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Penn Virginia Corporation (ROCC)
Q2Â 2019 Earnings Call
Aug. 08, 2019, 11:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to the Penn Virginia Second Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. Clay Jeansonne, Director of Investor Relations. Please go ahead.
Clay Jeansonne -- Director of Investor Relations
Thank you, Sean, and good morning, everyone. We appreciate your participation in today's call. I'm Clay Jeansonne, Director of Investor Relations, and I'm joined this morning by John Brooks, Penn Virginia's President and CEO; Steve Hartman, our Chief Financial Officer, and Ben Mathis, our Senior Vice President of Operations and Engineering.
We will discuss non-GAAP measures on the call. Definitions and reconciliations of those measures to the most comparable GAAP measures are provided in our second quarter earnings release and the presentation posted on our website this morning.
Prior to getting started, I'd like to remind you the language in the forward-looking statements section of the press release, which was released yesterday afternoon. Our comments today will contain forward-looking statements within the meaning of the federal securities law. These statements, which include, but are not limited to, comment on our operational guidance and EUR, are subject to a number of risks and uncertainties that could cause actual results to be materially different from those forward-looking statements, including those identified in the Risk Factors in our most recent Annual Report on Form 10-K, as they may be amended in subsequent Form 10-Qs. Cautionary language is also included on Slide 1 of the presentation. We will use the presentation to go through today's discussion. Finally, after our prepared remarks, we will answer any questions you may have.
With that, I'll turn the call over to John.
John A. Brooks -- President, Chief Executive Officer and Director
Thanks, Clay. Let's start on Page 3, with a quick Company overview. Penn Virginia is a pure play Eagle Ford Shale operator in Gonzales, Fayette, Lavaca and DeWitt counties in South Texas. We have approximately 98,500 gross acres and 84,400 net acres in the Eagle Ford, which is approximately 92% held-by-production and 99% of which is operated by Penn Virginia. Our estimated drilling inventory at June 30th, 2019, was 510 gross, or 438 net locations. I should point out that this inventory count is only for the Lower Eagle Ford.
One of our goals for our land and technical team is to continue replenishing that inventory through organic leasing, small acquisitions, as well as acreage swaps with adjacent operators. We also hope to increase that count by identifying additional location inventory in the Upper Eagle Ford and Austin Chalk from our recently constructed earth model.
Our product mix in the second quarter was 87% liquids, of which 72% was oil. Penn Virginia's oil production receives premium Louisiana Light Sweet, which we sometimes refer to as LLS, or Magellan East Houston, also referred to as MEH pricing, which enhances our adjusted EBITDAX margins. We're currently running two rigs and one dedicated frac spread. We are targeting year-over-year production growth for 2019 of 25% to 30%, and we are well on our way to achieving that target based on our first half results.
Let's move on to Page 4, and take a closer look at our solid operational and financial performance for the second quarter. For the first half of 2019, production averaged 26,278 barrels of oil equivalent per day, which was a 37% increase from the same period last year. For the second quarter of 2019, we grew total production 13% over the first quarter.
We continued to benefit from our close proximity to the LLS and MEH markets, which resulted in a first quarter realized oil price of $62.63. This was approximately $2.70 higher than or 105% of the average WTI price for the second quarter. Adjusted EBITDAX for the first half of the year was $168.7 million, which was 34% higher than the same period last year, or $35.48 per barrel of oil equivalent.
Looking specifically at the second quarter of 2019, adjusted EBITDAX was $85 million, slightly higher than the first quarter. We recorded adjusted direct operating expenses of $11.65 per barrel of oil equivalent for the first half of 2019, which is a 5% improvement year-over-year. Our growth in adjusted EBITDAX allowed us to improve our leverage ratio to a 1.6 times as compared to 1.7 times at the end of 2018 and 2.4 times at June 30, 2018.
Finally, increased production, lower costs and continued strong pricing drove adjusted net income per share for the first six months of the year up 8% to $4.23 per diluted share from the first half of last year.
Looking at Page 5, we believe there are five keys to Penn Virginia's continued success. Starting with production growth, with a continuous two-rig program, we expect production growth of 25% to 30% this year and to generate free cash flow in the fourth quarter. Looking beyond 2019, assuming we maintain a two-rig program, we expect production growth will moderate as we begin to generate free cash flow.
We have a focus on cost and in this volatile commodity price environment to remain profitable, you must maintain a lean cost structure. We believe Penn Virginia, has one of the lowest cost structures for an oil-weighted E&P, and we need to maintain strong margins. As I mentioned previously, our close proximity to the Gulf Coast allows Penn Virginia to access premium priced markets. This includes accessing Gulf Coast waterborne markets such as Corpus Christi by truck and the LLS and MEH markets through multiple pipeline access points.
And ensure financial discipline, given the current and expected continued volatility in the energy commodity markets, we remain laser focused on maintaining financial discipline and a strong balance sheet. Growing production, while drilling within cash flow, is a great example of that.
And finally, the most important measure is to generate free cash flow. Ultimately, you must live within your means and we expect to generate free cash flow beginning in this year's fourth quarter. We believe this makes Penn Virginia unique, a proven small cap with solid production growth and a clear path to free cash flow generation in the near term.
Turning to our capital budget for 2019 that is summarized on Page 6. Capital spending is currently estimated at $335 million to $355 million, all of it in the Eagle Ford. This represents a slightly lower budget than we presented in the first quarter. 97% of total spending will be directed toward drilling and completion, with a balance focused on facilities, pipelines and grassroots acreage leasing. As I mentioned previously, our plan assumes continuation of a two-rig program. For the full year 2019, we expect to drill approximately 44 gross, or 39 net wells. In the second half of the year, we expect to drill 19 gross wells in Area 1, in 7 wells in Area 2.
We have seen significant decreases in overall drilling and completion costs. Comparing the second quarter of 2019 to the second quarter of 2018, we saw drilling and completion costs reduced by approximately 10% to 15% after adjusting for completion design differences. We also expect to benefit from additional service cost reductions beginning in the fourth quarter. The organization is hyper-focused on lowering costs by driving efficiencies throughout the organization and working with our service providers to control costs.
Finally, I would note that we recently elected to defer capital expenditures related to our EOR project as we continue to focus our efforts on generating near-term free cash flow. We are still very encouraged by ongoing third party EOR projects in the immediate vicinity of our acreage and plan to continue the necessary engineering studies to lay the groundwork for future development of enhanced oil recovery on our acreage position.
Turning to the next slide, as I mentioned in my brief comments on the Company overview slide, one of our goals for the Penn Virginia land and technical teams is to continue replenishing our drilled inventory and growing it further through organic acreage leasing, small acquisitions, acreage swaps with adjacent operators and delineation drilling. We call this our focus on the ground game.
We believe we can replenish inventory for a two-rig program by adding between 3,000 to 4,000 net acres per year. In 2017 and '18, we added 3,366 and 4,336 net acres, respectively. We have completed several small acreage transactions so far this year and we're currently working on several additional transactions which give us confidence in our ability to accomplish our target for the year.
Next, let's take a quick look at our inventory over time in the graph at bottom right. In 2017 and 2018, we were successful in not only replacing our net inventory of future drilling locations, but also growing it. This year, we have set a target of increasing our location inventory to 486 net drilling locations by year in 2019.
Turning to the total length of lateral feet available in our drilling inventory, which is the solid black line plotted above the net location bars. We refer to that as total net treatable lateral feet. We've also been successful in increasing that number every year. We can increase net treatable lateral feet in several ways: by adding inventory to leasing, swaps, acquisitions, including the acquisition of additional net interest in our existing gross inventory and through delineation drilling.
Another part of the ground game is to find areas where we can increase lateral lengths, thereby, increasing total treatable lateral feet. As an example, we recently executed an acreage swap with an offset operator that added 40,000 feet of net treatable lateral, although net acreage was not increased, yielding a positive outcome for both parties as we were both able to benefit by capturing otherwise stranded acreage. This year, we have set a target of increasing our net treatable lateral feed inventory to 3 million net lateral feet by year end 2019.
We have also completed the first phase of constructing our earth model. As you may recall from prior discussions, the earth model combines petro-physical data, seismic data, well logs and other down-hole information to more accurately map the subsurface geology of our acreage position. This allows us to generate a three-dimensional view of the subsurface to help optimize our Lower Eagle Ford drilling program, identify Upper Eagle Ford and potentially other targets, and guide our enhanced oil recovery evaluation. Initial results are promising, indicating additional potential prospects in the Upper Eagle Ford, where most of our early technical efforts have been focused. We look forward to keeping everyone apprised of our efforts on this important initiative.
Looking at Page 8, we believe Penn Virginia is one of the highest weighted oil companies in the E&P sector, with oil comprising 72% of our production stream for the second quarter, with an overall blended quality that averages approximately 45 degree API Gravity. We are especially well positioned as the entirety of our oil production is sold into the LLS or MEH market. As of yesterday, LLS is trading at a $4.58 premium to WTI and MEH is trading at a $3.62 premium to WTI.
Moving on to Page 9, we believe Penn Virginia has one of the lowest levels of lease operating expenses per barrel of oil equivalent in our peer group and the industry, especially given our heavy weighting to oil. For the second quarter of 2019, LOE per BOE was at record low for the Company at $4.09 per BOE, down 17% from the first quarter. Given the progress in reducing our LOE, we are updating our guidance. We now expect LOE to average between $4.30 and $4.50 per BOE for 2019, which is materially lower than our previous estimate of $4.50 to $5 per BOE.
We are focused on three initiatives to keep LOE at low levels. First, we'll continue to implement our fieldwide smart gas lift intermittent system which optimizes volumes of lift gas. Currently, approximately 80% of our wells are on gas lift, which reduces costs associated with down-hole repairs and maximizes, well uptime.
Second, we also continue to expand our saltwater disposal or SWD system. Currently, 30% to 35% of our produced water is transported via our 22-mile system. For every barrel of produced water we transport on pipe, we save approximately $1.25 per barrel versus having to transport via truck to third-party disposal sites.
And third, we continue to focus on maximizing the competitive advantages of our contiguous acreage footprint. This allows us to build out our SWD system more cost effectively, expand centralized gas lift delivery, maximize third-party pipeline takeaways for oil and gas, and reduce labor costs by optimizing our workforce effectiveness. Also, it should be noted that substantially all oil and gas pipeline build out costs are borne by our midstream partners.
Moving on to page 10, unlike other basins in the US, the Eagle Ford has many crude oil delivery points and virtually no pipeline constraints. Penn Virginia is in an enviable position geographically as well as geologically, as all of our production receives premium pricing that is either LLS or MEH. We have access to enterprise products in Kinder Morgan pipelines, which delivers directly into the Houston markets.
We also have the ability to deliver crude to the Phillips 66 refinery in Sweeney and to access other waterborne markets, including Corpus Christi via truck or pipe. These factors are the primary reason Penn Virginia is recording crude realization of $2.70 above WTI. In addition, we have ample takeaway capacity with multiple marketing options for both our oil and gas for the foreseeable future.
Turning to Slide 11, I'm going to walk you through the Penn Virginia value proposition over the next several slides, starting with production growth. To be clear, we're targeting getting to free cash flow in the fourth quarter, so while production growth is obviously important, managing the timing of our drilling and completion schedule and our level of spending is critical.
That being said, in 2019, we expect 25% to 30% production growth over 2018 based on our current plan. Our guidance for third quarter of 2019 is 28,400 to 29,100 barrels of oil equivalent per day. More importantly, oil production is expected to grow by approximately 9% from the second quarter and we expect oil growth into the fourth quarter. We expect full year production of between 27,400 to 27,700 barrels of oil equivalent per day.
And this growth leads us to Slide 12, where we show our adjusted direct operating expenses on a per barrel of oil equivalent basis. In 2013, we recorded $11.99 per barrel of oil equivalent for our adjusted direct operating expenses. This is the sum of LOE, GPT, production and ad valorem taxes and cash G&A adjusted for some one-time items, which is reconciled in the appendix of the presentation. Now that's down from $14.40 per barrel of oil equivalent in 2017, and we continue to improve on that number by lowering our cash cost to $11.67 per BOE in the first quarter and slightly improving on that number in the second quarter to $11.64 per BOE.
Over the next several slides, we compare Penn Virginia to certain of our small to mid-sized E&P peers. On 13 here, we have historical data for peer companies, which was sourced from peers' press releases, filings and presentations and other public data. I should note that we are not endorsing or confirming any of the public data of our peers in this presentation. But based on this data, we had the highest adjusted EBITDAX per BOE ratio in our peer group during the first quarter of 2019. Bottom line, our relentless focus on cost optimization is continuing to drive expenses down and generate strong cash margins.
Slide 14 shows our adjusted EBITDAX per BOE over time. For full year 2018, we generated $37.70 per barrel of oil equivalent and matched that number in the first quarter. For the second quarter, we still generated strong margins, even though we experienced a decline in commodity prices. We have benefited greatly from lower cost and premium pricing, which is reflected in our cash margins. Importantly, we expect adjusted EBITDAX per BOE to remain at a high level for the balance of the year.
Turning to Slide 15. We believe comparing our net debt to adjusted EBITDAX ratio as compared to our peer group is a good indicator of Penn Virginia's relative financial strength. And as it can be seen from the slide, according to this data, we compare very favorably.
On Slide 16, we show the cadence of improvement in our financial position over the past couple of years. We have successfully driven our net debt to adjusted EBITDAX ratio down from 2.6 times at year-end 2017 to 1.7 times at year-end 2018. We saw a further improvement in the first quarter of 2019, and maintained that strong ratio in the second quarter. We expect the downward trend to continue with a targeted leverage ratio of approximately 1.5 times by year-end 2019. The Company is committed to maintaining financial discipline and a strong balance sheet.
Turning to valuation metrics on the next slide, here on Slide 17, within the Eagle Ford, although we are not endorsing such numbers, consensus estimates have Penn Virginia trading at one of the lowest multiples for 2019 compared to peer companies. With the growth I laid out for you, the low cost structure, very strong cash margins, low leverage ratio and a clear path to free cash flow during the fourth quarter and beyond, we believe that Penn Virginia is an attractive investment.
On Slide 18, we summarize the attributes that we believe makes Penn Virginia a quality investment. In this volatile commodity price environment, you need to be profitable through all cycles. You must maintain a lean and low cost structure, and we believe Penn Virginia has one of the lowest cost structures for an oil-weighted E&P as exemplified by our second quarter 2019 adjusted direct operating expense of $11.64 per barrel of oil equivalent.
Our proximity to waterborne market allows Penn Virginia to access premium price markets as our crude oil prices realized 105% of WTI. Access to Corpus Christi by truck and the LLS and MEH markets by multiple pipeline access points, helps to maintain our strong price and combined with peer-leading low operating costs, our second quarter 2019 adjusted EBITDAX was $33.53 per barrel of oil equivalent.
To survive and grow during turbulent times, you must maintain financial discipline and preserve the balance sheet, and we will continue to do so. Our second quarter 2019 net debt to LTM adjusted EBITDAX ratio was 1.6 times, and we expect it to decline further. And with a continuous two-rig program, we expect production growth of 25% to 30% for 2019.
Finally, Penn Virginia is unique in the small-cap space, with production growth and a clear path to generating free cash flow beginning in the fourth quarter and plan to continue living within our means in 2020 and beyond.
And with that, Sean, we can go to Q&A portion of the call.
Questions and Answers:
Operator
Thank you. We will now begin the question and answer session. [Operator Instructions]. Our first question today will come from Dustin Tillman with Wells Fargo. Please go ahead.
Dustin Tillman -- Wells Fargo -- Analyst
Hey, guys. Thanks for taking the call. Can you talk about the balance sheet? And as you think about when you start to generate additional cash flow next year, where that goes to and how you're thinking about the balance sheet longer term?
John A. Brooks -- President, Chief Executive Officer and Director
Well, it's a high-class problem to have. I think we would probably look to reducing debt as our first option and further strengthening the balance sheet is one of the many ways that we can return cash to our shareholders.
Dustin Tillman -- Wells Fargo -- Analyst
And does it make sense to then refinance the term loan to allow you some additional flexibility?
John A. Brooks -- President, Chief Executive Officer and Director
I think, right now, we're not looking to do that in the near term, but we certainly have that option as time goes by.
Clay Jeansonne -- Director of Investor Relations
Dustin, we can pay down part of the term loan too as well with free cash flow.
Operator
Our next question today will come from Ray Deacon with Petro Lotus Analytics. Please go ahead.
Ray Deacon -- Petro Lotus Analytics -- Analyst
Yeah. Hey. Good morning. I was wondering if you could convert that 8 million foot target of lateral to year number?
John A. Brooks -- President, Chief Executive Officer and Director
I think it was a 3 million where we plan to be at year end.
Dustin Tillman -- Wells Fargo -- Analyst
Right. Got it. And how many years of inventory would that be?
John A. Brooks -- President, Chief Executive Officer and Director
Well, we want to keep at least a minimum 10-year rolling.
Dustin Tillman -- Wells Fargo -- Analyst
Okay. Got it. Thank you.
[Operator Instructions] At this time, there are no further questions in the question queue, and I would like to turn the conference back over to John Brooks for any closing remarks.
John A. Brooks -- President, Chief Executive Officer and Director
Thanks for your time this morning and your interest in Penn Virginia. We look forward to talking to you again next quarter.
Operator
[Operator Closing Remarks]
Duration: 25 minutes
Call participants:
Clay Jeansonne -- Director of Investor Relations
John A. Brooks -- President, Chief Executive Officer and Director
Dustin Tillman -- Wells Fargo -- Analyst
Ray Deacon -- Petro Lotus Analytics -- Analyst
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