Hess Midstream LP
Q2 2021 Earnings Call Transcript

Published: 28 Jul 2021

[Operator:]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2021 Hess Midstream Conference Call. My name is Michelle, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Jennifer Gordon, Vice President of Investor Relations. Please proceed.

[Jennifer Gordon:]

Thank you, Michelle. Good afternoon, everyone, and thank you for participating in our second quarter earnings conference call. Our earnings release was issued this morning and appears on our website www.hessmidstream.com.

[John Gatling:]

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's Second Quarter 2021 Conference Call. Today Jonathan and I will review the highlights from a series of announcements that Hess Midstream and Hess Corporation made earlier this morning. We'll also discuss our operating performance and financial results as we continue to deliver our strategy, provide an update to our 2021 guidance, and review Hess Corporation's latest results and outlook for the Bakken. The announcements we made this morning, delivered multiple positive catalysts for Hess Midstream. First, we reported strong second quarter results that surpassed our quarterly guidance, driven by increasing gas capture and lower-than-anticipated operating costs. Second, driven by strong performance in the first half of 2021, we're raising our key full year throughput and financial guidance and confirming our transition to significant free cash flow generation. Full year adjusted EBITDA is now anticipated to be in the range of $880 million to $900 million, representing an increase of 19% at the midpoint compared to full year 2020. Third, Hess Midstream announced a 10% increase in our distribution per share level relative to the previous target, allowing us to use our financial flexibility to return free cash flow to shareholders on an ongoing basis, while maintaining at least 1.4 times coverage. Fourth, the Board of Directors of our general partner also approved a $750 million unit repurchase from Hess Midstream sponsors. The unit repurchase optimizes our capital structure to a conservative three times adjusted EBITDA leverage target and generates ongoing accretion to shareholders. The repurchase and distribution increase demonstrates the strength of our financial position, and allows us to deliver an immediate and meaningfully accretive return of capital to our shareholders.

[Jonathan Stein:]

Thanks John and good afternoon, everyone. As John described we are pleased to have made some important announcements this morning that deliver immediate, accretive and meaningful return of capital to Hess Midstream shareholders. First, we are returning excess free cash flow to shareholders through an increase in the level of our distribution by 10%, while continuing to target 5% annualized growth through 2023. As we said before, the dividend is an output, not an input that should be consistent with our financial metrics and strategy. We are unique in that we have the visibility and balance sheet to deliver an ongoing and lasting return of capital to our shareholders. Second, we are optimizing our capital structure through an accretive $750 million repurchase of units from our sponsors that brings our leverage to three times adjusted EBITDA on a full year 2021 basis. We believe that a conservative three times adjusted EBITDA leverage target is the optimal capital structure for our business and are excited to execute on our financial strategy today. After these announcements, we will continue to have financial flexibility, including distribution coverage of at least 1.4 times, expected ongoing free cash flow after distribution and leverage declining below our three times adjusted EBITDA target, as early as 2022, allowing for potential future accretive opportunities, including incremental return of capital to shareholders. Let me provide some additional details on these announcements. Our second quarter distribution represents an approximate 11% increase, compared to the distribution for the first quarter of 2021, including a 10% increase in the distribution level, in addition to a quarterly increase, consistent with Hess Midstream's targeted 5% growth in annual distributions per Class A share. Hess Midstream continues to target annual distribution per Class A share growth of at least 5% through 2023 from this new higher distribution level and expected annual distribution coverage of greater than 1.4 times. The quarterly distribution will be payable on August 13, 2021 to Class A shareholders of record, as of the close of business on August 9, 2021. Turning to the unit repurchase. The $750 million unit repurchase from Hess and GIP is consistent with Hess Midstream's three times adjusted EBITDA leverage target on a full year 2021 basis. It's expected to be approximately 8% accretive on a distributable cash flow per Class A share basis. The unit repurchase is expected to result in distribution savings to Hess Midstream of approximately $30 million in the second half of 2021 on a consolidated basis.

[Operator:]

Our first question comes from the line of Jeremy Tonet with JPMorgan. Your line is open. Please go ahead.

[Jeremy Tonet:]

Hi, good afternoon.

[John Gatling:]

Hey, Jeremy. Good afternoon

[Jeremy Tonet:]

Hi. Just wanted to touch base on the big news today and just wanted to see big allocations of capital going back to the shareholders through the buybacks. I'm just wondering, if you could talk a bit more on the process there and -- as how you got to that decision. Can you share any thoughts on how you evaluate buybacks versus M&A or drop-downs and leaving capacity for that in the future? Just want to kind of see if that's something that -- what your latest thoughts are on drop-downs at this point?

[John Gatling:]

Yes. Maybe I'll just -- I'll start and then Jonathan, can -- just from the standpoint of drop-downs and assets within Hess. GoM continues to still be an option for us. But it's become clear that it's really not going to happen this year. It's a great opportunity but we really don't need it to achieve our targets. So with that I'll hand it over to Jonathan.

[Jonathan Stein:]

Thanks, John. Right. So with that background we look forward at our capital structure for the year. As I mentioned, in my remarks at the end of the quarter we were 2.2 times EBITDA in terms of leverage as we look forward. By the end of the year we had always said we'd be at 2 times had we done nothing at this point. So rather than let our capital structure become suboptimal we've always said that we believe 3 times EBITDA is the optimal capital structure for the business. And given the fact, that we're free cash flow positive after distributions, we thought this is the right opportunity to be able to execute on return of capital both in terms of using that leverage for buyback as we discussed in a very accretive way but then also to be able to increase our distribution on an ongoing and long-term basis that can be supported and still be free cash flow positive after distribution. And I think it's important to highlight that even after these transactions, we'll continue to be free cash flow positive. We'll continue to have distribution coverage of 1.4 times and most critically our leverage will continue to decline as we look forward. As early as next year, we'll already be below again our 3 times leverage target. So that means that opportunities, whether it be investments like Gulf of Mexico drop down or other bolt-on opportunities or potentially additional incremental return of capital to shareholders, will continue to be something that we can continue to execute in the future in the really near term. And we have the financial flexibility just about as much as we had before going forward and continue to have that going forward to be able to execute on those -- on that strategy.

[Jeremy Tonet:]

Got it. So it sounds like even after this large buyback and dividend increase still a lot of financial flexibility to execute in -- I guess across a number of different measures. So that's great to hear. Maybe kind of pivoting towards growth CapEx. I think you discussed growth CapEx could increase next year with higher Hess activity. I was just wondering, if you could boil down a little bit more what that might look like if that's compression well connects or anything bigger that we should be thinking about here?

[John Gatling:]

Yes. No. I mean with the TGP expansion behind us and the turnaround ongoing now, we'll have the processing capacity that we need here in the near-term. So most of the CapEx it's going to be increasing. In particular in 2022, it is going to be tied to the greenfield compression that I mentioned before. That will be a little bit associated with well connect with the acceleration of the third rig and potentially a fourth rig, but right now it's mainly driven from the compression CapEx and the well connects.

[Jeremy Tonet:]

Got it. That's helpful.

[Jonathan Stein:]

Yes I mean I would just add with that background. So even in -- as next year we may see as John described, some higher CapEx I do -- just reemphasize that with that we're still going to be as you know our revenues next year are going to be growing based on growing MVCs. About 18% growing MVCs on the gas side that's about 70% of our revenues. And then CapEx even with a slightly higher CapEx still below let's say, historical levels certainly 2020 or below. We're still going to be free cash flow positive after distributions next year. So we'll still maintain significant financial flexibility. And as I mentioned, of course, we'll continue to delever as a result. So really in just a great position even with that being able to support Hess ramping up our rigs.

[Jeremy Tonet:]

Got it. That’s very helpful. I will leave it there. Thanks.

[Jonathan Stein:]

Thank you.

[Operator:]

Thank you. And our next question comes from the line of Brian Reynolds with UBS. Your line is open. Please go ahead.

[Unidentified Analyst:]

Hi. Good afternoon, everyone and congrats on the announcement this morning. As a follow-up to Jeremy's question on capital allocation. Just looking ahead into 2022 and 2023. How should we -- I mean should we be effectively targeting a specific payout ratio assume all growth or M&A high-teen return hurdles have been met. I guess just any color around that? Should we be targeting maybe free cash flow neutral after dividends as a way to return capital to shareholders assuming all growth for Hess has been met? Thanks.

[Jonathan Stein:]

Yes. Look in terms of our financial strategy it continues to be what we've said which is that we believe that three times EBITDA leverage target is the optimal capital structure. We've also said that in terms of our distribution and dividend policy that we believe it should be an output not input meaning it should be consistent and something that's sustainable and meets with our financial strategy and our financial metrics. So as we go forward today we're really just executing on that strategy. And then as we go forward we'll continue to do that to the extent that we're below our target level. We'll be looking for opportunities to optimize our balance sheet to the extent that there are investment opportunities whether it be drop-downs or bolt-ons. Certainly, we will take advantage of those. And to the extent that they're not there we don't have visibility to those and looking at our forecast in terms of free cash flow growth and our leverage profile then we'll continue to execute on our strategy as we did today by using our financial flexibility for additional return of capital to shareholders. Whether that be in the form of buybacks or distributions I think the good news for us is that we have the financial flexibility to be able to as we did today execute both.

[Unidentified Analyst:]

Great. Sounds like 3 times leverage is the target there. As a follow-up on gas capture you guys were hovering on MVCs for gas gathering for the quarter. Was just wondering about the future gas capture opportunities for you guys. Is there more wood to chop? And how would you help characterize like what percentage of the increase in gas gathering for the quarter was attributable to reduction in flaring or just higher GORs on your footprint in general? Thanks.

[John Gatling:]

Sure. And maybe I'll just start off with -- on the well side. As you know there really hasn't been a change in well performance from a gas to oil ratio perspective. So it's primarily associated with the gas capture. And as Hess mentioned earlier today they're running below 5% flaring. And obviously the state target is set at 9%. So they're exceeding expectations from that perspective. But as John Hess mentioned earlier and Greg also discussed on their call they've got -- there's a commitment to continue to drive flaring down continue to have a more positive impact from a sustainability perspective. So from that perspective, we're continuing to -- continue to aggressively chase the gas and make sure that we're able to capture it and get that to the level as low as possible. So again, I mean, I think we've made strides over the last several years in helping Hess get below the 5% flaring level. But I think as we continue to build out our infrastructure we're going to continue to see improvements in that area. So that is going to continue to be a focus for us. And that's part of the reason why the two additional greenfield compressor stations are going to be added along with the associated gathering system to support that.

[Unidentified Analyst:]

Great. That’s all from me. Have a good day. Thanks.

[John Gatling:]

Okay. You too. Thanks.

[Operator:]

Thank you. And our next question comes from the line of Praneeth Satish with Wells Fargo. Your line is open. Please go ahead.

[Praneeth Satish:]

Thanks. Good afternoon. Just one question for me. We're seeing inflation picking up on traditional metrics like CPI and PPI. From a HESM perspective -- sorry recovering from a cold. What kind of tariff increase should we expect in 2022? I think you have inflation escalators across all your contracts. And then as a follow-up do you think that revenue increase will all flow through to EBITDA? Or do you think some of that revenue increase will get eaten up by higher costs? Thanks.

[John Gatling:]

Maybe I'll take the actual -- the execution inflation then I'll let Jonathan talk a little bit about the inflation structure kind of the CPI built into the contract. But from an inflationary perspective, we are seeing some cost increases, but we continue to leverage our technology and innovation and lean activities to try and offset the inflation. So from our perspective, the big areas where we are seeing price increases is around steel. It's around the cost associated with steel and associated chemicals. But overall we feel like that, we're able to moderate that. And with our operational efficiencies offset the pressures we're currently seeing, from an inflationary perspective. So with that I'll hand it over to Jonathan, for the contractual piece.

[Jonathan Stein:]

Right. So thanks. In terms of the contract mechanics, I mean, first, in terms of as you mentioned there is an inflation escalator that can -- backs out up to 3%. So we will certainly pickup. Some of that inflation will go into the rates. In terms of costs, the costs will really go into the rates but essentially we also as we have been discussing, we are going to have certainly higher volumes on a longer-term basis. Next year, we still expect to be primarily MVC driven beyond that. Certainly there's opportunity for volume growth as John's talked about, from Hess increasing production and as well as continued gas capture. So I think in terms of the mechanics, we're not necessarily expecting significant rate increase just driven from the mechanics of volumes and costs, although, we will certainly pickup any inflation. But again that will be within the range that -- up to that 3%. So besides that not really expecting any significant change, really we think the real driver going forward will be again MVC volumes -- MVC levels going up next year. And then, as we move into 2023, organic growth driven by growing Hess production and gas capture.

[Praneeth Satish:]

Got it. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Doug Irwin with Credit Suisse. Your line is open. Please go ahead.

[Doug Irwin:]

Hi guys. Thanks for the question. Maybe just as a follow-up to Brian's question on gas capture, if you look at gas volumes this quarter, they're above MVCs, and just curious with the projects coming online and Hess adding 1/3, and they even talked about potentially adding a fourth rig on their, call this morning. Just wondering, if there's a scenario where we could potentially see some upside versus MVCs in 2022, maybe ahead of expectations?

[John Gatling:]

Yeah. So from a 2022 perspective, if you remember the 2022 was set at a higher rig rate back when Hess was still running at six rigs. So, we're going to be at or slightly below MVCs or anticipate to, be at or slightly below MVCs in 2022. But as we move into 2023, we see opportunity for continued volume growth with the addition of the third rig and potentially the addition of a fourth rig. So we do anticipate being above MVCs in the longer term. So overall, I mean, I think we're well positioned. 2022 is going to be kind of a transitional year for us and then we'll begin to see that volume growth again and start to get above the MVC levels.

[Doug Irwin:]

Okay, got it. That's helpful. Thank you. And then, maybe back to just some of the potential accretive opportunities you talked about. In the absence of the Gulf of Mexico just kind of curious what kind of opportunities in terms of bolt-ons, you think would make sense for HESM? And I guess, specifically, are you looking just at the Bakken? Or would you be interested in potentially looking at opportunities in other basins?

[John Gatling:]

Yeah. I mean, our -- I think we've been pretty clear that our focus is the Bakken. Our focus is taking care of Hess and our other customers in the basin. So that is our priority. As we talked about, Gulf of Mexico is definitely an attractive opportunity for us and something that is available to us. We don't need it from a growth perspective. But it is something that we're continuing to work through. And can pull that trigger pretty much anytime. We're ready for that. Again, there's no plans to do anything this year for that. And back to the Bakken, as far as our infrastructure goes we definitely see opportunities to continue to build on our strategic footprint. And that's the priority. It's really a priority around Hess and our third-party customers. And where the infrastructure adds strengthen our footprint strengthen our ability to take care of our customer needs and make sure that we're able to get them to market. So, we would definitely look at opportunities for bolt-ons. There are going to be smaller opportunities, I would say. And I would say -- and the other piece that's again really important to emphasize is it's all -- it represents all upside for us. It's all growth potential, so nothing that we've built into our plans as of yet, but we're always interested in strengthening our position and that continues to be a focus for us.

[Doug Irwin:]

Yeah. That's all I have. I'll leave it there. Thank you.

[John Gatling:]

Okay. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Alonso Guerra-Garcia with Scotiabank. Your line is open. Please go ahead.

[Alonso Guerra-Garcia:]

Hey, guys. Appreciate the time. A couple here. I hope it's pretty brief. But wondering about the -- more about the 10% distribution increase that came along with the sponsor buyback announcement. Of course, that's in excess of the 5% growth target. So was this more of a onetime rightsizing of the distribution level? I guess, I'm just curious about the decision to lift that meaningfully. And if that's something that sort of stays in your playbook for the future just given that guidance of growing by a minimum of 5%?

[Jonathan Stein:]

Sure. So as we've always said the way we look at the dividend is what's the right output, what is sustainable, what is consistent with our financial metrics. As we look forward, as we had said, we're going to be free cash flow positive after distribution still above 1.4 times coverage even with this distribution level step up. And even after this distribution increase, we're still going to be $75 million of free cash flow positive after distributions this year. And as I said earlier, we'll continue to be free cash flow positive after distributions again next year. So we're really in a unique position that we're able to not just do some type of special one-time dividend, but actually to be able to provide ongoing and lasting return of capital to our shareholders through a step-up in the level. And again, we're stepping up the level of distribution by 10% and then we'll be growing off that new level 5% going forward on an annualized basis. So really for us that's the right output. It's sustainable. It's consistent with our financial metrics and with our strategy.

[Alonso Guerra-Garcia:]

Got it. That's helpful, Jonathan. Thanks. And then I guess as a follow-up on activity in the Bakken. I guess -- so Hess obviously third rig, potentially fourth rig by the end of next year. I'm just wondering what you're seeing in terms of activity increases from the third-party customers? And ultimately, how you see that kind of playing into the mix of the third parties for your business for the foreseeable future?

[John Gatling:]

Sure. Just from the standpoint of third parties just to hit that first. I mean, we've continued to see pretty stable volumes coming from third parties about 10% on the gas and 15% on oil. And so that's kind of our revised forecast or estimate going into the future. Now as I just kind of look at the basin more broadly, there definitely is activity ramping up across all producers. So it's not just Hess, there's other producers as well. And so that does represent upside for us. But until we start to see that coming into the system that will be something that we'll continue to monitor and manage. The fortunate thing that we have is the infrastructure is in place. We're already connected to a lot of these customers as it is. So as they grow their volumes, we're well positioned to capture that upside. And so from our perspective, we're forecasting the 10% and 15% respectively between gas and oil. And then looking at opportunities as the broader basin ramps and to be in a position to help our customers capture their volumes and meet flaring reductions and capture water and oil as well and get to the best markets available.

[Alonso Guerra-Garcia:]

Got it. Make sense. Thanks, John. I’ll leave it there. Thanks.

[John Gatling:]

Okay. Thank you.

[Operator:]

Thank you very much. This concludes today's conference. Thank you for participating and you may now disconnect. Everyone, have a great day.