Legacy Reserves LP (NASDAQ:LGCY)
Wells Fargo Securities 12th Annual Energy Symposium Call
December 11, 2013 8:00 AM ET
Cary Brown – President and CEO
Praneeth Sathish – Wells Fargo Securities
Praneeth Sathish – Wells Fargo Securities
Thank you all for coming. My name is Praneeth Sathish. I am one of the MLP analysts here at Wells Fargo. The first presenting company is Legacy Reserves, ticker LGCY. And with us today, it’s my pleasure to introduce President and CEO Cary Brown.
Thank you, Praneeth and appreciate you guys coming out this morning and I’d say, this is a great day for me. One of my guys as I looked at when we started Legacy with Rich Kinder and getting to go up against Rich Kinder this morning. It’s kind of a fun thing to think that driven that growth and I so I appreciate you guys coming to hear what we have to say. You’ll hear a lot about a company that’s really near and dear to my heart and I’ll tell you why in just a minute.
We’ll start with the forward-looking statements you guys know. You are seeing these this means that what I say, you can’t really listen to and I am going to give you the best shot I can, but it is without – there is some risk in these things. So, before I get started, I just want to say, thanks to Wells Fargo for inviting us to come and for those of you from New York, appreciate getting to be here.
I’ve brought my daughter and my wife in Sunday. So we’ve done a little bit to help the economy here and how things get going in New York. A great time for Christmas and I am sure you have enjoyed it and I always enjoyed visiting New York as a guy from Texas, always enjoyed going back to Texas. So, that’s where I am from at Midland, Texas.
Legacy is a company and I’ll talk kind of in terms of phases. We started the company, the original company with my dad Dale Brown and Jack McGraw back in 1981. We were in the oil and gas business headquartered at Midland Texas.
You can see the star right there in Texas obviously, if I got a pointer here I’ll point to right to that star. That’s where I grew up, home town and kind of the heart of the Permian Basin. We will talk a little bit about that.
But if you think about the oil business, there is the different cycles we go through. The cycle of finding the oil and then you develop the oil and then at the end of the cycle, you actually produce that oil. Legacy is the company that we’ve built to buy at the end of that cycle - those producing assets.
When I explain what Legacy is to people, I tell them we are a kind of a RIET to people – in real estate business they understand RIET or the real estate investment trust. We are REIT, but we got underlying that the cash flow that we use to pay our distribution is long life oil and gas assets.
And so we buy these assets in the production phase. We don’t do much exploration. We try to do enough - putting enough money back in the ground to hold production flat. I’ll talk a little bit about that. But then the balance of that, we pay out to our unitholders in the form of distributions.
One thing you’ll see, we’ve grown quite a bit. We went public in 2007. I really think about, we did a 144A in 2006. So, from a public standpoint, we are about eight years old. But, back in 1981 we when Dale and Jack started – we’d be doing the same thing really for all those years.
And what we – the way we got to start – my dad was an accountant. Jack was a petroleum engineer. I am an accountant, Kyle McGraw; the second generation is running the business now. He is a petroleum engineer and so, we would find an asset that we wanted to buy and hold to our property.
We’d go to the bank, we’d ask for some money, the bank would loan us some money. We would buy that asset and then we take the cash flow from that asset and maybe put a little bit back in the ground to try to improve production and then most of the cash will go to pay-off the bank.
And we’d go buy another one and buy another one and buy another one and that’s how we grew the business. And we had grown all back 2004, 2005. We were up to about 2200 barrels a day. We were debt free at the time and we started looking around at the MLP model.
We had since Linn I think it come out and it was on the way and we said, you know what, that’s the model that’s going to work for the kind of stuff we like to buy. So, we had a choice. We could either not continue – not keep buying what we were buying or we could go public. I had decided early in my career, I’d never go public.
And so here I am as a public company eight years later so and it’s been a great drive. We’ve done pretty much what we said we were going do. We produced oil and gas properties. We’ve bought some oil and gas properties and we paid a consistent distribution.
Today, we are paying about a $2.34 per year, about an 8.6% yields. What you find about, because oil and gas properties, we drill a lot we get those pass-through IDCs, it’s a very tax-advantage yield. So about 80% to 90% of the distribution you get back is going to be tax shielded and that’s great for us.
One thing is probably unique to most of the companies you are going to find is, we still own 18% of the company. So, if you look at management, my family, the McGraw family, we own 18%. Same count in units that anybody would buy out in the public market.
There is no IDRs and that’s not because we are not smart enough to figure out the value of IDRs, but at the time, we felt like, there wasn’t any deal we could do, go out and buy that, us keep half the production, you get half of the production to the unitholders and that would be a good deal for the unitholders.
Just couldn’t figure that out and so never haven’t taken anybody else’s money until we went public in 2007 we decided the most straightforward easiest thing to do and most transparent to the market would be what we own is just like what you own. We get paid to run the company, but our growth of distributions; we share in that growth in distributions as unitholders not as management.
That’s the long last nature of the assets and I think we’ll talk about what we are good at. You can see where we are in the country, see here. This middle part of the country is really what we think is our playground. You see Midland there.
The Permian Basin represents about 75% of our production, that’s our roots. We’ve grown north. We’ve got some pretty good assets in the Texas Panhandle, Oklahoma, that’s what we call our Mid-Continent region and then we had a chance, few years ago to buy some assets up in the Rockies with a group – some friends of ours in Cody. So we actually have our office in Cody Wyoming and we run our Rockies out there.
So you can think about 12%, and 12% on the Mid-Con and the Rockies and then 75% in the Permian. We are mostly oil. If you look at our production, about 65% of our production is oil.
We got about 30% gas. Almost all the gas we make comes out with a barrel of oil. So it’s very rich gas. If you looked at our gas price, we get a significant premium to Henry hub, because, that’s really what I’ll call, well head gas.
We don’t have very much true gas well gas or the dry gas. So, I think of us as an oil company. If you look at our revenue stream, 80% of the revenue that we make is going to be black oil that’s what we do. About 10% if you look through will be NGLs. It won't show up that way in the – we booked most of our NGLs with our gas.
But if you actually look at how we get revenue, about 10% of the revenue is going to be NGL revenue and about 10% will be the residue gas or dry gas that we would sell on the spot market. We are at about 20,000 barrels of day-to-day. So we’ve grown from 2000 to 20,000 and I’ll show you how we do that.
But, you probably – as we grow, we need to buy assets. If you think about in this production phase, we are going to spend about, call it 20% to 30% of our revenues or EBITDA back in the ground of whole production flat and then the balance of that will pay out in distributions.
The rest as we buy acquisitions, that also helps grow the distributions. You won't probably see us grow distributions dramatically just as a drill bit. It’s pretty hard to do that on a sustainable fashion. So we think about acquisitions, our distribution growth, what we spend back in the ground helps us maintain that distribution and that’s over the long-haul.
So let me talk about my favorite place as you guys, I know this slide is tough to read. It’s tough to look at from you. But this is the map that we look at every day. And so, you see right here is Midland, Texas. This is New Mexico, that’s the Southeast corner to Mexico.
And if you look at this, that will be the Permian Basin. It’s about a 100 mile radius around Midland and each color on that map is a different age of rock. So, the yellow is the shallower rock or newer aged rock and then as you get deeper, you go all the way down to the red and so in the Permian, what I still focus is if you stood in the back room we dotted that map, drill an oil well, you’d probably make a producing oil well. So there is a tremendous amount of oil that comes out of this basin.
We can produce anywhere from 500 feet, all the way down to about 25,000 feet. So it’s a big pile and lots of different zones. We are spinning that 20% to 30% back in the ground. We are usually spinning inside the well bores that we already have and always spinning it inside a field that we already been known to produce.
So we don’t have the risk of – is the rock there or not. We know the rocks there. What we have is economic risk, is enough oil going to come out, fast enough to be economic. The thing about that, it’s a pretty tight rock area.
It’s a lot tighter rock that maybe down on the South Texas or Gulf Coast, which means, as we produce the oil, if you just drill an oil well and frac it and do your thing, you might get in a good reservoir, you might get 20% to 25% of the oil out. So that 75% of the oil stays in the rock.
If you do a water flood or a tertiary flood, you might get that number up to about 40% of the oil that we know is there, you’ll get out of that rock. Well, in these rocks that means, 60% to 75% of the oil, that we know is there, is still in the rock and what we’ve been doing for the last 20 years is figuring out how to get more of that oil out.
So, I would say today, in 2006, we thought that Permian was a great place for MLP, why because we could get more of this oil out. I don’t know that there is a hotter place in the world than the Permian Basin right now.
Because what you are seeing with $100 oil and the new – and it’s not brand new, but horizontal drilling technology has gotten good enough than these multi-stage fracs that this really tight rocks they are able to go in and drill horizontally and now you are seeing rates of return that are pretty staggering.
It will be some of the best wells we’ve drilled rate of return-wise, rate-wise have been over New Mexico, where we drill horizontal wells and you are seeing an explosion of horizontal drilling. If you talk to Concho, you talk to Pioneer, those guys; they are going from a vertical drilling program to a horizontal drilling program.
So, a pretty fun place to be and all of the assets that we have will have some rights and we’ve got in - there is different basins even inside the Permian Basin. In the Midland Basin, we asked a lot how much acreage do you have in the Permian – in that Basin. It could be drilled horizontally somewhere between 19,000 and 25,000 acres is what we get.
We have not drilled that in the Midland Basin part of it. I’ll say the Midland Basin would be this big yellow right here. That’s the Sprayberry field, just to the east of Midland. All of that right there is going to be what they call the Midland Basin.
Over here on the Central Basin platform is where we’ve drilled some horizontal wells, but Pioneer has drilled some big wells in here and they are looking at you’ve got the Wolfcamp, several different zones in the Wolfcamp. That yellow, that big yellow is the Sprayberry field. We used to call that’s the largest uneconomic field in the world, because there is ton of oil in there, but it just come out really, really slow.
So, we didn’t drill it very often didn’t drilled much of it, but today, you are seeing the horizontal go in both Sprayberry, I am hearing about Sprayberry, Wolfcamp and then there is going to be multiple benches in those.
What we did in 2006 or actually as an industry practice in 2005 to today is we’ve been drilling those wells vertically and completing all of the different sections with maybe a 10, 12 stage frac from the bottom up, maybe 3000 feet to 4000 feet of intervals that we’d frac. Now, we are going in one of those intervals and we are putting 7000 foot lateral and then we have put 30 stages in one interval.
So, all it is just to trying to get more that oil that we know is there out. And so it’s great place to be, I thought it was going to be when we did this and it’s proven to be a great background. The other thing about Permian is - it’s a lot of – because it’s an old basin there is a lot of players in it. 1275 companies last time we counted.
So there is always something for sale. We’ve got, if you took a shotgun and shot right at that star in Midland, we’ve got assets all around that basin. We are very scattered. I think we are up over 7000 wells now in the Permian and about 90% of our capital for the company is going to go into the Permian.
But it’s just a really good place to be. When we got in, our I’ll tell folks is, on our asset base, if you told us to spin a 100% of the cash flow back in the ground, we’d probably destroyed value. Close to 20% an year, we could put back in the ground a pretty much, hold production flat that was good place to invest minimal amounts of capital, but not a great place to put all the capital.
Today, because of the horizontal, you could probably spend all of your capital right back there. We won't, that’s not the business model we are pursuing, but it’s a pretty exciting place to be today.
Let’s talk about the acquisitions. I’ve told you that, holding production flat is what we try to do with that reinvestment. But to grow the distribution, you got to make acquisitions and we’ve made acquisitions every year since 1981.
So we have always been in the game. There is not a year that we didn’t make some acquisitions. Some years we make more and some years we make less. But I call it the deal of the day. There is never a time in our office that we are not looking at something to buy.
Now, I wish I could stand up here and tell you we don’t go ahead and look at three deals and we buy one of the three deals we look at, but really we look at lots of deals. Our mindset and the way we go about things that were pretty value-oriented, value-focused. And our model, it works really well if you make your numbers.
If you pay for something that ensure what’s being there, it’s a little more challenging and so, we have a very rigorous evaluation. We use our own guys anything that we are looking at our engineers are the ones doing the evaluation.
So, we operate as I talked about properties in all those areas. So when a deal comes up for sale, the first thing we do is look that deal and then we look at our properties and say, do we think we can do better than what they are doing based on what we are doing on our properties.
And a lot of times we’ll get a report that says, they are going to spend $10 a barrel lifting cost and when we look at our properties and they are $18 a barrel. And we know that report has been scrubbed pretty good. So we have a pretty good idea going in and what it’s going to take us to operate and because of that, we have – I do a look back.
One of the things I make our guys do, every deal we buy, we go back to the original valuations. So we are still looking at deals we’ve bought in 2006, 2007, 2008 and we are comparing how did we do compared to what you thought we were going to do.
We send out the engineers, and that’s a hang them out – I don’t – it’s how we learn, but if you added all those evaluations up, we’ve been within about a 0.5% of our numbers on that $1.6 billion of acquisitions.
So, we are very good at understanding what these assets are going to be able to produce and then you bring the financing around them. So, we unfortunately, because of our experience, there are times that other guys see more value there than we do and we miss out.
But we’ve been out of the bar for sure. We came out, we told you guys a couple 100 million dollars a year of acquisitions, what it takes to be sustainable in the model and grow that distribution and if you average, you got to look at the average over those eight years.
It’s about $200 million a year, $1.6 billion over eight years and about $200 million a year. Now you see, this year we are only at a $100 million, in 2009, we were at $8 million, but year in year out, we’ll get our fair share. Right now the Permian is really hot. So, we are looking at a lot of things there that means there is a lot coming on the market.
We haven’t bought as much what we did buy this year is a pretty good packets of water floods from the chemical recycle. I am really excited about that. It’s not one that, next week you are going to go out and go, here is how you increase production.
But it is one, it was an underperforming packets of water floods and tremendous amount of oil in place and I think over the next three to five years our gas will find quite a bit of value in those fields. So, a very disciplined process we go through to look at these. We bring the operations guys in.
I don’t like to bid on anything that I don’t know who the guy is looking at and so, I use names, but if one of our engineers is looking at a project, he generally knows those assets, those field that we have people in the field that know it. I need to cover there.
Okay, let’s talk about just financially how we’ve done and you can see the numbers are going up into the right as they are supposed to oil, rate per day is going up, the EBITDA is going up, debt per barrel staying in line and I like to focus on that bottom, this box over here.
This – if I am sitting out there and you guys used, I want to know how do these guys run the company. We try to make acquisitions and we finance those acquisitions generally about half with new partnership units and half with bank debt. But the number I’m watching is that, debt-to-EBITDA.
We generally try to be between 2 and 2.5 as we issued some high-yield this last year. And that number needs to go up to about 3. I think the high-yield market at historical lows and we took the opportunity. We’ve got about $500 million of high-yield debt out. So you’ll see us run, where we have been running between 1.5 to 2.5, you’ll see us run to 2.8.
We don’t point out; you see in 2008, we got all the way up to 2.7 times debt-to-EBITDA. I’ll talk a little bit about that on this next slide, but, we had dropped back down to 2.0 in 2009. And this is the question that I get. Here is a chart of oil prices, all related with our distributions.
So we came out and you can see oil prices were just coming up. Everything was looking good. This is a 2008, got a period about a $140 a barrel. We bought some stuff at a $140 a barrel and promptly went all the way down to $35 a barrel. So, fortunately we were hedged and at that time.
I was not worried about our cash flow, because I know we were hedged. I was worried about our bank debt because we hedge all of our production with the banks and during 2008 that was kind of a scary time.
I wondered which banks were going to fail, which ones would they honor owed their money, I was going to have to pay that money would they honor their share and they did and we were able to weather that storm and maintain. You see, we didn’t keep growing distributions but we maintained distributions flat through that cycle and then as we bought some more acquisitions.
If I flip back, you can see 2009 here, we actually only did $8 million of acquisitions in that year. So we were – what we were doing is focusing on paying down debt with our excess cash flow. We didn’t do acquisitions; we didn’t spend a lot of money back in the ground.
We actually had our best coverage year ever in 2009 if you take total cash spent and we worked our balance sheet back into a good shape. So, I expect that that's what you are going to see. So then we got, prices start coming up. We held distributions flat.
And then we began to grow distributions about 12 quarters ago in 2010 and have been consistently growing about half percent a quarter. What I tell folks is, that’s what hedging does, what hedging allows you to deal with is shorter term commodity swings and we’ve got a very disciplined hedge approach that allows that to happen.
Good or bad, you are in the commodity business. So when you look three and five years out, if commodities are going to go up, it’s going to be an easier model to work with. If commodities go down and stay down, it’s going to be challenging and we have to make good acquisitions in those cycles to continue to pay those distributions.
So, good or bad, we’ve got longer-term commodity exposure. I think that’s good. I think, when I try to tell who should own these units, it’s been who wants some protection against long-term inflation, because we are hedged in this three to five year window. Pretty good, but in the out years, we are going to participate and I think what was going to keep pace with inflation worldwide and we’ll be able to continue to pay that distribution for years and years.
I’ll tell you sentiments of our unitholders and they are not really concerned about next quarter. They are looking five years and ten years out because the bulk of our net worth really is big.
I talked a minute about hedging, I just said we hedge with the banks because it’s the right way hedging so we are never exposed to margin falls. We don’t have – there are some companies that play the hedging game differently than we do. We don’t do – we don’t buy hedges.
Whatever the current market is, we take those hedges at the market and then manage the company off of that. We don’t try to move cash from three years from now. In this year, we don’t try around our hedges. It truly is trying to smooth that revenue curve, so that we can pay that distribution consistently.
So, in closing, I’d just say, consistent track record of paying distributions. If you like been invested with people who eat their own cooking, you got a management team and a group that have most of the net worth tied up in this company and our management for the long haul pretty straightforward structure on our development inventory.
We don’t spend a lot of time talking about even though we are in the hottest basin in the world, we have plenty of development to do. I am not worried about having good places to spend capital. We like to keep about two to five years of development capital on the books and then from that, we’ll as we do work we add work.
We’ll continue to manage the balance sheet the way have and grow, so, I think if you like an 8% tax shield with yield, and you want some long-term exposure to upward commodity prices, I think it’s a good investment for you.
So, with that, I’ll close and then we are headed to breakout room Praneeth. Okay, well, thank you guys.
[No formal Q&A for this event]
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