CPE - Callon Petroleum Company (CPE) Q1 2023 Earnings Call Transcript
2023-05-04 14:23:09 ET
Callon Petroleum Company (CPE)
Q1 2023 Earnings Conference Call
May 4, 2023 9:00 AM ET
Company Participants
Kevin Smith – Head-Investor Relations
Joe Gatto – President and Chief Executive Officer
Jeff Balmer – Senior Vice President and Chief Operating Officer
Kevin Haggard – Senior Vice President and Chief Financial Officer
Conference Call Participants
Zach Parham – JPMorgan
Neal Dingmann – Truist Securities
Derrick Whitfield – Stifel
Phillips Johnston – Capital One
Paul Diamond – Citi
Fernando Zavala – Pickering Energy Partners
Tim Rezvan – KeyBanc
Presentation
Operator
Ladies and gentlemen, welcome to the Callon Petroleum Frist Quarter 2023 Earnings Conference Call. [Operator instructions] Just to remind you today’s conference is being recorded. [Operator Instructions]
I will turn the call over Callon’s Head of Investor Relations, Kevin Smith. Please go ahead sir.
Kevin Smith
Thank you, Mallorie. And good morning everyone. I am joined by our CEO, Joe Gatto; our COO, Jeff Balmer; and our CFO, Kevin Haggard.
During our prepared remarks today, we will reference our release on the first quarter and our recently announced Permian and Eagle Ford transactions, as well as supplemental slide decks related to both. All these materials are available on our website, at www.callon.com.
Today's call will include forward-looking statements that refer to estimates and plans. Actual results could differ materially due to risk factors noted in our presentation and SEC filings. We will also refer to some non-GAAP financial measures that help facilitate comparisons across periods and with our peers. For any non-GAAP measures reference, we provide a reconciliation to the nearest corresponding GAAP measure in the appendix to our slide deck and in our earnings press release, both of which are available on our website. Following our prepared remarks, we will open the call for Q&A.
I would now like to turn the call over to Joe Gatto. Joe?
Joe Gatto
Thank you, Kevin. Good morning everyone. We are thrilled to have you with us today on this very exciting day for Callon. We delivered another strong quarter of performance highlighted by improved Permian cycle times and continued debt reduction. I will cover the first quarter highlights later in my remarks, but we're off to a great start in 2023.
I'll spend most of my time today discussing our accretive and transformative transaction in the Delaware Basin. Simply put, this deal is a great fit for us. It solidifies our focus and positions us as a leading operator in the Permian with more than 145,000 net acres and 107,000 Boe per day of production. It's contiguous with and complements our existing Delaware position where we have proven history of adding value and these high quality assets will be seamlessly integrated into our development model and will immediately compete for capital within Callon's broader Permian portfolio.
The cash portion of the transaction totaling approximately $265 million will be funded with a sale of our Eagle Ford position for $655 million in upfront cash. The transactions will be accretive to our absolute leverage and credit metrics. Our strength and balance sheet achieves our initial debt reduction milestone, allowing us to launch a share buyback program upon closing.
Let's tick through some more of the deal highlights. We're adding 18,000 net acres and about 14,000 barrels of oil equivalent per day of production from oil assets that sit contiguous to our core Delaware acreage. We are gaining a larger footprint in the Permian and increasing the critical mass of our operations. This will create opportunities for further capital efficiency improvements and economies of scale. This deal extends our decade-long Permian inventory of high return, oil-weighted drilling locations. We are adding 70 operated, long lateral locations, of which 90% have a positive PV-10 at $45 oil.
These locations are in the well-established Third Bone Shale, Wolfcamp A and Wolfcamp B intervals with additional potential in both shallower and deeper zones. This contiguous acreage position with Stack Pay Horizons sets up perfectly the application of our proven, "Life of Field" co-development model. Today's earnings deck highlights sustained well productivity benefits across our asset base in both the Delaware and Midland Basins that are driven by this model.
These transactions will improve our operating margins due to a similar pro forma oil-weighting and lower Loe per Boe. We have also identified more than $10 million in annual G&A savings and are confident that we will find other cost saving opportunities through the integration of the asset. This deal is priced right at 2.5 times EBITDA and provides an efficient way for us to exit the Eagle Ford and is highly accretive to key financial metrics, including a 15% uplift to adjusted free cash flow in 2023 and a 55% increase in 2024 at recent strip commodity prices. It also improves free cash flow per share by 10% in 2023, and after a full year of integration and synergies, 40% in 2024.
Per share metric accretion has the opportunity to further improve even before share repurchases, since the number of shares issued to the selling parties decreases to the extent that Callon's 20-day VWAP is above $32.50 at closing.
And importantly, we'll focus a hundred percent of our capital and operational teams on the Permian. This will yield stronger well economics, enhanced flexibility in project scheduling and improve cycle times. Together, this will reduce our reinvestment rates and increase the conversion of EBITDAX and the free cash flow. The bottom line, we will generate more free cash flow with our investment dollars through significant capital efficiency gains and cost savings as a focused Permian company.
From our forecast, you'll see that 2023 production will be relatively unchanged with the lower capital spend, despite the fact that we are selling more current production that we are buying.
Looking into 2024, we expect production to grow at a low single-digit rate year-over-year as contributions from the newly acquired assets increase.
The final point I'll make is the culmination of everything that I have covered on this call and perhaps the most important. As you know from recent conversations, reducing debt and initiating a shareholder return program, are our top objectives for 2023. These transactions get us there on both counts. Upon closing, our debt will be reduced by more than $300 million to approximately $1.9 billion, below our $2 billion initial debt milestone. We will continue to focus on de-leveraging and see substantial progress in 2024 towards our optimal debt target of less than $1.5 billion and leverage below one times.
Subject to closing, our board has approved a $300 million share buyback that we plan to execute over a two-year period. We believe that Callon's intrinsic value proposition, which will be significantly improved by these accretive transactions, is not reflected in the public market valuation, creating a very compelling case for a repurchase program moving forward.
Before taking your questions, let me quickly give you the main takeaways from the first quarter. First, we are executing extremely well. Our first quarter financial and operating results were in line or better across all key metrics. This gives us high confidence in our ability to deliver on our 2023 business plan. We are also maintaining our focus on capital discipline and balance sheet strength. We generate $7 million in adjusted free cash flow for the quarter, allowing us to realize our 11th straight quarter of debt reduction.
Second, our "Life of Field" co-development model is differentiating Callon from the pack. We provided a great deal of insight into this model last quarter and had discussions with many of you on the road over the last few months. We've implemented this model consistently over the last five plus years, and it underpins our longer term asset value proposition.
Third, we are seeing significant operational improvements. These gains are owed to scale, larger project sizes and deep knowledge and experience within our teams. We are drilling wells faster, pumping more completion stages per day, and using multiple rigs and completion crews on single projects. Increased D&C efficiencies, combined with our focus on simultaneous drilling and completion operations are rapidly reducing cycle times and increasing capital efficiency. All these factors contribute to strong momentum for our production outlook. We forecast that our second quarter production will be up over 5% to 105,000 to 108,000 Boe per day. We've updated our 2Q guidance in today's materials. And have also provided updated guidance for 2023 that assume six months of impact from the transactions.
In closing, note that our results year-to-date are strong and in line with our top priorities of investing in premier assets, generating free cash flow and reducing debt.
Today's transaction fits us perfectly, both financially and operationally. Financially, it allows us to achieve our near term debt milestone and launch a share buyback program this year. Operationally, it solidifies our focus on the Permian Basin. Similar to past acquisitions, we are highly confident that our "Life of Field" co-development model will allow us to add significant value on our new acreage in the Permian and enhance our cost structure and capital efficiency outlook.
And finally, I'd like to personally thank our talented Eagle Ford employees for their commitment and hard work. They have done an exceptional job operating safely and efficiently and have consistently made valid contributions to Callon.
This concludes our prepared remarks. We're now happy to take your questions. Mallorie?
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from Zach Parham with JPMorgan.
Zach Parham
Hey guys, thanks for taking my questions. Joe, first one for you. You mentioned 55% higher, 2024 free cash flow and 40% higher free cash flow per share following the transactions. Could you just walk us through some of the underlying assumptions, particularly on proforma CapEx and production volumes that that underwrite that number?
Joe Gatto
Yes, what we've talked about, you saw in the release, we're moving over the course of this year from seven rigs down to five, would expect similar type of cadence going into 2024. We'll fill in some more details go going ahead. But obviously with the efficiencies we pick up with just operating in the Permian go a long way on that front. Underlying assumptions of strip pricing as of a couple days ago are going to go into that. And production growth now, this is compared to a higher baseline in 2023 because we had six months of higher Eagle Ford production in the first half. But we see on top of that higher baseline that low single digits of production growth in 2024.
Zach Parham
Got it. Thanks Joe. And then maybe one just on well productivity and kind of your expectations from percussion, the 70 locations that you are acquiring, how do you think about the timing of developing those? In your prepared remark, you mentioned they would be immediately – or they would immediately compete for capital. But maybe just any thoughts on how those returns compare with your current Delaware Basin drilling program?
Joe Gatto
Yes, look, we think that they squarely compete for capital. They talked about similar to what we've done with acquisitions. We'll fill out some completion activity on their asset base over the coming months and then get going with our overlay of our model over the next 12 months and, and really start seeing some more of an impact in 2024. I guess with this asset base in particular, it's always worth going back and explaining how these asset bases have come to where they are. And the southern Delaware Basin is about learnings, right? And we have as much learnings as anybody in this part of the world to overlay our model.
So, previous operators we've seen pretty tight spacing, seven to ten wells per section at couple zones and under stimulation on completion designs. Now that's evolved with the current operator, it took over just under two years ago that they started moving to wider spacing, some increased completion design intensity. We've seen some progress there. They have also started very recently moving to what we've done over the last couple years on artificial lift and removing gas lift and just going straight to ESP. So we see a lot of opportunities to overlay our model just like we've done with Primexx and see the benefits over time.
So you put that all together with great rock that that's here, this is going to be an asset that's squarely competing for capital going forward.
Zach Parham
Thanks, Joe and team. Congrats on the deal.
Joe Gatto
Thank you.
Operator
Your next question comes from Neal Dingmann with Truist Securities.
Neal Dingmann
Hi, good morning guys. Thanks for the time, Joe. Again, congrats, I think, the deals look good. My first question is maybe just comments around the accretiveness of the deal. Can you walk through how maybe you and Kevin think about the future fee cash of the new deal versus the existing that you're selling? And also I assume part of that plays into the large amount of future fee that you now have to be drilled on this new acreage as well. If you could maybe hit both of those.
Jeff Balmer
Yes, let me make sure I'm answering the right thing Neal. Could you just quickly run me through that one more time? We were having a little bit of hard time here and I apologize.
Neal Dingmann
I'm sorry. Yes, just on the deal, I mean, there is always with existing assets, existing free cash that you are selling with those Eagle Ford assets and just how that compares with when you look at the free cash flow with the new deal, I mean, knowing that it doesn't have given production. And then where I was going with that second part of that is knowing that the deal also has a large amount of undeveloped inventory that's with more feet to be drilled. So I'm just wondering if you could maybe hit both the free cash flow, the two, how those compare and the deal being sold, the deal being bought, and then the future fleet being drilled.
Jeff Balmer
Yes, I guess, I got it. Couple of things that I will address there. One is like if you look at the assets just sort of in a vacuum, right, in terms of their profile, what's great about this asset we're acquiring typically with private equity that type of companies, we'll see a lot of drilling and maybe some steeper declines. This is not the case here. We see PDP declines around low 30% which is depending on what point in time you look at our Eagle Ford similar, maybe even a little bit better depending on the timing there.
So you have that nice base of PDP production helping you out on the free cash flow side. Obviously both assets in the Eagle Ford or with this new position in the Delaware, they have attractive inventory developed so they get their share of development dollars.
So from a free cash flow standpoint, they're somewhat similar on the baseline PDP, but we're going to have more opportunities for development on a longer term basis in this new Delaware asset just because our Eagle Ford inventory was getting a little bit short.
But that's in a vacuum, so if you move to putting this asset base into our model, right, in a more consolidated critical mass of Permian activity, there's just in – there's efficiencies we're going to get and improve free cash flow from being able to do that on a more streamlined basis going forward. So there's some pickups in terms of synergies that add to that baseline of shallower declines on the PDP.
Neal Dingmann
Yes. Great color. And then really appreciate that, and then my second question just on shareholder return, I know early in the plan my question, Joe, for you or Kevin, I know you're always prudently looking to keep your options open. But just any thoughts on how large you believe the shareholder return maybe should initially be or how that should grow? I know, you know, again I don't want to pin you down yet, but maybe just you or Kevin's thoughts on how you're thinking about what would make sense?
Kevin Haggard
Yes. Thanks, its Kevin. So at this point we have a two-year period of time authorized once this deal closes. So that would run through the second quarter of 2025, and that's a $300 million program. We haven't set quarterly targets for percentage of free cash flow or allocation percentages. The magnitude of the time in each quarter is going to depend on free cash flow, commodity prices, stock price et cetera. So we're trying to have some optionality here to create shareholder value, the best way we see to use that free cash flow.
I would give you some additional guidelines here. We expect to pursue the additional $400 million of debt pay-down to reach that 1.5 billion number, and to do that side-by-side with that two-year $300 million share repurchase program. I guess I'd offer one other point of data here, I would say in the mid-to-low-70s WTI oil price there is – there's more than enough cash flow to cover both the share repurchase objectives and the debt pay down over that two-year period of time.
Neal Dingmann
No, love the optionality. Thanks Kevin. Thanks Joe. Congrats again.
Joe Gatto
Thanks Neal.
Operator
Your next question comes from Derrick Whitfield from Stifel.
Derrick Whitfield
Thanks. Good morning, all and congrats on your transformative transactions.
Joe Gatto
Thanks Derrick.
Derrick Whitfield
With regard to the acquisition, could you speak, I think you've referenced earlier some degree of activity, but could you maybe outline current activity on the asset today and your plans to integrate it within the portfolio and the degree of synergies you see with the acquisition?
Joe Gatto
Yes. So today we'll be stepping in, we're going to do some completions as the year rolls on. They've moved – they've taken down their rigs. There's no – there's not going to be current activities as we step in, which is good, right? So it allows us to direct activity in our development model the way we want. A lot of times that's not the case, so we're starting with a bit of a clean slate, but we are going to have a chance to employ our completion designs on some of the activity that we're stepping into.
Moving forward it's hard to just discreetly point out where the synergies are? Like again it goes with a broader models; we go in and really try to optimize the combined development program. But I think you get a sense of that certainly from the pre-cash flow per share and absolute pickup going forward. But the flexibility in scheduling, employing our learnings and models does go a long way. And I think we've shown those synergies to a large degree with the Primexx transaction over the last couple of years.
Derrick Whitfield
Terrific. And then with regard to the acquisition, could you just speak to how it came together, and if it was your or the seller's preference for Callon stock?
Joe Gatto
Yes. A lot of these deals come together over many, many months. Certainly when you have two pieces of the puzzle, it takes a lot of time, so that's a whole another sidebar conversation. But these are assets that we've kept an eye on for a long period of time, going back to when they originally were sold by Ford. So we know this area quite well, and then we have been thinking about what is the best way to approach an acquisition as Callon today and achieve all of our objectives we talked about the financial side and start thinking about the Eagle Ford and how that fits into the mix. So it's been something we've been percolated on for quite some time and it took a long time to get here, but it's great that we're here.
And yes, on the equity side it was a clear ask out of the sellers that they wanted some upside here, right? They have other opportunities to sell for all cash. But it was clear and it took some time to get our head around that, just given where we were trading. But given the accretion we saw on this transaction and also overlaying this mechanism that we hope that the stock performs well between now and closing we'll be able to claw back some of those shares as well.
Derrick Whitfield
That's terrific. Great update guys. Thanks for your time.
Joe Gatto
Thanks Derrick.
Operator
Your next question comes from Phillips Johnston with Capital One.
Phillips Johnston
Hey guys, thanks and congrats. Just one from me; it looks like the rig count on the Percussion property has trended down from around three or so at this time last year to one as of a few months ago. And the production does seem to have kind of leveled off over the last six to nine months or so. So I'm guessing that PDP decline rate on the properties isn't super high, but can you maybe talk about how these two transactions will affect your company-wide 12-month PDP decline rate?
Joe Gatto
Yes, you are right. The activity has been coming down and it has helped to shallow out the PDP decline profile that right now somewhere in the low-30s, which is somewhat where we are as a company, maybe even a little bit better. So overall it's neutral to maybe a slight benefit to overall corporate decline.
Phillips Johnston
All right, perfect. Thank you.
Joe Gatto
Sure.
Operator
Your next question comes from Paul Diamond with Citi.
Paul Diamond
Good morning, all. Thanks for taking my time and congratulations on the transaction. I just wanted to touch this quickly on some of the efficiency gains we've seen in your drilling program over the course of the last 18, 24 months. How does the – I guess how does the kind of repositioning away from Eagle Ford and into or primarily into Permian. Do you see any kind of step change in that trend, or should we expect that kind of continue on that?
Joe Gatto
Yes. Generally speaking, it's been absolutely outstanding performance both on the drilling and completion side. The teams are never satisfied. So what we do is we take a look at what we call the perfect well, so we apply a limit or theory where we break down each individual component of the drilling and completions everything from starting and moving the equipment in to how we turn the wells online and connect into the facilities and flow lines. So we anticipate that this new acreage that we have coming in, which has been developed very nicely. Will integrate extremely well into the things that we do well, so we would anticipate – I can't stand here hand-on-heart and say, well we'll see another 20% in the next six months. But we're extremely proud of the performance that we've had and the results speak for themselves.
Paul Diamond
Understood. Thanks for the clarity. And just another quick kind of housekeeping one. As far as your hedging strategy, does the – those transaction really shift any of that kind of 30,000 foot strategy or should we expect that to really continue on path?
Joe Gatto
Yes. So thanks. That's a good question. Our strategy hasn't changed, which is really we kind of are targeting around a 30% WTI hedging over the next 12 months on a roll-in basis. Right now we did – we did inherit or will inherit some hedges from their book, which will take us closer to high-20s on a hedge basis for the back half of the year. And we are currently in the 17%, 18%, 19% range on that hedging. So we gained some incremental hedges from them, but it doesn't take us over the level we view as our strategy, which is that 30% of next 12 months WTI.
Paul Diamond
Understood. Thanks for the clarity. Congratulations again.
Joe Gatto
Thanks Paul.
Operator
Your next question comes from Fernando Zavala with Pickering Energy Partners.
Fernando Zavala
Hey guys, good morning. Just a quick one from me. So pro forma for the deals, do you see any material changes to your cash tax status heading forward?
Joe Gatto
Yes. It's a good question, and the answer is we're still sticking with our original guidance for cash taxes for 2023, and that is $5 million to $15 million guidance which we offered on the Q4 call. No change from either of these two transactions. No additional limitations on NOLs et cetera.
Fernando Zavala
Okay. Great. Thanks. And then just another one follow-up on your comments around the low-single-digit production growth; is that similar on oil and equivalent, or is it weighted to one or the other?
Joe Gatto
Pretty similar. We're stepping into asset base with 70-plus percent oil, which is relatively similar to Eagle Ford, so no meaningful changes there.
Fernando Zavala
Great. Thanks.
Operator
Your next question comes from Tim Rezvan with KeyBanc.
Tim Rezvan
Hey, good morning everybody. Thanks for taking my question. First one maybe for Kevin, when we think about the net cash proceeds, I guess its $390 million, is there any tax leakage we should be baking in? Is there, or anything else that would affect that that net balance?
Kevin Haggard
Sorry. So I think I heard you say it's 300 – about $310 million of kind of net cash that will be applicable to, to paying off the RBL, as a result of this transaction and no cash tax leakage here.
Tim Rezvan
Okay. $310 million is in net amount, okay.
Kevin Haggard
Yes, after [indiscernible].
Tim Rezvan
Yes.
Tim Rezvan
Okay. Okay. In my follow up, I guess that more for Joe. In the past in our discussions with investors, some of the hesitancy from buying Callon shares kind of stem from the frequency and size of acquisitions that that you've undergone, and as you think about coming up on the close on this in July, I guess what's the new message to investors about the willingness or appetite for future deals now that you've transformed the portfolio like you have?
Joe Gatto
Look, I think we've shown over the last couple years we're very focused on our financial objectives and this is a very important step that we're taking here. But we've figured out creative ways to, number one, find assets are going to compete for capital and benefit from our overall methodology and we'll continue to look for opportunities to overlay our model and add value to asset bases paying reasonable prices.
I think every company should be looking for opportunities like that. I think it will ultimately add value, but we have to be realistic and we're going to be very selective just given the quality of the inventory we have, it's a high bar to find assets like that. And then certainly how do we finance these items? I mean, this is a pretty unique situation in terms of having the Eagle Ford be a source of proceeds here. So we don't have another Eagle Ford position. I guess it's a long way of saying we'll be very smart about it. Obviously laser focused on continued debt reduction and now share returns, but we're in the business of looking for opportunities to step into positions and add value as an operator that done that in the past.
Tim Rezvan
Okay. Okay. I appreciate that. And congratulations on the deal, it's really a pretty impressive transformation. Thanks.
Joe Gatto
Thanks Tim.
Operator
There are no further questions at this time. I would now like to turn the call back over to Joe for closing remarks.
Joe Gatto
Thank you everyone for joining. Hopefully we've been able to provide a lot of detail on a transaction that we're very excited about here. I think checks all the boxes for what we've been talking about with you all over the last couple of years frankly to get to this point. So we're all excited. I'm sure we'll be talking more going forward, and as always, please let us know if you have any more questions. Thanks again.
Operator
This concludes today's conference call. You may now disconnect.
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Callon Petroleum Company (CPE) Q1 2023 Earnings Call Transcript