Magnolia Oil & Gas Corporation
Q3 2018 Earnings Call Transcript

Published: 15 Nov 2018

[Brian Corales:]

Good morning, everyone. Welcome to Magnolia Oil & Gas' Third Quarter 2018 Earnings and Inaugural Conference Call. Participating on the call today are Steve Chazen, Magnolia's Chairman, President and Chief Executive Officer; and Chris Stavros, Executive Vice President and Chief Financial Officer. As a reminder, today's conference call contains certain projections and other forward-looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that may cause actual results to differ materially from those expressed or implied in these statements. Additional information on risk factors that could cause results to differ is available in the company's proxy statement filed with the SEC. A full safe harbor can be found on Slide 2 of the conference call slide presentation with the supplemental data on our website. You can download Magnolia's third quarter 2018 earnings press release as well as the conference call slides from the Investor section of the company's website at www.magnoliaoilgas.com. I will now turn the call over to Mr. Steve Chazen.

[Steve Chazen:]

Thank you. Well, seems like just yesterday I was -- I ended my 63rd call -- earnings call at Occi, given my current age is unlikely that I'll be able to do 63 here. So in my remarks, I'll referred to both GAAP and pro forma financial information. Chris will discuss this in more detail, but for reference, the pro forma information includes the results of the Karnes assets, Giddings assets and the subsequent Gulftex assets that were acquired by EnerVest on March 1, 2018 for all periods presented and excludes transaction costs. Literally, the financial statements to read are fairly complicated and the most useful, I think, is to talk about the pro forma. When we originally set out to create a publicly traded independent E&P company, which is now Magnolia, we did so with the understanding that had to be investable within an energy sector that had generally struggled to perform both absolutely and relative to the S&P 500 over the last decade. Our business model was designed to be differentiated and with the primary objective to generate stock market value over the long term. Our strategy was to establish company's characteristics would demonstrate a certain basic set of criteria that would appeal to generalist investors, who are more accustomed to an industrial model. There were several basic elements to our business model and we're off to a good start so far as we've exceeded on the delivery of our objectives. We've summarized this on Slide 4 of the presentation slides. We expect to generate real GAAP net income and growing earnings per share overtime. Magnolia's pro forma net income for the third quarter of 2018 was approximately $58 million and a $151 million in the first 9 months of this year. One of our goal is to generate high operating and full cycle margins. As you can see on Slide 8, we generated pretax operating margins of 23% on a GAAP basis and more than 41% on an adjusted basis, during the period that Magnolia owned the assets in the third quarter of 2018. We plan to spend within 60% of our annual EBITDAX or gross cash flow generation on drilling completing wells and in order to achieve moderate production growth of 10% to 15% a year. We had originally said this level of spending is expect to deliver approximately 6,000 BOE per day of annual organic production growth for the company. As our organic production growth is well ahead of our expectations this year, we're in the midst of recalibrating our outlook for 2019. And we'll have more to say about that production as we move forward into next year. In any event, this level of spending and growth is expected to result in meaningful free cash flow generation. For the nine months ending September of this year, $285 million of capital were spent on drilling completing wells, which represented 50% of our pro forma EBITDAX for that period shown on Slide 9. Our third quarter 2018 pro forma production approximately 55,200 BOE a day, exceeded our previous guidance and provided year-over-year organic production growth of 59%. Bear in mind that much of this growth is achieved during the period when we're only running one rig in our Karnes County assets. Our strategy is to maintain a very strong balance sheet with a low amount of leverage. We have approximately $400 million of long-term debt at the end of the third quarter, which is less than a half of turn or our annual-wise pro forma EBITDAX for the most recent quarter. We've an undrawn revolving credit facility of $550 million at the end of the quarter. As part of our plan, we expected approximately 40% of our annual gross cash flow to be free cash flow or undesignated and beyond our needs required to achieve our moderate annual production growth targets. The free cash flow will be used for accretive acquisitions, share repurchases and debt reduction. During the third quarter, we announced the acquisition substantially all of South Texas assets of Harvest Oil & Gas Corporation were $133 million in cash and 4.2 million Magnolia shares. The assets produced approximately 4,800 barrels a day during the first half of 2018 and added approximately 114,000 net acres to our Giddings Field position and 1,500 net undrilled locations to our core Karnes County inventory. The transaction closed at the end of August. We continue to evaluate several small to medium-sized bolt-on acquisition opportunities that fit our business plan, have similar financial and operating characteristics Magnolia's existing assets. During the third quarter of 2018, we operated three drilling rigs across our acreage with two rigs in Karnes County and one rig in the Giddings Field, with a plan to continue this level of activity for the remainder of the year. Our third quarter production partially benefited from a step in nonoperated related activity. Our production in Giddings saw a sequential quarterly increase of 3,800 BOE a day to 13,800 BOE per day in the third quarter. As all the completion of several new wells during the period was one month of production from the Harvest acquisition. We expect to see further growth on production in Giddings for the fourth quarter as a result of additional well completions. Looking into next year, we expect to add a second rig in Giddings in the first quarter of 2019, to appraise and delineate the opportunities within our large net acreage position. All in all, we're off to a terrific start and are very pleased with what our assets have delivered so far. Our 2018 development plan continues to exceed our original expectations, while generating significant free cash flow after capital. Our pro forma EBITDAX of $575 million for the year-to-date running at a pace that is well ahead of what we had forecast when we announced the original transaction with EnerVest back in March. As we look forward into 2019, we are very optimistic regarding our prospect of opportunities, which should allow us to continue to deliver on our business model objectives and help enhance Magnolia's stock market value. I will now turn the call over to Chris Stavros, who'll review our third quarter financial items and operating highlights in greater detail, and also provide some guidance for the fourth quarter. Chris?

[Chris Stavros:]

Thank you, Steve, and good morning, everyone. Before I walk through some of the numbers, I'd like to talk for a moment about the corporate structure and financial recording implications that you may notice as a result of the business combination. As a result of the closing of the transaction with EnerVest in the third quarter, U.S. GAAP requires us to present the financial statements for the period prior to the acquisition, which include the results of only the Karnes County asset as the predecessor, while the financial statements on or after July 31, include the results of both the Karnes County and the Giddings Field assets and one month of the results of the Harvest acquisition, which we refer to as successor. We were also required to allocate the fair market value of the acquisitions to our individual assets, including oil and gas properties based on their estimated fair values. As a result, the financial statements on or after July 31 lacked comparability with those prior to that date. We recognized that this required presentation format may make it difficult to compare the predecessor's successor periods. So wherever possible, we will try to provide additional context between the two periods in order to try and help you understand the underlying financial and operational trends of the business. We will also sometimes refer to pro forma information, which includes the results of both the Karnes and the Giddings assets as if they had been combined as of January 1, 2017. As Steve noted, the pro forma results also include the results of the GulfTex acquisition that occurred on March 1, 2018, as if it had been included in all periods presented, but exclude any nonrecurring items such as transaction costs. Additionally, it's important to note that Magnolia has adopted an upsea structure in order to preserve certain tax benefits to both Magnolia and the sellers of the Karnes County assets. The consequence of this structure is two classes of shares

[Operator:]

[Operator Instructions] Our first question comes from the line of Neal Dingmann from SunTrust.

[Neal Dingmann:]

Steve for you or Chris, my question is really just when you add that second rig or maybe talk about both the rigs in the Giddings Field. Could you talk about where you believe the focus will be there at least initially to start off next year?

[Steve Chazen:]

No. With the second rig especially, we'll be looking at different areas, not necessarily where we've drilled so far to try to see what that might be there probably some in the south and then some probably in the -- in our northeast -- northwest corner of it right now. As the results come in, that rig is in development mode and so we'll probably move that around as the year progresses. It's still -- we're still really in our early days of this, and I think the planning should be viewed as flexible for the next year.

[Neal Dingmann:]

Okay. And then just lastly, anything you could add, just I know you guys have been great on bolt-on acquisitions on timing behind the use, many things and the size potentially?

[Steve Chazen:]

Well, we look at a lot of stuff. So and we just -- we expect there'll be some in this quarter, probably fairly small, but we don't -- we're not interested in large public deals. And they're not very many of these large private deals either. So I would accept that there will be some modest growth in -- from that in the fourth quarter and maybe more in the first quarter. There's volatility that were currently enjoying or experiencing however you want to describe it, probably makes more acquisitions likely as people get more nervous. And to some extent, we're setup to respond to that.

[Operator:]

Thank you. Our next question comes from the line of Jeffrey Campbell from Tuohy Brothers. You’re now live.

[Jeffrey Campbell:]

Can you disclose -- yes, well, you record precedes itself. Can you disclose how much your Giddings average working interest increased due to the Harvest acquisition?

[Steve Chazen:]

I think it's about 15%, 15 percentage points.

[Jeffrey Campbell:]

And it was mentioned that you're going to add rig in Giddings first quarter next year. Will Giddings still be a self-funding program with the two-rig program?

[Steve Chazen:]

Yes. But it won't be -- it probably won't be a 50%, 60%, it'll probably closer to 100%. So we'll probably use all the cash flow from Giddings to work Giddings and Karnes will probably continue at sort of around 50%, I would guess.

[Jeffrey Campbell:]

And if I could ask one last one, because I don't see it on the presentation. Are you currently hedging any production and what's your approach to hedging going forward?

[Steve Chazen:]

No. If we had to, we would buy insurance, but that's the only reason we would hedge. My track record in predicting oil and gas prices are pretty crummy, and so -- and I can prove that to you, if I had to. So the idea is that you hedge when you need to, you need to protect your capital program or you need to predict your balance sheet and we're designed to do that. I assume the good folks who sell hedging products actually make money on it. So I just -- I'm really not in the business of enriching Goldman Sachs.

[Operator:]

Thank you. Our next question comes from the line of Irene Haas from Imperial Capital. You’re now live.

[Irene Haas:]

I was noticing that your NGL pricing was quite strong this quarter. Could you give us a little color on that? Should we expect the same trend next quarter? Then secondarily, how is your in-house staffing coming along? Because you still probably has that service contract with EnerVest team, and when would you bring in a COO?

[Steve Chazen:]

Well, we actually hired a operating executive who was announced, Steve Millican, So we hired an operating executive last few weeks ago. And we refiled because he's our reporting person. So he was at EnerVest. He ran their south, the stuff we bought essentially. So we have an operating person. And we're in no hurry at all. Right now, the EnerVest people are doing a great job for us at reasonable cost. And there's no real reason to change that unless it changes. As far as the NGL pricing goes, NGL pricing has been strong. And there's no reason to think it's going to change for this quarter. It's been running pretty good, it's a percentage of WTI, probably its percentage is up as the WTI price seems to want to decline a $1 of barrel a day.

[Irene Haas:]

Right. And also gas prices looking pretty good. So you guys should be positioned to enjoy that as well?

[Steve Chazen:]

Yes. And we nearly produce about 80 million a day roughly in gas. So it was at $1 change basically. So $80,000 a day roughly speaking, I think that not so bad.

[Operator:]

Our next question comes from the line of Jeff Grampp from Northland Capital Markets. You are now live.

[Jeff Grampp:]

Sticking over on Giddings, can you guys maybe touch a little bit on how maybe some of the recent wells that you've recently completed, how those have been performing? And maybe how some of the longer term performances has been from the first few batch of wells that you guys announced earlier this year?

[Steve Chazen:]

I think when we started this we said that one of our goals was not to provide a lot of detail because there's still open acreage and so we'll file when we have to. But generally speaking, the wells have been performing in line with the ones we disclosed in the offering. So there's been some small decline but clearly, a lot of these wells are -- we had a well making 1,000 barrels a day of oil, that's been making it for 6 months. So I mean, it's pretty good, but it's not perfect there. Obviously, there's things that some are a little better than others, but we haven't drilled really bad wells. But given enough time, enough wells, I'm sure we will. We'll file when we have to and you'll be able to see the wells as we file them. But generally speaking, we've been pleasantly surprised.

[Jeff Grampp:]

I'm curious as you guys look into '19 here with the added rig in Giddings, do you guys need a frac crew that would support each of the activities in each kind of operating area? Or would you look to keep one crew and bounce it back and forth in '19 or is that kind of...

[Steve Chazen:]

We'll probably keep the single crew. Unless we pick up some -- the Giddings, because the other wells is going to drilling sort of one-off wells rather than development wells, it's going to be a little slower than we might have in the development mode. And so we ought to be able to make do with the single crew. It makes a production a little lumpier than we might like, because all of a sudden it's going along you think you know it, and all of a sudden you turn on some wells and you get a big run up. But you're watching quarterly numbers, it's maybe a little confusing.

[Jeff Grampp:]

And then last one from me. We've seen a couple of nonenergy specs lately do some tender offers on some warrants. And I was just curious if you guys have given that any consideration? Obviously, it's generating a lot of free cash and that's kind of a roundabout way of a buyback, which you kind of referenced earlier. So I was just kind of curious to get your thoughts on some sort of transactional thing related to the warrants.

[Steve Chazen:]

Yes. We view the warrants as having exceptional value. I think that's probably all we can say about it.

[Operator:]

Our next question comes from the line of Michael McAllister from MUFG Securities. You are now live.

[Michael McAllister:]

Welcome back to all. Well...

[Steve Chazen:]

I don't know about that. I'm still thinking about how I can get out of this in the future.

[Michael McAllister:]

What was -- if you could, what was Harvest production at the close of the deal?

[Steve Chazen:]

About the same as it is now. Same as what we said. It was heavily towards the Giddings, the production was almost entirely Giddings, I think. And so you can see where the Giddings production is. So it's about what we said for the beginning when it closed, because it'll mirror pretty close to growth that's in our outlook for Giddings. Maybe a little better on average because the locations are little -- some of the locations are better.

[Michael McAllister:]

Okay. And with the thought of getting bigger, what about going outside of the two core areas in acquisitions?

[Steve Chazen:]

Well, I think what we said to that question over time is you don't have to fit the business model. So 50%, 60% of the cash flow to grow the business 10% to 15% a year, high operating margins, 40%, 50% EBIT margins. It would take a -- so that implies a high quality reservoir. And it would take a considerable reduction in purchase price to make that work, because I count purchase price as part of the EBIT calculation. A lot of people ignored the purchase price because it's the noncash charge DD&A, once was cash, but now it's noncash. So I think we're just cautious about going out, if we could find an exceptional value we would consider that, but we spent a year looking for that and didn't find it. So I think there might be something, but it's probably not imminent.

[Operator:]

[Operator Instructions] Our next question comes from the line of Joe Evans from SG Capital. You are now live.

[Joe Evans:]

It's John Evans. I was just curious...

[Steve Chazen:]

No, he has -- the guy in the thing doesn't work for us.

[Joe Evans:]

Yes, known and honest. I was just letting you know. Just from the standpoint, you're building this kind of unique company, from a generalist standpoint. And I guess, I was hoping maybe you could help me understand how you guys go about thinking spending the extra EBITDA that you have relative to dividends or stock buybacks as opposed to just buying more oil and gas properties, etcetera. A lot of industrial companies obviously do that overtime and I'm curious to understand your guys' thought process towards that.

[Steve Chazen:]

Okay. So the oil and gas, if you can buy oil and gas properties that fit the business model. Let's just say, you earn these good EBIT, it doesn't dilute us. Good EBIT and you can have generate an aggregate growth out of it, a 10%, 15% organic growth with under 60% of the cash, then that's a non-dilutive acquisition, we go do that. If you get -- eventually, you would think there'll be more happiness in the oil industry and the opportunities to do that goes away. And so once we can't do that anymore, then we'll turn our attention to either dividends or share repurchases or both. We're not -- we don't plan to -- there's not hardly any float anyway, so you wouldn't to go in the open market now to buy any shares. So -- and so, obviously EnerVest has shares but I'm not sure there are sellers at current prices. So I think you -- it's just a matter what -- where the value would be at the time. The bias, if it's neutral between the share repurchase and dividends, my bias historically been for dividends. Easier to count.

[Joe Evans:]

And then just a follow-up question. Within this tumultuous slide that we've seen in crude, do you think that gives you better opportunity as you go into next year to make some of these accretive bolt-on acquisitions?

[Steve Chazen:]

I hope so. It's the old line about when everyone is frightened, we're greedy, and when everyone is complacent, we dose off. So generally speaking, in a buoyant environment where everybody's all happy, probably less opportunities, for sure. In a more volatile environment, people get more frightened and we set the company up, so we don't have to be frightened.

[Operator:]

Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn to the floor back to management for closing.

[Steve Chazen:]

Thank you all. Appreciate your time today.

[Operator:]

Thank you, ladies and gentlemen. This does conclude our teleconference for today. You may now disconnect your line at this time. Thank you for your participation, and have a wonderful day.