CONE Midstream Partners' (CNNX) CEO John Lewis on Q2 2016 Results - Earnings Call Transcript

| About: CONE Midstream (CNNX)

CONE Midstream Partners LP (NYSE:CNNX)

Q2 2016 Earnings Conference Call

August 04, 2016 11:00 AM ET

Executives

Steve Milbourne - VP, Investor Relations

John Lewis - Chairman, CEO

Joe Fink - COO

Dave Khani - CFO

Operator

Good morning, and welcome to the CONE Midstream Partners Second Quarter 2016 Operating and Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Steve Milbourne, VP of Investor Relations. Please go ahead, sir.

Steve Milbourne

Good morning, everyone, and welcome to CONE Midstream Partners second-quarter conference call and webcast. Thanks for joining us this morning. John Lewis, Chairman and CEO, Joe Fink, Chief Operating Officer, and Dave Khani, Chief Financial Officer, will begin today's call with some comments on the quarter. At the conclusion of their remarks, we will open the phone lines for questions.

A short presentation that will be referenced during the call is posted on our website conemidstream.com. The slides are available in the Events and Presentations feature box on the home page.

Please be reminded that during the course of our remarks and in our answers to questions, we may make some forward-looking statements and refer to non-GAAP measures. Our forward-looking statements or comments about future expectations are subject to a variety of business risks that are more fully described in our public filings with the SEC. Reconciliations of non-GAAP to GAAP measures are contained in this morning's press release.

We'll now turn the call over to John Lewis for his comments on the quarter. John.

John Lewis

Good morning, everyone, and thanks for joining us today. This morning, CNX announced another quarter of solid financial and operating results. This is our seventh full quarter as a publicly traded company, and the key performance measures for the quarter continued our pattern of meeting or exceeding our expectations. As indicated in our earnings announcements, based on our performance to date and the outlook for the balance of the year, we've modestly increased our guidance for full-year 2016 results.

Comparing this quarter with the second quarter of 2015 illustrates our strong growth. Throughput volumes attributable to CNX increased by 51%, unit operating cost net of power were down by 40%. And net income, adjusted EBITDA, and distributable cash flow all grew in excess of 55%. We had 14 wells turned online during the second quarter. The new pipeline connections included the pad with the first producing wells at the Allegheny County Airport and another Green Hill pad.

Our operations team has continued its success in further reducing operating expenses. Unit operating expense net of power for the second quarter was $0.074 per billion Btu. This represents a decrease of approximately 40% from 2Q 2015, and a sequential decline of approximately 7% from 1Q of 2016. Volumes during the second quarter were modestly impacted by some wells temporarily taken off line for maintenance and repair work, and a period of production management by the sponsors during this spring's low commodity pricing.

We estimate these activities reduced our average net volumes for the quarter by about 45 billion Btu's per day, which resulted in a revenue deferment to CNNX of approximately 1.8 million for the quarter. The impact to adjusted EBITDA and distributable cash flow is slightly less than that amount. As we announced earlier, our regular cash distribution with respect to the second quarter is $0.254 cents per unit. This is our fifth consecutive quarter of consistent distribution increases and represents a 3.7% sequential increase over the first quarter of ’16, and a 15.5% increase over the second quarter of ’15. Our cash distribution coverage for the quarter on an as declared basis was 1.55 times. The recovery of natural gas and liquid pricing should result in an improved environment for our sponsors. We consider this a positive in our expectations for the remainder of the year and our outlook for 2017. CONSOL's announcement last week of plans to resume drilling this month, including two wells planned for this year on the Anchor System acreage dedicated to CONE is evidence of this improved environment.

Slide four shows our updated expectations for the connection activity for the balance of 2016, and our projected year end DUC inventory. The curve projected of 75 drilled but uncompleted wells at the end of the year shown on the slide, excludes the potential 2016 impact of the two additional wells from the expected resumption of drilling. I want to also note that we are still actively working and I believe we're making good progress on several third-party business opportunities. We are optimistic that we will be successful in the relatively near-term and adding more shippers to CONE's gathering systems.

I'll conclude with a few words about 2017, as I know investors are anxious for more information about the sponsors' plans for next year. I can tell you that the 2017 plans are under development in accord with the normal budget cycle and calendar of the sponsors' joint venture. This means that the Joint Development Committee, or the JDC, is just beginning their work on the detailed plans for 2017 activity. These plans typically go through many iterations before being approved by each of the sponsors' respective boards in December.

With respect to CONSOL's recent announcement to restart drilling activity with two rigs, CONSOL has only disclosed their current 2016 intentions, which include the two wells in Washington County on our Anchorage Systems acreage that I spoke about earlier. The resumption of drilling by CONSOL in the current commodity price environment are, in my opinion again, certainly positives for CONE's 2017 outlook. However, we will have to wait for the final JDC budget before we can provide more information on the expected activity and the resulting volume expectations for CNNX next year.

So with that, I've asked Joe to give a brief update on CONE's operations and to give some insight on how our operating flexibility benefits our shippers. Joe.

Joe Fink

Thanks, John. We are frequently asked about CONE's system capacity and current utilization rate. So I thought it would be helpful to comment about that. I know some investors have compared our quarterly throughput statistics with capacity information in our 10-K and investor presentations, but it really doesn't give a full picture of our operations. Our actual capacity utilization varies widely across and within each of our systems. In some places we have plenty of capacity to take additional volumes and in others we are fully utilized.

In February, I noted that at that time we had roughly 100 connected wells with field pressures averaging above 1,000 pounds of volume pressure. Those 100 wells are entirely in our Anchor System and account for roughly 400 million, or just over a third of CONE's throughput. Comparing the same 100 wells from February to June, the pressure is actually up approximately 3%, while their productivity is down a modest 2% to 2.5%. With that said, it is easy to understand our optimism around our legacy gathering system, decline and throughput profile.

The topic of capacity naturally leads me to talk about de-bottlenecking and system optimization work. We've spoken about our North Ninevah project, and we are on track to bring the final phase of that project online later this year. This will not only help relieve pressures, it is also the extension to our MRO-30 pad, the first pad our sponsors are scheduled to complete with the recently announced new rig activity. In addition, finishing the plan line looping will allow us to create a separate high and low pressure gathering system and/or a wet and dry gathering system.

In the northern most quarter of the North Ninevah field, which is currently gathered by our dry system, the gas composition reaches north of 1,200 Btu, a composition that is high enough that NGL extraction can be accretive in most market conditions. We, our sponsors, and other producers see value in this type of operational flexibility. In fact, if you take a look at slide 6, you can see an example of how our gathering system spans the wet and dry portions of the Marcellus and the locations of our Majorsville and McQuay stations. We have the operational ability to take the production from some wells that produce in this intermediate Btu window to either Majorsville, which, in turn, delivers to a third party, Cryogenic Processing, or to McQuay, which delivers directly to interstate trunk lines.

Depending on liquids pricing, it may be more advantageous for our shippers to pay for processing the gas and capture the liquid value or simply blend with drier gas and capture E value. Not only is this beneficial for our sponsors with whom we worked to take advantage of this flexibility this past quarter, we believe this also is beneficial to CONE, as it may allow the producers to sustain economic production from these intermediate wells when they might otherwise be incented to curtail production in low liquids price environment. In summary, beyond the obvious field pressure reduction, this fully looped system offers, we see field optimization opportunities well into the future.

We've also been asked about the impact of Utica production on our gathering system. As you know, CONSOL has talked about its highly successful Gott [ph] well that produces through our Mamont facility, which is also in the Anchor System. It has been a very prolific well by any measure, and CONE has been able to handle these volumes by working with the sponsors to strategically locate the well very near to the station where a short segment of new pipe would allow the gas to not displace lower pressures legacy Marcellus production. This ability to coordinate development with an eye towards capital efficiency is one of the major advantages of our close-working relationship with the sponsors and something we believe provides value for third-party shippers with whom we are having conversations. We are capitalizing on our ability to reuse the same infrastructure to develop two premiere shale plays.

I'll now hand the call over to Dave for his comments. Dave.

Dave Khani

Thanks, Joe. Good morning, everyone. My comments will be relatively brief, but I'd like to emphasize several important points. First, CONE again has generated free cash flow after CapEx, interest expense, and paying an increased distribution. Second, our results were strong despite well maintenance and repairs, and volume management activities which reduced gross and net throughput volumes of approximately 90 and 45 billion Btu's per day respectively.

The gross and net impact to EBITDA and DCF was about 3.6 and 1.8 million respectively. This is important to understand when looking at the gross and net sequential trends. Third, we paid down $27 million of debt and our net debt to EBITDA ratio has declined to 0.46 times from 0.9 times at yearend 2015. Fourth, our distribution coverage ratio of 1.55 times, which generated entirely from organic throughput. And fifth, we think our combination of our low leverage and strong distribution coverage is unmatched in the MLP space.

As John noted earlier, we have modestly increased our 2016 guidance. The EBITDA increase is about 3%, using the midpoint of our range as a reference. Our practices is always to be conservative on guidance and to have a high level of confidence in which we will tell investors. Joe talked about the wet/dry operating flexibility which we have to service some of our intermediate B2 gas as we gather. And the sponsors are currently evaluating making adjustments to the wet/dry delivery mix. Those changes, if implemented, may result in some volume and revenue upside to our current projections for the third and fourth quarters. And later this year, we could be a potential catalyst for moving expectations up a bit further.

I'll also give you some color on our gross $10 million of inventory revaluation. This resulted from a markdown in the valuation of our mainline pipe that has been purchased in 2014 for the Tygart Valley project. That project was subsequently deferred and the pipe was held in inventory. Given the current uncertainty about the timing of the Tygart Valley project, a decision was made to sell a portion of the pipe to a third party. The inventory was re-valued to reflect the agreed upon sales price. Because the assets were in DevCo 2, or the growth system, the net impact of the revaluation to CNNX was only about $0.5 million charged to the allocated net income, with no impact on adjusted EBITDA or DCF.

I'll conclude with some thoughts about organic outlook for CONE. The largest concern CNX investors have expressed is the recent absence of drilling on our dedicated acreage. Given the large inventory of DUCs, the sponsors have focused this year on reducing that inventory and will still only work off about a third of that year end 2015 levels. The issue the sponsors are now focusing on is what capital spending levels will be in budgets for 2017 will be within the Marcellus and dried Utica. To help jump start the outlook, the sponsors have communicated their intention to add a rig and drill a couple of Marcellus wells within DevCo 1. CONSOL has also raised its view on its operated Green Hill type curve by 10% to 30% and reiterated its positive view on the dry Utica.

Looking further ahead, we expect more takeaway capacity from the Appalachian basin will reduce basis differentials and in turn produce realizations. While commodity prices are impossible to predict, the current environment outlook and the forward curve are giving producers more incentives to increase the pace of activity. This should translate into more future activity for the sponsors and also help in securing third party business.

Now, we've consistently said that CONE's growth will come from a combination of organic activity, third party business, and asset drop downs. We have many levers to pull to enhance our distribution growth. While the commodity cycle creates volatility, it also creates opportunity. And we have proven that we can continue to deliver, as the underlying assets are some of the best within the industry, operating teams are second-to-none, and our industry leading balance sheet provides flexibility to pursue numerous options.

We're ready to take questions now. Operator, please go ahead and open the line for questions.

Question-and-Answer Session

Operator

Thank you, sir. We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Jeremy Tonet from JP Morgan. Please go ahead.

Unidentified Analyst

This is Rahul [ph] for Jeremy Tonet. I guess want to touch on your updated strategy on drop downs going forward. Can you provide us some color on that?

John Lewis

Sure. I think our strategy really hasn't changed from what we initially came out with, that drop downs are key part of our growth strategy as we move through time. What I always have to say on this is the drop downs are a negotiated transaction between the sponsors and the MLP. And that will occur kind of when it occurs to the betterment of both parties. I'll also say my other comment is the same as always is, I don't want to wait until we have to do a drop-down to do a drop-down. So we have the capability to do it at almost any time, and we'll continue to work with our sponsors to look at that. Dave, you got anything you'd like to add on that?

Dave Khani

Sure. I think what we've also said in the past is if we do a drop-down, the drop-down will be to help enhance out further distribution growth into probably 2018.

Unidentified Analyst

Got you. Also, on the kind of growth CapEx, I think like there was some kind of good step-down this quarter compared to last quarter. So going forward like for the second half, how do we think about this?

John Lewis

So the question is it looks like our growth capital spend was a little bit less in second quarter than it had been. Joe, you want to comment on that?

Joe Fink

Sure. We're waiting for permits at our Hopewell facility to begin construction of some additional dehydration. So really, the expenditure in the Anchor will occur later in the year so relatively modest.

John Lewis

So I think the bottom line of all of that is that our guidance for the year for CapEx is unchanged and it's really timing, not total level of expectation.

Operator

[Operator Instructions] And at this time, we have no further questions. I'd like to turn it back over to Steve Milbourne.

Steve Milbourne

All right. Well, thanks, everyone, for joining us. And we appreciate your participation and we'll look forward to talking to you again next quarter.

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect the lines.

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