Hess Midstream Partners LP (HESM) Q4 2021 Earnings Call Transcript

Hess Midstream Partners LP (HESM -0.48%)
Q4 2021 Earnings Call
Jan 26, 2022, 12:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2021 Hess Midstream conference call. My name is Michelle, and I will be your operator for today. [Operator instructions] 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 -- Vice President of Investor Relations

Thank you, Michelle. Good afternoon, everyone, and thank you for participating in our fourth quarter earnings conference call. Our earnings release was issued this morning and appears on our website, www.hessmidstream.com. Today's conference call contains projections and other forward-looking statements within the meaning of the federal securities laws.

These statements are subject to known and unknown risks and uncertainties that may cause actual results to differ from those expressed or implied in such statements. These risks include those set forth in the risk factors section of Hess Midstream's filings with the SEC. Also on today's conference call, we may discuss certain non-GAAP financial measures. A reconciliation of the differences between these non-GAAP financial measures and the most directly comparable GAAP financial measures can be found in the earnings release.

With me today are John Gatling, president, and chief operating officer; and Jonathan Stein, chief financial officer. In case there are audio issues, we will be posting transcripts of each speaker's prepared remarks on www.hessmidstream.com following their presentation. I'll now turn the call over to John Gatling.

John Gatling -- President and Chief Operating Officer

Thanks, Jennifer. Good afternoon, everyone, and welcome to Hess Midstream's fourth quarter 2021 conference call. Today, I'll review our operating performance and highlights as we continue to execute our strategy, provide details regarding our 2022 plans and discuss Hess Corporation's latest results and outlook for the Bakken. Jonathan will then review our financial results.

2021 was a year of strong performance and strategic execution for Hess Midstream. We're proud of our continued safe and reliable operating performance and project delivery highlighted by the successful execution of the planned maintenance turnaround and tie-in of the gas processing expansion at the Tioga Gas Plant. Following the turnaround, stable and reliable operating performance in the fourth quarter enabled us to finish a strong year with record gas gathering and processing volumes, driving full year adjusted EBITDA above guidance to $909 million, an increase of 21% compared to 2020 and 4% above the midpoint of our original 2021 adjusted EBITDA guidance. Looking forward, the continued investment in low-risk system expansion gives us the needed capacity to capture volume growth through mid-decade.

We remain focused on operational, infrastructure, and commercial execution to capture increasing gas volume growth, which by 2024 is expected to increase by more than 30% relative to Hess' 2021 nomination. We expect gas gathering and processing volumes to continue to comprise approximately 75% of our revenues and with a visible growth trajectory, we expect volumes to rise above MVCs in 2023 and continue to grow into 2024. Now focusing on Hess Midstream's fourth quarter 2021 throughput performance. Gas processing volumes averaged 330 million cubic foot per day as our post turnaround ramp-up drove results above expectations.

Fourth quarter crude terminaling and water gathering volumes averaged 113,000 barrels of oil per day and 72,000 barrels of water per day, respectively. Now turning to Hess upstream highlights. Earlier today, Hess reported fourth quarter results with Bakken net production averaging 159,000 barrels of oil equivalent per day, reflecting increased drilling activity, strong development performance and continued focus on gas capture. For full year 2021, Bakken net production averaged 156,000 barrels of oil equivalent per day, in line with guidance.

For 2022, Hess plans to operate a three-rig program and expects to drill approximately 90 gross operated wells and bringing on approximately 85 new wells, an increase of 67% compared to 2021. This leaves more than 2,000 future drilling locations beyond 2022, which generate attractive returns at $60 WTI per barrel and represents approximately 70 rig years of activity. And 2022 has forecast Bakken net production to average between 165 and 170,000 barrels of oil equivalent per day, a six to 9% increase over 2021 and expects production to steadily ramp over the year and average between 175 and 180,000 barrels of oil equipment per day in the fourth quarter. Additionally, Hess reiterated its commitment to sustainability as a top priority, announced its endorsement of the World Bank's Zero Routine Flaring by 2030 initiative, and set company targets to eliminate Zero Routine Flaring from its operations by the end of 2025.

Hess Midstream is proud to partner with Hess to achieve its sustainability and climate goals. Turning to Hess Midstream guidance. Our complete financial and operational guidance was released yesterday and is available on our website. For full year 2022, we expect gas processing volumes to average between 330 and 345 million cubic foot per day, representing growth of approximately 11% compared to full year 2021, primarily driven by Hess' production growth and focused gas capture.

Gas processing volumes are expected to remain generally at or below MVC levels in 2022, which are approximately 13% higher compared to 2021 physical volumes. For full year 2022, we anticipate crude terminaling volumes to average between 110 and 115,000 barrels of oil per day, water gathering volumes to average between 70 and 75,000 barrels of water per day. As physical volumes on most of our systems are at or below MVC levels, our 2022 forecast is approximately 95% revenue protected, giving a high degree of confidence to our financial guidance, which projects adjusted EBITDA in the range of 970 million to $1 billion, an increase of approximately 8% at the midpoint compared to full year 2021. We expect first quarter physical gas, oil, and water volumes to each be approximately flat compared to fourth quarter 2021, reflecting severe winter weather in North Dakota.

Turning to Hess Midstream's 2022 capital program. Full year 2022 capital expenditures are expected to total 235 million comprised of 225 million of expansion activity and 10 million of maintenance activity. Approximately $135 million of the 2022 capital expansion budget is focused on the completion of two new compressor stations and associated pipeline infrastructure. In aggregate, the new stations are expected to provide an additional 85 million cubic foot per day of installed capacity in 2022 and can be expanded up to 130 million cubic foot per day in the future.

In addition, Hess Midstream expects to initiate construction on a third compressor station in 2022, which is expected to provide additional 65 million cubic foot per day of installed capacity in 2023. And further enhancing our gas capture capability and supporting development in the basin. By the end of 2023, we will have more than doubled our compression capacity from a few years ago, growing it in line with Hess' drilling activity and our increased processing capacity. Reflecting increasing drilling activity by Hess, approximately $90 million is allocated to gathering system well connects.

In summary, we're continuing to execute our strategy, making focused low-risk infrastructure investments to beat basin demands, delivering safe and reliable operating performance and strong financial results, which enables us to take advantage of future accretive growth opportunities, including potential incremental return of capital to our shareholders. I'll now turn the call over to Jonathan to review our financial results and guidance.

Jonathan Stein -- Chief Financial Officer

Thanks, John, and good afternoon, everyone. Today, I will summarize our financial highlights from 2021, discuss our recently completed nomination process with Hess, provide details on our 2022 guidance and long-term outlook as well as our framework for continued return of capital to shareholders. We delivered strong results in 2021, growing full year adjusted EBITDA to $909 million, an approximate 21% increase compared to the prior year. As we look forward to 2022 and beyond, we have clear visibility to expected revenue and adjusted EBITDA growth, supported by increasing MVCs in 2022 followed by continued organic growth in 2023 and 2024, as John described.

Return of capital to shareholders is a key priority of our financial strategy. In 2021, we optimized our capital structure and utilized our excess free cash flow beyond our growing distributions to provide increased return of capital to our shareholders through both a 10% increase in our quarterly distribution levels and a $750 million repurchase of units from our sponsors. Together, these actions delivered immediate, accretive, and meaningful return of capital to our Hess Midstream shareholders. Looking forward, we will continue our financial strategy that includes consistent and ongoing return of capital as a primary objective.

Our return of capital framework includes the following key elements. First, distributions that are targeted to grow 5% annually on a per-share basis to at least 2024. Second, continued incremental return of capital beyond these annual distribution increases, through share repurchases and/or additional distribution increases funded by leverage capacity below our conservative three times adjusted EBITDA target and ex adjusted free cash flow after distribution. For 2022, we expect to have significant financial flexibility for potential incremental return of capital beyond our distributions that are targeted to grow 5% annually on a per-share basis.

Turning to our results. We continue to deliver strong performance with fourth quarter 2021 results beating our quarterly guidance. For the fourth quarter, net income was $165 million, compared to $131 million for the third quarter. Adjusted EBITDA for the fourth quarter was $247 million, compared to $205 million for the third quarter.

The change in adjusted EBITDA relative to the third quarter was primarily attributable to the following: Total revenues, excluding past-due revenues, were up by $20 million, driven by a strong volume ramp following the Tioga Gas Plant turnaround, resulting in segment revenue changes as follows: an increase in processing revenues of approximately $11 million; an increase in gathering revenues of approximately $10 million; and [Inaudible] revenues decreased by approximately $1 million, driven by slightly lower MVC levels. Total cost and expenses, excluding depreciation and amortization, pass-through costs, and net of our proportional share of LM4 earnings decreased by $22 million as follows: Low operating expenses related specifically to the Tioga Gas Plant turnaround that was completed in the third quarter of approximately $14 million. Lower other seasonal maintenance activity at the Tioga Gas Plant of approximately $5 million. And lower other costs and expenses, net of our proportional share of LM4 earnings of approximately $3 million, resulting in adjusted EBITDA for the fourth quarter of 2021 of $247 million, exceeding our guidance primarily driven by lower-than-expected operating and maintenance expenses.

Fourth quarter maintenance capital expenditures were approximately $2 million. And net interest, excluding amortization of deferred finance costs, was approximately $29 million. The result was that distributable cash flow was approximately $215 million for the fourth quarter, covering our distribution by 1.6 times. Expansion capital expenditures in the fourth quarter were approximately $52 million, resulting in adjusted free cash flow of approximately $163 million.

At year-end, debt was approximately $2.6 billion, representing leverage of approximately 2.9 times adjusted EBITDA on a trailing 12-month basis. Turning to our annual nomination process. Our contracts continue to provide a unique and differentiated level of downside protection through a combination of our annual rate redetermination process, that maintains a contractual return on capital displayed and MVCs that provide revenue for us set at 80% of expected throughput three years in advance. With the contract extensions completed at the end of 2020, we now have commercial contracts with Hess with downside protection through 2033.

At the end of 2021, we completed our nomination process with Hess and updated our tariff rates for 2022 and all forward years. As with prior cycles, the nomination process considered changes in actual and forecasted volumes and capex to maintain our contractual targeted return on capital deployed. 2022 tariff rates were generally stable relative to 2021 as higher expected volumes from Hess' accelerated development activity were mostly offset by higher expected capital investment. In our recent guidance release, we provided MVCs for the years 2022 through 2024.

As part of the nomination process, MVCs for 2022 and 2023 were reviewed and were required increased, while MVCs for 2024 were newly established based on 80% of the nominated volumes for each system in that year. Our MVCs provide line of sight to expected long-term growth in system throughputs and incremental revenue growth each year through a combination of increasing MVCs in 2022, followed by higher expected [Inaudible] volumes in 2023 and 2024. For 2022, MVCs remained substantially unchanged from those previously set under higher historical pre-pandemic basin activity levels, and we expect 2022 physical volumes to be generally at or below MVCs. Most of our 2023 MVCs were revised higher, reflecting Hess' accelerated pace of development in the Bakken and additional gas capture, and we anticipate physical volumes will grow above MVC levels in 2023.

MVCs for 2024, were set at 80% of nominated throughputs and provide line of sight to potential long-term growth in system throughputs. For example, looking at gas processing, Hess' nomination for expected volumes for 2024 was 425 million cubic foot per day, resulting in an MVC of 340 million cubic foot per day, set at 80% of the nomination level, implying greater than 30% growth and an approximate 12% annualized growth rate in physical volumes from 2021 actuals. We continue to expect gas gathering and processing to comprise approximately 75% of total affiliate revenues, excluding pass-through revenues. As a result, we have clear visibility to revenue and adjusted EBITDA growth through 2024, with MVCs supported growth in 2022, followed by year-on-year organic growth in 2023 and 2024.

Turning to guidance for 2022. For the first quarter of 2022, we expect net income to be approximately 150 to $160 million. And adjusted EBITDA to be approximately 235 to $245 million. First quarter maintenance capital expenditures and net interest, excluding amortization of deferred finance costs, are expected to be approximately $30 million, resulting in expected distributable cash flow of approximately 205 to $215 million delivering distribution coverage at the midpoint of the range of approximately 1.6 times.

For the full year 2022, we expect net income of 630 to $660 million, and adjusted EBITDA of $970 million to $1 billion. At the midpoint of guidance, full year adjusted EBITDA is expected to increase by approximately 8% from 2021, primarily driven by higher gas gathering and processing MVC levels as we expect our physical volumes to be at or below MVCs with an adjusted EBITDA margin consistent with our historical margin of greater than 75%. For 2022, with total expected capital expenditures of $235 million, we expect at the midpoint to generate adjusted free cash flow of $630 million. Highlighting our financial strength, we expect distribution coverage greater than 1.5 times and excess adjusted free cash flow of approximately $90 million after fully funding our targeted growing distributions.

As a result, we expect declining leverage of approximately 2.6 times adjusted EBITDA on a full year basis in 2022, below our conservative three times adjusted EBITDA target. The combination of adjusted free cash flow beyond our distributions and the leverage below our target provides significant financial flexibility for potential incremental return of capital to shareholders beyond our targeted 5% annual distribution per share growth. Looking beyond 2022, as described, our MVCs provide visibility to continued expected growth in adjusted EBITDA, supporting our ability to continue to fully fund our growing distributions from growing adjusted free cash flow through at least 2024 and to maintain ongoing financial flexibility for disciplined capital allocation. In summary, we are very pleased to have delivered a strong 2021 and look forward to a visible trajectory of growth in our operational and financial metrics that underpins our unique and differentiated financial strategy with a focus on consistent and ongoing return of capital to our shareholders.

This concludes my remarks. We'll be happy to answer any questions. I will now turn the call over to the operator.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from the line of Doug Irwin with Credit Suisse. Your line is open. Please go ahead.

Doug Irwin -- Credit Suisse -- Analyst

Hey, guys. Thanks for the question. Maybe just to start with 2022 guidance. Given that volumes are expected to be below MVCs -- or at MVCs this year, just curious if you could elaborate a bit on some of the other factors that kind of drive the high versus the low end of the range.

Is it primarily cost variability and timing of these compression projects? Or are there other factors involved?

Jonathan Stein -- Chief Financial Officer

Yes. So in terms of our EBITDA guidance for the year and kind of the cadence of that, if you will, through the year, I gave guidance for Q1. As we said there in Q1, opex is going to be broadly flat relative to Q4 that's consistent with lower seasonal opex that we usually see during these quarters. And then in terms of revenue, which will be the driver there for Q1 really driven there by oil and water, a combination of lower volumes based on weather, as John mentioned, and then slightly lower MVCs there on oil year on year.

But for the rest of the year, what we'll see is that opex will fall seasonality with Q2 and Q3, those are typically higher for us when we have more activity going on. And then revenue will steadily increase through the years. Our MVCs while we give annual averages are actually quarterly and they're increasing throughout the year. So we'll see increasing revenue from that.

And then physical volumes as well to the extent that we have some systems like water that are above MVCs will be consistent with the Hess production ramp that Hess has discussed. So in terms of EBITDA for the rest of the year, we see kind of Q1 as the starting point and then see higher EBITDA quarter for the rest of the year relative to Q1, and that will get us to that $985 million midpoint of our EBITDA.

Doug Irwin -- Credit Suisse -- Analyst

OK. That's helpful. Thank you. And then maybe just a follow-up on the capex guidance you gave.

I know you pointed to 135 million on the compression projects. Does that include any of the spend for the expected third project that you talked about here? Or is there going to be some more spend on that next year? And then I guess, on the 90 million well-connected capex, should we look at that as a decent run rate beyond 2022? Or is that still a bit elevated this year with rigs coming back in the Bakken?

John Gatling -- President and Chief Operating Officer

Sure. So I'll start off with the $135 million question. The bulk of that spend is the completion of the two stations that will be coming on this year. There is some spend, some preconstruction spend engineering that is focused on that third station, but the bulk of that spend will be toward the end of this year and really into 2023.

So that's where the bulk of the spend is from a compression perspective. On the $90 million -- the $90 million question related to well connects, as the third rig comes on and wells start to ramp up in 2022, we see that as a more representative spend profile associated with the well count as Hess brings that third rig on, and we actually start to see wells coming off that rig line, but also then as Hess looks at potentially adding a fourth rig next year as well.

Doug Irwin -- Credit Suisse -- Analyst

OK. Great. That's helpful. That is all from me.

I'll hop back in the queue. Thanks.

John Gatling -- President and Chief Operating Officer

OK. Thank you.

Operator

Thank you. And our next question comes from the line of Jeremy Tonet with J.P. Morgan. Your line is open.

Please go ahead.

Unknown speaker

Hi everyone. This is Dan Walk on for Jeremy. Just a couple of quick ones from us. The first, I guess, in light of yesterday's updates from Hess and from Hess M, just extending the financial framework through '24.

And given the significant flexibility, it sounds like you'll have even as early as by year-end, I think, you mentioned 2.6 times. Just curious if you could give an update on the opportunity set, particularly potentially the Gulf of Mexico. There's a good deal of discussion on the Hess call earlier today about their plans this year, so just curious if we could get a quick update on that.

John Gatling -- President and Chief Operating Officer

Yeah, sure. And I'll hand it over to Jonathan for the financial flexibility piece of this. But from a Gulf of Mexico perspective, the transaction isn't an immediate priority for the Midstream or Hess Corporation. We're continuing to be focused on executing our strategy and supporting Hess' development and capturing third parties in the Bakken.

So that's primarily our focus at this point. So I'll hand it over to Jonathan for the financial flexibility part of the question.

Jonathan Stein -- Chief Financial Officer

Sure. Thanks, John. Yes. I mean I think with that background on Gulf of Mexico, and we've already talked about our capital program that includes deliveries of the growth that we expect that you can see in the MVCs that I walked through.

So that really means, again, our focus will be on executing our financial strategy. The two elements I described, the increased 5% annual distribution per share growth that will go through 2024. And then incremental return of capital beyond that distribution growth, either through share repurchases and dividend increases as we did last year. And as we're saying that was really a part of our ongoing financial strategy and our return on capital framework.

So for this year, as you highlighted, we have 2.6 times expected EBITDA on a full year basis. So that's declining relative to where we are now and certainly below our three times target. So you can do the math relative to the midpoint of our EBITDA, that's $400 million in capacity that could be utilized to fund a potential incremental return on capital, really, with the Gulf of Mexico not being a priority, that really is the focused priority of our return -- of our financial strategy. In terms of actual sizing and timing, obviously, we'll evaluate that with the board during the year, and that just gives us the full capacity.

But certainly, as I said, incremental return on capital is a key part of our financial strategy this year.

Unknown speaker

OK. Great. Thanks for that. And then just, I guess, a bit more granular.

Just following the Tioga Plant expansion and the North Bakken expansion, could you just give us a little bit more detail, I guess, from your perspective, how I assume all those volumes are flowing down to Northern Border and Btu content is relatively high. I think there's an 1,100 Btu cap. Where do you see that going in terms of, I guess, potential ethane extraction or just, I guess, the dynamic from your perspective?

John Gatling -- President and Chief Operating Officer

Sure. I mean I think we're uniquely positioned with the Tioga Gas Plant. We've expanded the plant now by 150 million cubic foot a day. That's got us up to 400 million there.

And then we have 100 million down at our LM4 partnership with Targa as well. From the Btu content perspective and Northern Border, we've got a number of export options. We've got a connection with Alliance for both -- for our wet gas. We also have our ethane connection, our long-term contract as well to deliver ethane up to Canada.

And then we have our -- as you mentioned to have our export with Northern Border. From our perspective, the plant is very efficient and has high recovery efficiency. So we have no trouble meeting Btu specs if Northern Border decides to get more aggressive with their Btu specs. The plan is designed for significant Btu recovery.

So we don't really that being an issue for us. And then we've also got the NGL takeaway capability tied into to Oneok as well. So again, the plant is -- both plants are very well strategically placed with a number of export options, and we really don't see any constraints from our perspective as far as getting our Tailgate products to market.

Unknown speaker

Great. Thanks. That's very helpful.

John Gatling -- President and Chief Operating Officer

Thanks.

Operator

Thank you. And our next question comes from the line of Michael Lapides with Goldman Sachs. Your line is open. Please go ahead.

Michael Lapides -- Goldman Sachs -- Analyst

Hey. Hey, guys. Thank you for taking my question. Congrats on the MVCs for 2024, really healthy numbers, obviously, implies a pretty big pickup in production by Hess and therefore, flowing through Hess M.

Just curious, as you think about capital spend needs for '23 and '24, and I know you won't give guidance on that for another year. But should we assume that there is a pretty material pickup in capital spend in '23 and '24 to help kind of facility the increase in volume levels that Hess expects in 2024? Or do you think by the end of this year or early part of next year, your system will be built out enough to handle the '24 volumes?

John Gatling -- President and Chief Operating Officer

Sure, Michael. Thanks for the question. From our perspective, our compression is really phased with the development. So when we made the decision back in '19 to go and expand the Tioga Gas Plant up to 400 million cubic foot per day, that brought our total processing capacity up to 500 million cubic foot per day between Tioga and the Little Missouri Four, our gas plant partnership with Targa.

So from our perspective, the processing is well set. And then we've been phasing in compression as Hess has made its decision to accelerate its development activity. And so the continued phasing, I mentioned that we're going to be bringing on two stations this year, we're going to be bringing on a third station potentially next year. From our perspective, the infrastructure is in our plan.

It's set that supports the 2024 volume projections that we've got set out there based on the MVCs. So I would say, it's materially there. We're going to continue to see some investment in compression over the next several years to get up to our processing capacity. And then obviously, the well connects will be something that will be a bit more fluid as Hess decides its pace of development.

But from an infrastructure perspective, we are not expecting to see any significant increases in our capital spend. I don't know, Jonathan, if there was anything else you wanted to add to that?

Jonathan Stein -- Chief Financial Officer

No. No. I think that you hit it well. I mean I think we're in a unique position where the capital needs that John described really now just focused on well connects and compression, really at or below the levels that we have now, we'll achieve the growth that's in our plan.

So that really leaves us with financial -- significant financial flexibility going forward that we've talked about. We're not considering as we've been clear about any large-scale M&A. So obviously, we'll look at investment opportunities as we've done in the past in a disciplined way. But really, as we've hopefully been very clear about, our priority for us that our financial strategy is using that financial flexibility, certainly for continued return of capital to shareholders.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. Thank you for that. And then just kind of one quick follow-on. Can you remind me, and I listened to part of the Hess call, what's the timing Hess is thinking about for the fourth rig?

John Gatling -- President and Chief Operating Officer

Sure. So the timing that Greg mentioned in the call was really looking at 2023. So the plan would be is that if prices hold, and as Greg and John mentioned, there's over 2,100 wells -- well locations that are available for future development at $60 WTI per barrel. So from an overall inventory perspective, economic inventory perspective, Hess has a very, very strong portfolio.

So the plan would be is to continue with the third rig this year and then potentially on the fourth rig in 2023.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. Thank you, guys. Much appreciate it.

John Gatling -- President and Chief Operating Officer

Absolutely. Thank you.

Operator

[Operator signoff]

Duration: 34 minutes

Call participants:

Jennifer Gordon -- Vice President of Investor Relations

John Gatling -- President and Chief Operating Officer

Jonathan Stein -- Chief Financial Officer

Doug Irwin -- Credit Suisse -- Analyst

Unknown speaker

Michael Lapides -- Goldman Sachs -- Analyst

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