Seven Generations Engy (SVRGF) CEO Marty Proctor on Q2 2019 Results - Earnings Call Transcript

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About: Seven Generations Energy Ltd. (SVRGF)
by: SA Transcripts
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Earning Call Audio

Seven Generations Engy (OTC:SVRGF) Q2 2019 Earnings Conference Call July 31, 2019 11:00 AM ET

Company Participants

Brian Newmarch - Investor Relations

Marty Proctor - President and Chief Executive Officer

Derek Aylesworth - Chief Financial Officer

David Holt - Chief Operating Officer

Karen Nielsen - Chief Development Officer

Conference Call Participants

Michael Harvey - RBC Capital Markets

Arun Jayaram - JPMorgan

Patrick O’Rourke - AltaCorp Capital

Manav Gupta - Credit Suisse

Travis Wood - National Bank of Canada

Ian Macqueen - Eight Capital

Operator

Good morning and welcome to Seven Generations Energy Second Quarter Conference Call. I will now hand the call over to Mr. Brian Newmarch, Vice President of Capital Markets. Brian, please go ahead.

Brian Newmarch

Thank you for joining us for the Seven Generations Energy second quarter 2019 conference call. In attendance are President and Chief Executive Officer, Marty Proctor; Chief Financial Officer, Derek Aylesworth; Chief Operating Officer, David Holt; Chief Development Officer, Karen Nielsen, as well as other members of our management team. We will review our results for the quarter ended June 30, 2019 and then open up the line to questions.

All statements made by the company during this call are subject to the reader advisory set forth in the news release issued this morning and the company’s corporate presentation. All dollar amounts discussed today are in Canadian dollars, unless otherwise stated. The complete financial statements and MD&A for the period ending June 30, 2019, were published this morning and are available on www.7genergy.com as well as the SEDAR website.

I will now pass the call over to you, Marty.

Marty Proctor

Thank you, Brian. Seven Generations had a very strong second quarter, the results of which underscore the strategic evolution of the company. This evolution encompasses the creation of and growth of free cash flow, while improving corporate resilience to downside commodity movements. Our improving capital and operating cost structure are critical elements of a resilient, anti-fragile company. As well, strategic infrastructure spending is largely behind us implying a lower capital requirement for infrastructure and improving capital efficiencies looking forward. Today, we will also address our 2019 delineation capital investments, which have added to commercial inventory and increases our confidence in our ability to utilize existing infrastructure to sustain and increase free cash flow.

To that end, we generated $1 per share of cash flow during the second quarter and have reduced net debt by $24 million since year-end, even after buying back 18 million shares or 5% of the company since our NCIB was announced last fall. The transition of Seven Generations from rapid production growth to rapid and sustainable free cash flow growth is well underway. At current strip, we will generate $1.4 billion of cash flow in 2019, which equates to $300 million of cash flow in excess of our 2019 sustaining capital requirements of $1.1 billion. Phrased differently, this free cash flow equates to about $1 per share or about 15% of our market cap. An early look into 2020 suggests sustaining capital requirements will fall as decline rates moderate and operational improvements continue to be realized. In 2019, we strategically chose to invest half of that free cash flow, about $150 million or $0.50 per share, and to delineation efforts. We now have the results that reaffirm our convictions when we established our 2019 budget. Our delineation investment is proving that our lower Montney resource has the potential to ultimately add hundreds of premium locations. They make better use of our infrastructure investments and lengthen the useful asset life.

A quick note on our NCIB, capital allocation and cash flow prioritization is a core focus for Seven Generations. Given improving confidence in our sustainable, free cash flow generating ability relative to market valuation, we continue to view the NCIB as a competitive use of capital. To that end, we have amended the NCIB to allow us to buy back up to 10% of the company’s public float as of October 2018. Finally, Seven Generations was early in recognizing the benefits of ESG. It has been a fundamental building block for the company. Indeed, our company name was chosen because of this focus. That said, we know continuous improvements are required for responsible and sustainable management of emissions, water, community and stakeholder relations and employment diversity. As illustrated in our 2018 sustainability report, we have made great strides on these fronts and we are proud of our ESG accomplishments. We look forward to providing our stakeholders with additional decision-useful information on our progress.

I will now pass the call over to our Chief Financial Officer, Derek Aylesworth.

Derek Aylesworth

Thanks, Marty. The company remains on track with its full year guidance, seeing the second half of the year average between 205,000 and 210,000 BOE per day for a full year average production rate of approximately 202,500 BOE per day at the midpoint of our 2019 guidance range. Our total capital program of $1.25 billion remains firm. As Marty highlighted, the significant infrastructure spending now behind us in 2019, we can turn our sights to an expanding range of free cash flow, even in the current price environment with WTI in the mid-$50. This free cash flow is notionally earmarked for the buyback given it ranks as one of our best return in capital allocation decisions. And to support that, we have received approval for expansion of our NCIB to the full 10% of our public float. We also have the opportunity to commence a new NCIB in November for an additional 12-month period.

As we move into 2020, improvements to our declined profile and a lighter infrastructure footprint likely lead to a sustaining capital level of about $1 billion, maintaining a production profile that is similar to 2019. From that starting point, we will evaluate the appropriate level of capital allocation towards buybacks, net debt reduction and growth to best drive sustainable growth and cash flow per share, free cash flow and returns to shareholders.

While the current price environment is constructive for our business, I think it’s also important to highlight our defensiveness should oil prices suddenly change. In an extreme case, we believe in a low $40 WTI price environment, the interplay of near-term hedges, royalty rate reductions and improvements to sustaining CapEx from declined mitigation would allow us to remain at the same production level, while holding net debt-to-EBITDA stable in the range of about 2x. Building this kind of resilience has taken time, and we are increasingly comfortable that our efforts have come to fruition. Lastly, I want to add that our midstream process continues to progress and as previously discussed, we will update the markets when appropriate during 2019.

I will now pass the call over to our Chief Operating Officer, David Holt.

David Holt

Thanks, Derek. Operating expenses increased slightly versus Q1 as we had forecast and disclosed last quarter because of several planned maintenance events at both third-party pipelines and gas plants as well as at our own operations. These turnarounds proceeded smoothly and on cost. We diverted volumes within our system to Seven Generation’s Gold Creek plant, allowing us to better maintain production levels, preserve run times and quickly ramp production rates back up once turnarounds were complete. With these maintenance events now largely behind us and continued success in cost management, we’re able to take the top end of our operating cost guidance down by 5% to a range of $5 to $5.25 per BOE for the full year 2019.

As I have discussed before with many of you on the line, it’s not just about finding the big rocks of cost savings, the small rocks and the pebbles count, too. This includes process improvements in areas like supply chain management where we quickly get more vendors involved in bidding, or challenging something as simple as the cost of a cubic meter of drill fluid. All of these small initiatives add up for more meaningful wins over time. On the capital front, we have continued to make good progress. Our total drill and complete cost for the quarter averaged about $10 million, which is in line with our budget. Wells have averaged 9% deeper than this time last year and 5% deeper than last quarter. Lateral lengths are 20% longer than last year and 14% longer than last quarter. And stage counts increased 33% versus last year and 9% versus last quarter. As 2019 continues to progress, we have continuous improvement initiatives underway aimed at further optimizing the cost, productivity and EUR of future wells.

I will now pass the call over to our Chief Development Officer, Karen Nielsen.

Karen Nielsen

Thank you, David. I would like to emphasize how encouraged we are by the latest lower Montney results on our first full triple stack pad. While we never stop trying to learn more about our resource to extract even better productivity and costs, the results that we released today and our prior delineation efforts give us a lot of confidence in this resource and our approach to development and completions. From a drilling perspective, this full triple-stack pad was helpful for calibrating expected cost on the lower Montney. This somewhat softer rock accelerated our drill times and allowed us to shave nearly $0.5 million from each of these lower wells relative to our upper and middle locations despite being deeper in the formation. That’s a meaningful win, which we think we can reproduce on average in future development of this lower Montney. We completed some of the wells on that pad differently, testing incremental modifications in our cost-through design. All of those wells look good and the extra data should continue to help us fine-tune completions customization throughout the Nest.

Some of you might be wondering about the one lower Montney location with somewhat lower productivity. That horizontal well was done at the highest intensity frac on this pad and has taken longer to clean up than the other horizontals on the pad. So those rates still have the potential to move upwards as our cleanup continues. Overall, though, the real win in the lower Montney is a potential for up to 50% inventory expansion on prospective acreage by adding that third layer. Significant NPV increases perception and with similar capital efficiencies by taking advantage of the shared surface cost. And we think with further optimization, there’s a lot more that we can do with this.

So now I’ll pass the call back to Marty for a few closing remarks.

Marty Proctor

Thanks, Karen. Seven Generations is seeing early results of our strategic evolution towards a business model that is already showing free cash flow growth, while building in better downside resiliency. The combination of cost improvements, lesser infrastructure spending, increasing inventory and ultimately, lower corporate decline rates add to our confidence in a growing free cash flow profile. All of us at Seven Generations are aligned with shareholders in creating a long-term sustainable business that creates real economic returns above our cost of capital. As we progress through 2019, we are confident that Seven Generations will continue to deliver on our promises and emerge as a stronger, more efficient energy developer than ever before with the ability to consistently repeat year after year.

Operator, I will now ask you to open up the line to questions.

Question-and-Answer Session

Operator

Your first question comes from the line of Michael Harvey with RBC Capital Markets. Your line is open.

Michael Harvey

Sure. Thanks. Good morning, guys. Congratulations on the quarter. Just a couple of quick follow-up questions. Just on the royalties, [indiscernible] programs that are rolling off. Could we stick with that [indiscernible] the way move away? And then just a second one, the pipeline [indiscernible] upon July 11, it looks like it’s all wrapped up operationally. But I was just wondering if there is anything we should be including for Q3 that [indiscernible]? That’s it for me.

Marty Proctor

Thanks Mike. Good question. So if we are going to split the answers, Derek will handle the royalty part and David, the pipeline part. Derek?

Derek Aylesworth

Yes. Michael, on the royalty side, I think a 7% to 9% projection for the balance of the year is a good estimate. You are right with the dynamics. We have some of those rolling off, but we accounted for that when we put our guidance out.

Marty Proctor

David?

David Holt

Yes. Actually, what I can probably do here is just give a quick overview on what happened to Musreau Creek. So July 11, so we found a – through a normal pipeline monitoring operations, we did identify a leak from one of our small diameter gathering lines in the Kakwa field. What we have discovered since then is that there was a small naturally occurring land slough that let loose and took the line with it, damaged the line resulting in a leak. We currently estimate that no more 40 cubes of condensate was released before the line was secured and depressurized. So, as of this morning, 100% of the impacted soil has been removed. We have some final soil tests that are being conducted and final reclamation efforts are now getting underway. We’re continuing to work with the regulators and stakeholders, First Nations and responders bringing this to a quick resolution. As well, there have been no negative impacts to wildlife due to any contact with hydrocarbons. As far as downtime goes and any production impact, any production impact would actually be negligible to the point of being un-measurable on our volumes, so absolutely no production impact there. On a cost wise, we are approaching close to $4 million in reclamation costs, but most of that will be covered by insurance. And so we will have a deductible to pay for that to cover those costs.

Marty Proctor

Thank you, Mike.

Operator

Your next question comes from the line of Arun Jayaram with JPMorgan. Your line is open.

Arun Jayaram

Yes. Good morning. I was wondering maybe if you could talk about the potential of capital savings. If you shift to more of a triple stack type of development granted. I was just thinking about that relative EBITDA of $10 million per well that you reported for 2Q, pardon me.

Marty Proctor

You bet, Arun. So right now, it’s a bit early to make long-range projections on capital efficiency improvements and then the obvious benefits come from adding a third layer of wells to the same surface construction. So there will be some efficiencies that way, so we will need – we can use the same surface facilities for that extra layer of wells, therefore the capital efficiency on the facilities side has improved. We also observed that those lower new wells are a little less expensive to both drill and complete. That should indicate a little bit of capital efficiency improvement. At this time, we are actually seeing excellent results, probably exceeding our expectations. But I think our expectation is that the lower Montney won’t be quite as prolific, quite as productive as the middle and the upper. Overall, I think we’ll see an improvement in the capital efficiencies, mostly due to the surface facility usage and the extended life of those surface facilities. But a bit premature for us to speculate on the exact dollar amount.

Arun Jayaram

My follow-up question is the completion [indiscernible] around a little bit for the last couple of quarters. Could you talk to that – could you speak to that and just also on a go-forward basis on the background?

Marty Proctor

Yes. Look, I would say we’re continually trying to innovate and improve the way we execute. All of that can really support improvements that relate to your first question. We think that capital efficiencies can continue to be improved by innovating, working on our well designs, finding ways to save cost in every way. So we have evolved our completions from kind of fewer stage with larger sand amounts per stage to more stages with less per stage, but still about the same amount of sand in a well. But we are finding ways to apply that sand a bit differently, including, as we had talked about in the press release, a few more perf iterations – kind of perf clusters or frac initiation points within each stage. So we will continue to find ways to evolve and I think stay ahead of all the technology. We work well with other operators. In many ways, we think about this as an open source where we share ideas, we participate in conferences, technology conferences to get better and better. So it’s a constant evolution of how we execute, all driven towards improving capital efficiencies and ultimately, generating better returns on our investments.

Arun Jayaram

Great. Thanks a lot.

Marty Proctor

Thank you, Arun.

Operator

Your next question comes from the line of Patrick O’Rourke with AltaCorp Capital.

Patrick O’Rourke

Hey, good morning guys. Just a quick question on the lower Montney here. So I was just wondering, so to date, your results sort of book ended your net drilling program, just wondering [indiscernible] in a potential Montney well [indiscernible] preexisting development. Is it strictly going to be [indiscernible]?

Marty Proctor

It’s a really good question, Patrick. We don’t know for sure. In fact, we are looking to implement at least one if not two lower Montnies next year that will be in the area where we had previously developed the middle and the upper. Our expectation would be based upon a lot of scientific work that we’ve done over the last 1.5 years. Our expectation would be that probably the productivity will be a little compromised, but we don’t know to what extent. So, a bit early to conclude. I think we are still going to find a lot of productive capacity in the lower Montney even where we’ve developed the upper. But we have not done really any significant work in that way yet.

Patrick O’Rourke

Okay, and then just a quick question on volume capability on the condensate side. You’ve got the 80,000 barrels of stabilization that’s in play. You’ve produced above that in the past. Where would you say your capacity is on the condensate side?

Marty Proctor

Yes, we have produced above that. And we’ve got that condensate stabilizer facility of our own. We also are able to process some condensate through a third party plant. And we’ve got – we actually have a very large pressure treater at that condensate stabilization site that can handle and upgrade some of our condensates as well. So yes, I think we probably got close to our capacity for condensate handling in the past. We certainly have room now. We will optimize how we do that. We’re actually trying a couple of ways to look at some of the development, particularly towards the east where we tend to have a little higher density condensate. We are – we’ve experimented here in this past year with a more of a, you can say, an oil battery style of processing, which has allowed us to take some of the higher density condensate out through a separate path and leaving all the rest of the condensate with the lower density for which we get a better price. And so there are things we’re looking at. We really want to optimize that. David and team are working hard on ensuring that we do not over capitalize and that we could be as efficient as possible. So we’ve got plenty of room in terms of condensate handling capacity now and we’re working to improve even how we handle that growth in the future when it does resume.

Patrick O’Rourke

Okay, thanks a lot.

Marty Proctor

Thank you. Patrick.

Operator

Your next question comes from the line of Manav Gupta with Credit Suisse.

Manav Gupta

Hey guys. [indiscernible] question that [indiscernible] over on your condensate market, we have seen tightening of condensate [indiscernible], and at this point I think WTI is $1.50 for condensate. So what’s your outlook for condensate discount for the rest of it?

Marty Proctor

Thank you, Manav. A very good question. I’m going to ask Brian to handle that one.

Brian Newmarch

Yes. Good question. I think we’ve been pretty forthcoming with our views on the condensate market. We have not seen the growth that we’ve seen historically from a supply side. But from the demand side, we do see an actual uptick in demand, and that has to do more so with retooling of demand from some of the oil sands operators where there’s a conversion away from a synthetic blend towards a condensate blend that leads to incremental demand in the second half of 2019. But I think that’s been reflected in the disc that we’re seeing right now.

Manav Gupta

So just observation, you actually [indiscernible] discount which is currently prevailing. The free cash flow is higher than what you are trading. Just trying to understand your guidance on the [indiscernible]

Marty Proctor

Look. We put our guidance that matches our expectations. We would like to do at least as well as we promise. And so as we – when we put that guidance out to kind of a rough projection of free cash flow, it was based upon strip at the time we wrote the document. Of course, that goes up and down and at the moment, it might look a little more attractive than it did when we wrote. But in general terms, we’re just taking care of business. And condensate, being the biggest condensate producer in Canada, which is the most valuable hydrocarbon product in Canada, it’s a good place to be and our outlook for condensate pricing is excellent.

Manav Gupta

And last question on lower Montney. Should we assume that lower Montney is going to be more condensate rich than upper and middle?

Marty Proctor

Again, I guess it relates similar to a question that was asked before about the lower. It’s still quite premature for us to speculate too broadly over what we will get from the lower. Condensate rates have been very good for the tests that we’ve done. We’re very encouraged by what we see in the triple-stack recently, especially. I would say the condensate rates are probably quite comparable to what we have seen in the upper and middle. The gas rates are a bit lower, and so the condensate gas ratio is better. Overall, we’re very satisfied with those results. In fact, as I said, encouraged and I think the outlook is at least as good as we had hoped and probably better.

Manav Gupta

Thanks guys

Marty Proctor

Yes. Thank you Manav

Operator

Your next question comes from the line of Travis Wood with National Bank of Canada.

Travis Wood

There is a bit of kickback, operator, if you’re listening and follow along the Q&A. But my question is on the lower Montney. I think you have already alluded to it quite early on in providing some color. I’m trying to get an understanding of inventory, how you guys are thinking of that but then one of the pushbacks around the Seven Gen story. So inventory on the lower Montney provide some comments there, please.

Marty Proctor

Yes, you bet. Thank you for the question, Travis. Look, yes, I can – I do recognize that some people have talked about inventory. For us, we’ve been very, very satisfied with the inventory we have. We have always tended to talk about premium inventories, our top tier inventory. In just the upper Montney and in the Nest area alone, we see something like 1,300 locations. That is something like 15-plus years of drilling inventory in just the upper, just our premium area in the Nest. This lower has the potential to add significant quantity of inventory. As I’ve said, we’re trying to hold back a little bit in terms of our expectations. We’re encouraged, probably at least a few hundred premium locations to be found. It could be even more substantial than that. As Karen said in her opening comments, I mean, if you can add a whole layer to all of our Montney development, you’re talking about 50% increase in total inventory, not to say all those are going to be premium. But I guess I’m trying to hold myself back in terms of the rant on inventory. The reality is all we’re talking about here is Nest so far. And we have now discovered through, I think, some very good work on the science side and also now confirmed by our drilling that the lower is likely to be very productive and will contribute to more premium inventory. Beyond all of that, we haven’t – nobody has really included in their numbers all of the Wapiti inventory, which NuVista has done a great job of developing. They call it the Bilbo. And where they work, we see another 1,000 locations in that Wapiti-Bilbo region through our rich gas area. We also see a lot of other locations in other parts of our land. There’s cretaceous targets. In our opinion, we’ve got multi-decades of very good inventory and what we’re doing is bringing forward even more top tier inventory through this work that we’re doing.

Travis Wood

Okay. Thank you for that. And then one follow-up as we think about the drilling program for the rest of this year and can you provide color for next year? This triple-stack feels like it would have met our expectations, so could we start to think of doing more of the silo pad development through 2020 or we’re going back more to single well type?

Marty Proctor

Yes. It’s a great question. And that really – it really was our objective is to find a way to improve capital efficiencies. If we can stack one more layer, that lower Montney layer with the upper and middle development that will make everything more efficient. So it is our intent to – still early stages, we have not, of course, finalized or reduced a budget for next year, but it’s our intent to have several triple stack type of modules, pseudo-cubes, super pads, whatever you want to call them. We will have that in next year’s program. One great thing is and it goes to our comments about the improving profile of free cash flow, we now feel fairly confident that the lower Montney development goes into the development bucket next year as opposed to being in the delineation bucket. Therefore, again, less sustaining capital, less delineation capital, less infrastructure capital, all that leads to more free cash flow next year.

Operator

Your next question comes from the line of Ian Macqueen with Eight Capital.

Ian Macqueen

Good morning guys.

Marty Proctor

Good morning Ian.

Ian Macqueen

Just a question on – you talked quite a bit – actually, echoing back in the [indiscernible] Your capital investment this year is 1.25. Your sustaining capital was 1.1 and the number of wells you’re drilling is about 65 to 70. Next year, that goes down to sustaining capital, about $1 billion. What should we expect in terms of number of wells that should be drilled? Is it probably 60 more, 65 to 70?

Marty Proctor

Really good question, but we have not really finalized what the 2020 program would look like. But yes, you’re accurate in pointing out that the sustaining capital next year will be less than this year. This year, we chose to put infrastructure investments like connecting our Nest 3 up to our core area. We chose to put that into the sustaining capital budget. Most of that does not recur next year. So that, combined with the lower decline rates, combined with less delineation drilling should mean that sustaining capital is lower next year. In terms of well counts, how much we’re going to drill next year. Yes, it’s – again, it’s kind of premature to say. It will depend. Derek made comments in his – he did mention the fact that we’re looking at what is the best way to allocate capital. Is it to return of capital in terms of buybacks, reducing debt or reintroducing an element of growth? That extra growth that we did, if we did go that way, would require a little more drilling. But it’s premature to say how much. I think the amount of wells we’re drilling this year is likely to be repeated next year and possibly a few more if we do reintroduce some growth.

Ian Macqueen

Good. Thanks very much. I appreciate that.

Marty Proctor

Yes. Thank you very much Ian.

Operator

There are no further questions at this time. I will now turn the call back to Mr. Brian Newmarch.

Brian Newmarch

Thanks, everyone, again, for joining us on the call today. If you have any further questions, don’t hesitate to reach out to Ryan Galloway or myself. Our contact information is on our website. Operator, you can wrap the call.

Operator

This does conclude today’s conference call. You may now disconnect.