ARC Resources Ltd.

My name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Resources Second Quarter 2022 Earnings Conference Call. 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. If you would like to ask a question during this time, simply press star then 1 on your telephone keypad. If you'd like to withdraw your question, please press star, then the number two. Thank you. Mr. Lucco, you may begin your conference.

Thank you, operator. Good morning, everyone, and thank you for joining us for our second quarter earnings conference call. Joining me today are Terry Anderson, President and Chief Executive Officer, and Chris Bibby, Chief Financial Officer. Before I turn it over to Terry and Chris to take you through our second quarter results, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP and other financial measures, with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars unless otherwise stated. Finally, the press release, financial statements, and MD&A are available on our website, as well as CDAR. Following our prepared remarks, we'll open the line to questions. With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

Thanks, Dale, and good morning, everyone. We'll try to keep this conference call short, sweet, and to the point. As we know, many people are on vacation, and the rest of us want to go on vacation. I'll touch on a few noteworthy items before I turn the call over to Chris to discuss the financial highlights. First, the quarter itself was record-setting. Free funds flow and funds from operation per share were the highest in our 26 years, and this allowed us to further strengthen our balance sheet and accelerate returns to shareholders. We reinvested one-third of our cash flow into our assets to maintain production and generated $677 million of free funds flow, or $1 per share, which is equivalent to 7% of our market cap. 60% of that was returned to shareholders through the dividend and share repurchases, and the remainder was used to further strengthen our balance sheet. Reducing debt and the share count when your shares are dislocated from fair value are an excellent way to create value and represent permanent changes to our capital structure. We have now returned 11% of our market cap to shareholders over the past year through the growing base dividend and 10 months of share repurchases. Second, our operational momentum remains strong. Our scale and track record of operational excellence is helping to mitigate the tightness in supply chain and inflationary pressure on our business. Second quarter production was directly in line with expectations, and all of our planned maintenance was completed safely, on time, and within budget. As a result, we are set up for a strong growth over the back half of the year at CAQA, which continues to perform very well. Before I move on, I want to briefly reflect on CAQA and the significant progress we've made. We've been able to take a world-class asset and implement ARC's operational excellence to make it even more profitable. That culture of continuous improvement and focus on capital efficiency has been a part of ARC for 26 years and is more evident today than ever. As an example, we are observing the benefits of wider well spacing, We are using less water in frac operations, which lowers cost and our environmental footprint without degradation of our well performance. Since acquiring the asset last April, we've maintained production in that 180,000 BOE a day range and generated a whopping $2.3 billion of asset-level free cash flow, around 40% of the acquisition price, a tremendous achievement by the team in only 18 months. As it relates to the supply chain, we have all the critical pieces in place to redeploy capital in BC once the regulatory framework is in place to do so. This will represent a step change for ARC, given the quality and scale of opportunities at assets like Sunrise and Attachee. As most of you know, Attachee is very similar to CAQA, about 60% liquids, 40% gas, and the first phase of Attachee is a 40,000 BOE a day project. and we have four to five similar phases to develop. This will enable Hitachi to reach a similar production level in the future as CAQA is today. And Sunrise, which is among the cleanest and most profitable dry gas asset in North America, sits adjacent to the Coastal Gas Link, which will supply natural gas to LNG Canada upon startup in 2025. We are often asked how inflation is impacting our business. Well, first, we estimate a 10% to 15% inflation this year, both realized and anticipated. We have increased our capital spending guidance to reflect that. The majority of the increase is related to diesel and chemical price increases, which are related to the higher oil prices. Second, long-term planning and scale have been critical in ensuring we have access to material and high-quality services to execute our plan safely and efficiently. These types of challenges during periods of high prices is not new, but years of underinvestment and lack of skilled workers are compounding the challenges today. For the time being, these and other factors are acting as governors on supply growth that we have not experienced in prior cycles. As mentioned, we increased our capital budget from $1.2 billion to $1.4 billion. The majority of that is inflationary. However, it also includes water infrastructure investments, and funds to manage long lead items to support 2023 activity. Production guidance was also revised up with higher liquids waiting due to our confidence at CAQA and implies a 4% growth over the balance of the year. With that, I'll turn it over to Chris to walk us through the financial results.

Thanks, Terry, and good morning, everyone. As Terry mentioned, we delivered on all aspects of our business during the quarter. Production and capital spending were in line with expectations and cash flow and free cash flow were the highest in our 26-year history. Our market diversification drove strong price realizations. ARK realized a natural gas price of $9 in MCF or $2 above the ACO benchmark. Our transportation agreements allow us to market more than half of our natural gas to the United States and enhance our margin by capitalizing on periods of volatility. ARK's reach will expand into the international markets in 26 or 27, when our contract with Chenier takes effect. As a reminder, we will receive a price based on JTM, with our all-in landed costs to that market roughly $5 to $6 per MCF. With additional capacity remaining on the Gulf Coast, we continue to explore additional opportunities to diversify to other markets where we are competitive. We are also the largest condensate producer in Canada, which made up approximately half of our revenue during the quarter. Condensate fundamentals remain strong, Supply is highly concentrated, and we consume roughly 250,000 barrels a day, more than we produce here in Western Canada. During the second quarter, we realized nearly $140 a barrel, which is roughly equivalent to WTI once adjusted for the exchange rate. Altogether, ARK generated an operating net back of $50 a BOE and free cash flow that exceeded $20 a BOE in the quarter. Since inception, ARK has always been a balance sheet-first company. In the second quarter, we reduced debt by more than $300 million, or roughly 50 cents per share. At quarter end, we had $1.5 billion in net debt, and of which $1 billion is through our investment-grade long-term senior notes. Record profitability has allowed us to strengthen our financial position much faster than we anticipated, and in this price environment, we will quickly pay down our remaining bank line, leaving only the $1 billion of senior notes outstanding. All else equal, we would expect returns to shareholders to accelerate as we approach the $1 billion amount of net debt outstanding. Finally, ARC's capital allocation priorities have not changed. As we look ahead, we will remain disciplined and invest in our most profitable assets, which will result in a roughly 5% to 7% compound annual growth rate, and allocate 50% to 80% of our free cash flow to shareholders through a growing base dividend and share repurchases. Roughly 10 months ago in September, we initiated our first NCIB. Since then, we have bought back 9% of our shares and returned $1.1 billion to our shareholders, including the dividend. That's $1.65 per share in roughly a 10-month period. As Terry mentioned, this is an excellent use of our capital, and we intend to continue down this path and renew the NCIB in about a month's time. Should cash flow and profitability remain high and our share price remain disconnected from fair value, If we exhaust the next 10% NCIB, we will evaluate other measures such as significant issuer bids as a potential tool to add value. With that, I'll turn it back to Terry for our closing remarks.

Thanks, Chris. I'm excited where ARC is heading. The company has never been in a stronger position, and we're at an inflection point in our free cash flow growth. To help put things into perspective, it was 2008 when cash flow per share was was last at a similar level to today. Oil averaged $125 per barrel, equal was through $10, and our stock was $30 back then. Today, our company is much larger and stronger. Cash flow per share is 17% higher, production per share is 65% higher, and underpinned by a superior asset base and infrastructure network. It was a different environment back then, but I believe the pendulum swung too far a year or two ago, and it's starting to make its way back at a time when our company is performing at its best. With that, I'll turn it back over to the operator, and we can open the line up for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. and your question will be polled in the order they are received. Should you wish to decline from the polling process, please press the star followed by the 2. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Patrick O'Rourke of ATB Capital Markets. Please go ahead.

Hey, good morning, guys. Happy to be on the ARC resources call here this morning. Just a quick question with respect to TACHI and the potential for moving forward with this project. Obviously, we're watching in terms of the regulatory environment and framework here, but just wondering if you do happen to come to the right regulatory framework, what the sort of cadence and timing of capital deployment and on stream for production would look like. Is there any seasonality that would slow that down or impact that in terms of the timing of those things? And then in terms of the capital for that particular project, do you think of it as drawing away from other initiatives or do you think of that capital as completely incremental to the current outlook for the company?

Thanks, Patrick, for the question. As it relates to ATACHI, as soon as we, I guess, understand that resolution timing and we get that clarity, we're prepared to move on ATACHI quickly. We're going to do it in our disciplined manner, though. We're not just going to drop everything we're doing in CAQA and move the rigs over. We'll make sure it's in an efficient manner. And then once we move those rigs over and get that activity going, we believe it's going to take 18 months to... still construct that facility and get it on stream. As for timing, we do not like to actually turn facilities on and commission them in the winter. So that would be the only thing from a timing perspective in that 18 months that might push out a few months from that perspective. And also, we like what we're seeing in CACWA. We have the financial capability to continue progressing in CAQA along with Sunrise and with ATACHI. So we look at it as just prudently adding on to our capital program and pursuing all the opportunities that we have already talked about being the Sunrise expansion, increasing CAQA in that $180,000 to $200,000 BOE a day range and also increasing be able to progress on ATACHI. This still allows us to continue on with our share buybacks and our plan dividend increases so we can actually do it all in the financial capabilities that we have today.

Okay, great.

And then that's probably a great segue in terms of the return to capital framework here. Just wondering, you're going to probably exhaust the NCIB here in August. There was mention of an SIB. in the release here. And then, of course, we have the avenue of measured dividend growth. How do you think about timing in terms of dividend growth? How do you think about scale and scoping of that so that it's sustainable going forward? And then how does a sort of SIP potentially fit into all that framework if you are able to buy back more than 10% or you're able to fully exhaust the 10% of the NCIP on an annual basis?

Thanks, Patrick. It's Chris here. Obviously, I think, and we alluded to this, we'll complete our existing NCIB here in the coming weeks. We'll apply to get a renewal of that NCIB in roughly a month's time. And really, that gives us quite a bit of flexibility on how we want to move forward over the coming months, you know, coming September 1st. In the event that we do exhaust the NCIB or choose to take a dual-pronged approach, We can investigate an SIB and make sure that we understand it is an effective tool to retire a large number of shares at a single point in time. That is a tool that we'll look at and see if it makes sense at the time. As far as the dividend, we had a large increase to it last quarter, so we didn't think it was time to touch it this quarter. Ideally, we'd like to get to a scenario where we're looking at the dividend and reviewing it once per year. And I think one of the more logical times to do that is when you're setting your guidance for the year, setting your capital plans for the year when you're in a normal course environment. As you know, we will also we'll test that dividend down to very low levels because clearly to be sustainable, it has to be sustainable in all pricing environments. So we'll just run our stress testing and make sure that we're comfortable.

We would not have to adjust it again.

Is there a certain sort of base case scenario in terms of commodity pricing that you're stress testing down to now, and has that changed with the inflationary environment?

Realistically, there's no one downside scenario that we test to. We still stress test our business down to $45 US WTI and $2 gas, and the business is resilient today. at those levels. So it's an extreme scenario, but it does just show the strength of the underlying business that we have.

Okay, thank you very much. Thanks, Patrick.

Thank you. The next question comes from Michael Harvey of RBC Capital Markets. Please go ahead.

Yeah, sure. Thanks. Good morning. So just kind of building on the prior question. So on the 2023 program, I guess, at what point would you need a green light from the BC government to start or preserve any kind of winter or full year 2023 drilling program there? So just trying to get a sense for kind of the decision points and the milestones on the calendar of when you kind of would have to make the call on the 23 program and where you're putting the capital.

Yeah, good question, Michael. It's Terry here. So at the start of this year, we planned for the BC government and that resolution to come late in the year. And with that, we were able to execute our business efficiently by just making the decision back then to say, okay, let's plan for it for the end of the year. If we know by the end of the November timeframe coming into December, and we're already thinking about it and planning accordingly, then we'll be able to go back into BC and start executing our business for the start of January in 2023. So that's kind of how we think that we are, because we're already thinking about it, we're already planning about it, so it doesn't take us long to actually switch gears and be able to execute on that.

And do you think it would take a period of time just to get the new or updated licenses and then, you know, train the people, move the rigs, all that kind of stuff? What do you think is kind of the timeline on that, recognizing there's a whole bunch of things we just don't know?

You know, I think I'm done speculating on timing. I still believe in a lot of things that they... all parties at stake know how insignificant this is. And so I think it's going to happen. And that means that they're already thinking about the process and how the OGC is going to be able to implement this in a timely manner to start approving permits. So I really can't say for sure, Michael, on that. But I know in conversations with OGC, this is on their minds too, that Yeah, once the resolution is reached, then they're not just sitting there going, oh, now we have to figure out how to actually implement it. They're already thinking about that. So I think it should actually be quite efficient, I guess, once the resolution comes to fruition.

Gotcha. Thanks for the color.

Perfect.

Thank you.

Thank you. Once again, ladies and gentlemen, if you do have a question, please press star 1 at this time. The next question comes from Eric Nuttall of Megapoint Partners. Please go ahead.

Hey, guys. I'm happy to hear more and more talk of SIBs. I just want to just circle back and get a little more specific. What would it take for you not to implement an SIB? We've got you hitting your debt target by Q4 of this year. We all agree valuation is profoundly dislocated from fair value. Investing in SIP, I think Imperial proves that it's highly effective. So I'm just curious, the talk of investigating and whatnot, the template is there, the playbook is there, the profound dislocation is there. So what would it take for you not to do it, assuming a strip pricing holds out?

Yep. Thanks, Eric. Fair question. And, you know, I agree with everything you said. And realistically, you know, if pricing hangs in there and free cash flow stays where it is, it's likely that we would. The one caveat, and we've said this about the NCIB as well all along, like we are value investors, it has to be the best use of capital at the time. And given current valuations, you know, that certainly would be the case. But if the valuation metrics change substantially, we would just make sure that we still think that is the best use of capital at the time. But if everything plays out under your scenario or even under our scenario, it's certainly a real possibility. And when we say investigating, as you know, we're a planning organization, just like Terry was talking about on the execution of our capital program. We don't like to leave things to chance. So we just want to make sure that we understand exactly how we would execute it the pros and the cons and some strategies around to make sure it's the most effective execution possible.

Just to clarify, what I'm hearing is if strip pricing holds out, if your share price doesn't reflect more closer to what we all think fair value is, and if I'm right that you hit your leverage metrics in Q4 this year, then we could be looking at SAB Q4 this year? Is that what I'm hearing?

Q4 this year in 2022 is probably not an issue. As we get the new NCIB in September, we expect we will go into that one pretty hard and go from there. But what I am saying is it is highly of interest, obviously subject to board approval, subject to TSX approval, those types of normal course things. But if the business plays out as expected, the balance sheet is taken care of, and if that's a good use of capital, that's certainly what we'll intend to do.

Perfect. Thank you.

Thanks, sir.

Thank you.

There are no further questions at this time. Please continue. Great. Thanks, everyone, for attending the call. Have a good weekend.

Thank you. Ladies and gentlemen, this does conclude your conference call for today. We ask that you please disconnect your lines and have a great day.