can flow quite strongly. It doesn't affect the wells at all. It just means it stretches out how long they plateau longer. But we're doing that very efficiently, and we try and schedule things so that we mitigate that. But, you know, we want to bring the wells on timely and efficiently, and that's what drives it. So the bottom line is, yes, the constraints are relieved. The constraints will continue to pop up if we don't manage things tightly, but we're planning to manage things tightly.

Awesome. Thanks for the color.

You bet. And your next question comes from a line of Tim Risman from KeyBank Capital Markets. Your line is open.

Thanks for taking my questions, everybody. I think Oliver hit on one I plan to ask. So if I could pivot to the mystery, you know, Midland Basin asset, you know, you talked about 9,100 net acres. I was wondering, you know, I'm trying to think about that in context of the cash on the balance sheet right now. and your decision kind of not to redeem your notes that are callable par right now. How big is this opportunity set that you're pursuing? Do you think you're close to kind of getting the acreage put together that you want? And, you know, is there a time where you may be able to sort of share some more information with the marketplace?

Yeah, Tim, I think we mentioned this before at the JP Morgan conference that, you know, We're still seeing some opportunity to get additional acreage around that. And I'll just give you a heads up that on that slide 13, we show 2023 newly acquired acreage. That's only the most recent 20,000 acres. We haven't disclosed yet where the 9,100 acres are that we'd like to expand. So we haven't really given more color. We will at some point. And once we have some wells in there, we'll be sharing the results. But you won't be seeing those until, you know, mid-next year sort of timing based on the way we're planning to go about things.

Yeah, and I'll just add to that on your balance sheet question, Tim. It's a good one. You know, carrying the cash right now for me is pretty close to a no-brainer. Those 25 notes don't mature for a couple of years, and the coupon is, you know, five and five-eighths. our cash is earning pretty close to 5% now. So it's not a big negative carry to be able to, you know, to be more conservative and opportunistic and have some cash and liquidity is always a good thing.

Okay. That makes sense. And then one more question, I guess, circling back on sort of the dean opportunity. Herb, I spoke to you in December, and, you know, you went into great detail on your – your view on how good and prolific the formation is. Do you believe there's kind of more potential to add kind of dean inventory? And I was hoping to pin you down a little more in sort of spacing. You know, can we think about this traditionally in like a four wells per unit type development or just trying to give a little more context on kind of what you see there because there's been some debate in the marketplace and you seem sort of firmly you know, in the view that this is a distinct and highly prolific, you know, area.

Yeah, Tim, so I understand why people would have different views about it. It's really, it doesn't work everywhere. You have to really understand the geoscience and the nature of the sands where they are and where they are oil saturated and where the porosity is strong that would allow for high productivity. So that takes quite a bit of detailed mapping. You can really start with the vertical wells and then it helps when there's offset horizontals to confirm the thought process that you have. So I would say it isn't for everyone on everyone's acreage, but there are certain areas where it will work extremely well. And that's what we've honed in on and we've mapped uh throughout the basin and said okay here's the dean dean works here the dean would be wet and here the dean the fins are fans are too thin here the sands are really thick uh so we've mapped that through to identify the sweet spots that will give uh what i call top tier returns which is what we've had in our existing northwest rock star position uh which uh which which depend on Dean performance.

Okay, that's helpful. So I guess we should think about this as sort of an ongoing process to continue to find more inventory perspective for the Dean?

I would say we know where the inventory is, and then it's whether we can get access to the land or not.

Okay, okay. Fair enough. And then if I could just sneak one last one in to sort of close the loop on the oil handling question. So in theory, there could be some constraints next year, you know, if there's issues with the build-out. But that piece next year, would that sort of handle your medium-term development, you know, in South Texas for many years once that final build is done next year?

Yes, that would do it, Tim. It's just the last southernmost extension of that line is all we'll have left. And we'll make sure we get it in there before we bring the pads on. You know, it's unlikely that we get pads on early, but if it does happen, you know, that's always an issue. But in this case, we're ahead of it.

Okay. I appreciate all the answers. Thank you.

And again, if you would like to ask a question, press star, then the number one on your telephone keypad. Your next question comes from a line of Scott Handel from RBC Capital Markets. Your line is open.

Yeah, thanks. You all gave some pretty good color on how you think about buybacks. Maybe a little context of the dividend side of things. Do you feel comfortable with where it is? What do you think about the yield and where that might be going forward?

Hi, Scott. It's Wade. Good question. You know, we kind of established that dividend level, I guess, last September, October, so we'll be coming up on a year. You know, I certainly can't predict anything at this point, but as we said, We'll reassess occasionally, and you can assume we'd be doing that soon and decide whether we wanted to, you know, to increase it or not or leave it where it is based on our view of, you know, the market and commodity and free cash flow generation in the coming years. So stay tuned.

Yeah, but if you could give some context and, like, how do you think about sizing that? You know, do you want it to be, you know, competitive with, you know, some peers in this bid cap with larger caps with the S&P 500 or percent of, you know, cash flow, any kind of view on like how you think about sizing it?

Yeah, no, that's hard to answer at this point. Whether we want to compare it too much with who we want to compare it to, I think, is a great question. What we really want to accomplish is a very sustainable dividend that shareholders can count on, even in low commodity price environments. I think we used 60 and 3 before. So we'll do the same analysis again and determine what we think fits that bill.

Okay, fair enough. And thinking about 2024, you gave a few breadcrumbs on how you're thinking with that mid-single digits growth. Can you give some context around, and I think there's some context around that, maybe the Permian has a little more momentum going into next year. So if you can kind of discuss how you think about capital allocation and any kind of further cost savings tailwind that would have some implications to the budget.

Yeah, I'll say a word about that and then Herb can answer better. I mean, as far as capital allocation, you know, we're going to be watching real closely the next three months or so and determining what that free cash flow number is going to look like next year. Deflation is a big question and, you know, it appears that cost will be lower next year. commodity price kind of stabilizing here at a higher level, hopefully. So, you know, there will be some, you know, some allocation decisions coming out of that. But determining how much free cash flow we're going to have first, I think, is going to be a big thing for us in the coming months.

Yeah. And then, Scott, I'll just add, yeah, you heard exactly right. We do see mid-single-digit growth We will be leaning a little bit more into the Midland Basin, you know, just picking up the fourth rig in the fourth quarter. And we haven't identified how long we'll be running it through next year. But just that alone would allocate more to the Permian than we did this year and last year. And obviously, it's oily and the environment's quite good for that. So that's really what we're planning to do.

Okay, appreciate it, Nicola. Thanks. Thanks, Scott.

And there are no further questions at this time. Mr. Herb Vogel, I turn the call back over to you for some final closing remarks.

Okay, well, thank you, Rob, and we are very pleased with our first half successes, and we're well positioned to continue this trajectory to build value and deliver returns. Thank you all for your interest, and we look forward to seeing a number of you at upcoming events.

This concludes today's conference call. Thank you for your participation. You may now disconnect.