Antero Midstream Corporation (NYSE:AM) Q2 2022 Earnings Conference Call July 28, 2022 12:00 PM ET
Company Participants
Justin Agnew – Finance Director
Paul Rady – President, Chairman & CEO
Brendan Krueger – CFO, VP, Finance & Treasurer
Michael Kennedy – CFO of Antero Resources and Director of Antero Midstream
Conference Call Participants
John Mackay – Goldman Sachs
Michael Cusimano – Pickering Energy Partners
Michael Endsley – Tudor, Pickering, Holt
Operator
Greetings, and welcome to the Antero Midstream Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] And as a reminder, this conference call is being recorded.
It is now my pleasure to introduce Justin Agnew, Director of Finance. Thank you, Justin. You may begin.
Justin Agnew
Good morning, and thank you for joining us for Antero Midstream’s second quarter investor conference call. We’ll spend a few minutes going through the financial and operating highlights, and then we’ll open it up for Q&A. I would also like to direct you to the homepage of our website at www.anteromidstream.com, where we have provided a separate earnings call presentation that will be reviewed during today’s call.
Before we start our comments, I would first like to remind you that during this call, Antero management will make forward-looking statements. Such statements are based on our current judgments regarding factors that will impact the future performance of Antero Resources and Antero Midstream and are subject to a number of risks and uncertainties, many of which are beyond Antero’s control. Actual outcomes and results could materially differ from what is expressed, implied or forecast in such statements. Today’s call may also contain certain non-GAAP financial measures. Please refer to our earnings press release for important disclosures regarding such measures including reconciliations to the most comparable GAAP financial measures.
Joining me on the call today are Paul Rady, Chairman and CEO of Antero Resources and Antero Midstream; Brendan Krueger, CFO of Antero Midstream; and Michael Kennedy, CFO of Antero Resources and Director of Antero Midstream.
With that, I’ll turn the call over to Paul.
Paul Rady
Thanks, Justin. In my comments, I will discuss AM’s infrastructure expansion into the liquids-rich midstream corridor, capital synergies from relocation and reuse of legacy assets and well performance on AM’s gathering system. Brendan Krueger will then highlight our quarterly results, growth outlook and transition to consistent free cash flow generation after dividends.
I’ll start my comments on Slide #3 titled Castle Peak Compression Construction. This slide illustrates the construction progress on our Castle Peak compressor station in the liquids-rich midstream corridor in the Marcellus Shale. This station was on time and on budget, which is a test to the planning, engineering and civil groups given the topography as shown in the pictures on this slide. As you can see on the bottom right photograph, the Castle Peak station has an initial capacity of 160 million cubic feet a day. In 2023, we will expand the station’s capacity by another 80 million a day to a total of 240 million cubic feet per day.
This phasing in of capacity allows us to maintain high utilization rates and defer capital until the capacity is needed on a just-in-time basis. Importantly, the Castle Peak station is the first station that we will be relocating compression units from Antero Midstream’s assets base that are currently underutilized.
As detailed on Slide #4, titled Capital Optimization from Relocation and Reuse, our historical utilization has been very consistent, averaging 85% over the last five years. This is a result of our unparalleled visibility into AR’s development plan and just-in-time investment philosophy. Because of these high utilization rates, we haven’t previously had opportunities to relocate and reuse underutilized capacity. As you can see on the right-hand side of the page, we plan to move four units from a legacy station to expand the legacy — the Castle Peak compressor station by 80 million a day in 2023. Compared to buying and installing new units, we expect to save approximately $5 million in capital on this station alone.
In 2024, we expect to use the remaining eight units from the highlighted legacy station for our new build Grays Peak compressor station. We expect this reuse opportunity to save AM approximately $15 million, resulting in total capital savings of $20 million. Importantly, both of these stations are located in the liquids-rich midstream corridor outlined in purple, where AR’s development plan is focused over the next several years. Looking forward, AM is well positioned from a capacity perspective to accommodate the highly visible throughput growth expected over the next several years on AM’s dedicated acreage.
I finished my remarks on Slide #5 titled Improving and Consistent Well Performance, which highlights the well performance since 2018. The plot illustrates the average cumulative production over the first 90 to 180 days of the well. As evidenced on this page, well performance at AR continues to improve as AR has optimized completion techniques, well spacing and has moved into the heart of its development area.
To date, in 2022, AR’s average wells have displayed a 55% increase in cumulative production versus the 2018 average. These results in the liquids-rich midstream corridor give us tremendous confidence in the underlying resource that supports the throughput growth at AM. This also results in a more capital-efficient business model at AM.
Lastly, I want to highlight a Utica pad included in the 2022 production plot. Wells on this pad have outperformed the 2021 and 2020 production plots average by 50% and 65%, respectively. While AR’s development plan is focused on the liquids-rich Marcellus Shale, there are several pads planned in the Utica over the next 5 years located in areas with existing midstream infrastructure. This results in minimal capital spend for AM in the Utica while still capturing volumes from a strong expected well performance.
In summary, we continue to optimize our capital program as we expand our footprint into the liquids-rich midstream corridor. The well results give us tremendous confidence in executing our growth plan while maintaining high asset utilization rates. This results in attractive return on invested capital, which we estimate will remain in the high teens. Importantly, we are not reliant on competing for third-party growth projects that dilute our overall corporate returns.
With that, I’ll turn the call over to Brendan Krueger.
Brendan Krueger
Thanks, Paul. I will begin my comments with second quarter results at AM on Slide #6 titled Year-Over-Year Midstream Throughput Growth. During the second quarter, AM’s low pressure gathering volumes were 3 Bcf a day, a 3% increase year-over-year. Compression volumes were 2.8 Bcf a day, a 1% increase year-over-year and joint venture processing volumes were 1.5 Bcf a day, which reflects a 1% increase year-over-year.
Volume growth in the quarter was driven by the strong well performance that Paul discussed in his remarks. Looking ahead, we expect throughput to be approximately flat in the third quarter and then a slight increase as we exit 2022. This allows us to generate momentum into 2023, where we expect mid-single-digit throughput growth on an annual basis.
Moving on to the water side of the business. Freshwater delivery volumes in the second quarter averaged 110,000 barrels per day with 15 wells serviced. As a reminder, on the first quarter earnings call, we discussed a 7-well pad that was utilizing simultaneous completions in late March. This resulted in wells that started completion operations in the first quarter but had water volumes primarily delivered in the second quarter. Year-to-date, we have serviced 36 wells compared to our guidance of 75 to 80 wells or just under half. The second quarter also marked a critical inflection point for AM, which I will highlight on Slide #7. During the second quarter, our free cash flow before dividends was over $100 million, and our free cash flow after dividends was breakeven.
Looking to the back half of the year and beyond, we expect to generate increasingly positive free cash flow after dividends. This is driven primarily by declining capital as we completed some key growth projects such as the Castle Peak station in the first half of the year. This allows us to begin paying down debt and reducing our leverage towards our 3x target.
Looking to 2023, we expect the EBITDA growth and declining capital to result in significant free cash flow after dividends. This trajectory is expected to continue further into 2024 and beyond as volume grows, the fee rebate with AR expires and capital declines. The increasing free cash flow after dividends will result in increased debt paydown and reducing our leverage towards our 3x target. We expect to achieve this 3x leverage target in 2024, at which point we will evaluate further return of capital strategies.
In summary, the future for Antero Midstream is very bright. As Paul touched on in his remarks, we believe we have one of the most derisked business profiles in the midstream industry. We have unmatched visibility and to attractive volume and cash flow growth supported by a multi-decade drilling inventory and the lowest cost gas basin in North America. Our transition to generating consistent free cash flow after dividends will continue to strengthen our balance sheet and credit metrics.
Our primary customer, AR, has paid down over $2 billion of debt over the last 2 years, has leverage of just 0.6x and is quickly nearing investment-grade ratings. AM is well positioned as the first leg customized midstream solution for a producer with the greatest exposure to LNG export facilities in the U.S. With a significant role U.S. LNG is expected to play in the world over the coming years and decades and the step change expected in Antero Midstream’s free cash flow position in the near to medium term, we believe Antero Midstream offers one of the most attractive risk-reward opportunities in the midstream space.
With that, operator, we are ready to take questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from the line of John Mackay with Goldman Sachs.
John Mackay
I wanted to start on some of the AR comments about just improving well performance. Is there an impact we should think about AM? I mean does that mean lower capital intensity going forward? Really you could just talk about some of maybe the puts and takes coming out of that.
Paul Rady
Yes. I think certainly, that’s conceptually right that the build-out cost to a pad is x amount, it’s finite. And so if you have more volumes, particularly substantially more volumes than that’s going to just improve the return on the assets. So we’re on an uptrend. And as Mike described in our earlier call, we’re into some really good rock and a really good fairway. So — and we’ve got the process down in terms of interlateral distance and completion style and techniques. So good things growing on the growth end and with the same amount of capital on the midstream end.
Brendan Krueger
Exactly good points, Paul. And I’d also add, AR also altered their development plan, like you saw, we put on a Utica pad in the second quarter, just to make sure we’re as efficient as possible in the midstream, and we — AR does develop pads here and there to take advantage of open capacity on midstream and not have AM overbuild in certain areas. So that’s a terrific attribute for Antero Midstream as well.
John Mackay
Okay. Maybe is it a little too early to quantify what the potential decrease in gathering CapEx could be for AM, if these well results continue?
Brendan Krueger
Yes. I think right now, a little too early, but we’ll certainly follow up as we get into 2023 capital guidance and further updates on our five-year plan, John.
John Mackay
All right. Maybe just last one on that theme. Can you talk a little bit more about — is there more in the compression side you can do? You talked about the 20 million, is that kind of early stages? Could we see more after that?
Brendan Krueger
Yes. I mean I think this is an exciting component of the AM business. I think as we mentioned both in the press release and then in the prepared remarks, this will be the first pad where we are reusing equipment. We’ve historically run it at high utilization rates, and so we didn’t have this opportunity as certain legacy assets that were put in place five-plus years ago start to decline from a utilization, it gives you that ability to reuse. So we’ve touched on the 20 million. I think we’ve identified 50 million in total over, call it, a five to seven-year period. And as mentioned, it is early stage here. So this is something that we’re certainly spending a lot more time on from a company perspective and are looking for additional opportunities there.
Operator
And our next question comes from the line of Michael Cusimano with Pickering Energy Partners.
Michael Cusimano
Just thinking high level, AM trades at the same price or valuation it did in mid-’21, AR’s up over 3x since that same period, and obviously, commodity prices drove a lot of that. But I guess with that being said, like how do you think about cash allocation between the two entities? Like do you benefit from having the separate entities today? And at what point do you think about the cash generation at AR today, at what point does that potentially look to buy in AM? Or is the AR units just too cheap today to where that makes sense? I’m just wondering how you’re all thinking about that today, just the updated thoughts there?
Michael Kennedy
Yes. Good question. AR, although it’s gone up 3x, actually metrics have continued to trade down. It’s still at a mid-20% free cash flow yield, so almost 3x EBITDA. I think it’s a PDP, PV 18 or 15 to 18. I mean, it just continues their multiples compress. So whereas AM, I think, is a terrific company, but it’s been in this year or two period where it was relatively flat with dividend — free cash flow after dividends is relatively neutral. It’s about ready to go into a phase of EBITDA growth and declining capital. So that’s not going to be the case in ’23 and ’24. So we do look for AM to appreciate them and to trade better. But AR right now is definitely just focused on buying in its own shares and trying to capitalize on that — the disconnect and its valuation.
Operator
[Operator Instructions] Our next question comes from the line of Michael Endsley with Tudor Pickering Holt.
Michael Endsley
First one for me is just on the water side of the business. You noted you’ve serviced 36 wells year-to-date versus the 75 to 80 guide. Just any color you can provide on the quarterly cadence kind of as we look through the balance of the year?
Brendan Krueger
Yes. I think right now, as we look at it, you’ll have roughly 55% to 45%, 55% be in third quarter, 45% fourth quarter. But certainly, you can have some movement there. So right now, a little bit more in the third quarter and then a little bit of a fall off just going into the winter as is typical in the fourth quarter.
Michael Endsley
Okay. Got it. And then I guess just pivoting to the gathering and compression side of things. It looks like high-pressure volumes as a percent of low pressure has historically been pretty sticky around that 98% mark just over the last few years. But this quarter, it looks like it dropped down to 95% or so with a similar downtick on the compression side. Is this just driven by drilling in areas with less existing compression capacity? And should we expect high pressure and compression volumes to rebound as a percent of low-pressure kind of as capacity is optimized as you relocate these legacy compressor units?
Brendan Krueger
Yes. This was just related to a couple of pads that had a third-party dedication. It was really unique to one just trade that we did related to some acreage. So going forward, you should not see any impact beyond that disconnect that we saw this period. So you should have the same relationship as — if you take second quarter at the point now, you should have that same relationship going forward as it relates to volume difference between the two.
Operator
Thank you. At this time, there are no further questions. And I would like to turn the floor back over to Justin for any closing remarks.
Justin Agnew
Thank you, operator, and thank you, everybody, for joining today. Please feel free to reach out with any further questions.
Operator
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.
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