Good day, and welcome to the Western Gas first quarter 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by 0. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then 1 on your telephone keypad. To withdraw your question, please press star, then 2. Please note, this event is being recorded. I would now like to turn the conference over to Jon VandenBrand, Director of Investor Relations. Please go ahead, sir.
Thank you. I'm glad you could join us today for Western Gas's first quarter 2018 conference call. I'd like to remind you that today's presentation includes forward-looking statements and certain non-GAAP financial measures. The accompanying slide deck in last night's earnings release contain important disclosures on forward-looking statements, as well as the non-GAAP reconciliations. Please see the WES and WGP 10-Ks and other public filings for a description of the factors that could cause actual results to differ materially from what we discuss today. Those materials are all posted on the Western Gas website at www.westerngas.com. I would now like to turn the call over to our CEO, Ben Fink. Ben?
Thank you, Jon. Turning to our first quarter results, we reported adjusted EBITDA and distributable cash flow of $272.1 million and $231.4 million respectively, and a coverage ratio of 1.05 times. This coverage ratio was in line with our expectations. We still expect distribution coverage to be over 1.2 times by the end of the year. While adjusted EBITDA was essentially flat with the prior quarter on a reported basis, we actually experienced 2% growth after adjusting out the one-time payment DBM Water Services received in the previous quarter. As a reminder, we adopted the new revenue recognition accounting standard on January 1st of this year. While this new standard resulted in changes to how we recognize revenues and cost of product for certain contracts, adjusted EBITDA for the quarter was approximately $1 million lower than it would've been under the old standard.
Our quarterly results were driven by strong natural gas throughput growth in the DJ and Delaware Basins. We also saw incremental growth behind the Springfield Gas Gathering System and the Granger Straddle Plant. The adjusted gross margin for MCF of $1 was unchanged from the previous quarter. The growth in our crude NGL and produced water throughput was driven by the continued growth of our produced water business and higher volumes at the Springfield Oil Gathering System and White Cliffs Pipeline. The adjusted gross margin for crude NGL and produced water assets of $1.84 was $0.37 lower than the previous quarter, driven by normalized produced water margins and lower per barrel distributions from White Cliffs and Texas Express Pipeline. In yesterday's earnings release, we announced that we have secured options to participate in 2 long-haul crude pipelines out of West Texas in conjunction with Anadarko shipper commitments.
We believe there is a critical need for additional takeaway capacity to serve Permian oil production growth and are delighted to have the opportunity to be part of the solution. I want to be clear that our options to participate in these projects are at cost. We are not paying a promote of any kind to participate. We have the option to take a 20% stake in Enterprise's Midland to Sealy pipeline that will provide access to the Houston market, and as of today, we have exercised this option subject to the completion of final documentation. We also have the option to purchase up to a 15% ownership interest in Plains' Cactus II Pipeline, which will link the Delaware Basin to the Corpus Christi market in late 2019. Details about these projects can be found on the operator's investor materials, and I encourage each of you to look at them.
We believe that we will spend a total of $300 million-$350 million in 2018 to fund our share of both projects. Accordingly, we've updated our 2018 capital outlook to $1.35 billion-$1.45 billion, and we still intend to fund this capital program without issuing additional equity. Our 2018 run rate leverage ratio should not exceed four times, and we expect this ratio to decrease in 2019 as we see a full-year impact of the anticipated Delaware volume growth. All of our other guidance remains unchanged, and we continue to be focused on executing the plans we have previously communicated. As always, we appreciate all of your continued support. With that, operator, I'd like to open up the line for questions.
Thank you. At this time, if you would like to ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Our first question will come from Jeremy Tonet of JPMorgan.
Good morning. Congratulations on the equity options there. I was just wondering if these options were included in your EBITDA guidance as it stands now, or if that's something that you might adjust in the future when everything's finalized there.
Good morning, Jeremy. It's Ben. It's probably something we might adjust for in the future. It depends on how the final accounting treatment shapes up. Let me explain. We expect if everything goes as it should, everything will close by middle of the year, then we'll certainly report half a year of adjusted EBITDA. That by itself is not enough to really move our range either way. The question is what happens to the earnings that are attributed to us for the period from in-service to the time it closes. Is that going to be net capital, or is that going to be a gross capital and also report earnings? It really just depends. We'll know a lot more between now and closing. Does that answer your question?
That's very helpful. Thank you for that. Was just wondering, is the potential for other options as well to materialize in the future? These are great interests that your sponsor was able to provide for you. Could there be more opportunities like this going forward in the near term, any updated thoughts on, I think you talked about a Red Bluff equity option previously. Any thoughts that you can share there?
Sure. We've publicly talked about two others, although we've made no decisions on whether or not to exercise such options. There's an option to take a piece of the Red Bluff pipeline, which will get us from Ramsey to Waha, basically. There's the Cheyenne Connector pipeline, which comes online in 2019 out of the DJ. There is at least one other that's under negotiation, under discussion, and we'll see if we get to the closing line on that one. This is something we're always looking for to be able to use or that our sponsor is able to do to utilize its leverage as a customer to get an interest in some really great projects.
Great, thanks. Equity earnings seemed like it stepped down a little bit in 1Q versus 4Q 2017. Was that just seasonality and timing or anything else we should be thinking about there?
Two things. One, there were lower distributions from the White Cliffs Pipeline, which should surprise no one. Remember, in the fourth quarter, we had the one-time payment at DBM Water. When you normalize for that.
Hey, Jeremy, that helps explain the change to liquids that Ben was talking about. We also just experienced some normalizing of the cash distribution at several of our equity investment assets, including Texas Express Pipeline and the Front Range Pipeline, as well as Mont Belvieu. As you had a bunch of extra cash cleared out in the fourth quarter, you just returned to normalized distribution levels.
Yeah. Sorry, Jeremy. I was answering a question you didn't ask, which was about gross margin per barrel. Sorry about that.
Okay. Maybe we could pick up on gross margin per barrel, if you want to continue with your thoughts there.
Sure. You noted previously that it declined sequentially, and that was basically due to the normalization of the produced water barrels, which, as you know, is a gathering business, which just has lower margins than a long-haul transportation business.
Great. That's all very helpful. I'll pause there. Thank you.
The next question will come from Shneur Gershuni of UBS.
Hey, good morning, guys, or afternoon, I guess, at this point. Just wanted to ask a couple of quick questions here. First, on the stake that you have in the Midland-to-Sealy pipe that was disclosed last night. The fact that you're buying into it, do you get a refund of any of the earnings that they made on the pipeline in the last quarter or so in terms of cash flow once you pay in, or is it you just earn the cash flow go on a go-forward basis?
Sure, Shneur. Our option is effective as of the date it went into in-service, which was November of last year, right? As I said earlier, we're entitled to our share of those earnings, and the question will be whether it's accounted for as a net capital number, or will we report the gross capital plus the earnings going forward. We're certainly entitled to our share from the in-service date.
Okay, got it. We'll either see it as an earnings number, or we'll see it on a deductive against CapEx. Got it. The second question, I'm sure you're sick of it, but have to ask it, the simplification question. Any tone change from the last conference call? It seems like it's picking up a little bit, and it seems to be a big investor focus as of late and could be argued as a overhang on your equity.
No, I appreciate the question, Shneur, and understand it. The reason there was no comment in the prepared remarks is we really have nothing new to say. We continue to look at the issue, and if there's something to talk about, we'll make an announcement.
Great. Perfect. Thank you very much. Appreciate the color.
Next, we'll have a question from Richard Roberts of Scotiabank Howard Weil.
Hey, good morning, guys. Quick question on the water business. You've had some success recently on the water side with third parties. I guess going forward, should we expect any future third-party business is going to go on the Westwater assets instead of APC? Maybe you could talk about just how that gets determined, where that third-party business goes.
Yeah. Our current mode of operation, Richard, is that third-party business will be West business going forward.
Okay, got you. Then I guess sticking on the water side, I understand that most of the producers are building out their own water systems. As you try to add more third-party business, are you primarily targeting smaller producers that haven't made those investments, or are you making any headway with the larger producers kind of migrating some of that spend over to you?
Yeah, it's a great question, Richard. If you were to look at our deal pipeline, you'd see some blue-chip producers, and you'd see smaller guys. It would really run the gamut in terms of size. What we're able to do is by getting out in front of the problem and building a lot of infrastructure that's on dozens of producers' doorsteps, whether they're large or small, we can offer them a really competitive solution.
Okay, great. Maybe one more. You mentioned the amount of infrastructure you have going in. Clearly this year is a pretty big year for infrastructure spend, a lot of backbone infrastructure going in place as you set up for the volume ramp over the next couple of years. APC is doing a fair amount of midstream investing, too. Just as we think about the next couple of years, the cadence of spending from here, do you think we should see a rollover in spending as you start to reap some of the cash flow from these big investments you're putting up front, or is there more APC-level spending that migrates down to you, so you stay in that kind of billion-dollar-ish range? Anything you can share there?
Yeah, that's the 500-pound gorilla that we need to address between now and the end of the year. When you look at our portfolio as it stands today, our capital needs for next year should be significantly below this year, right? We're in various stages of four processing plants that'll all come in service by the end of 2019. We're building a lot of trunk line, and once plants and trunk lines are built, they're built, now you're really looking at well connections going forward. The question is, as we look at whether it's acquisition opportunities or what we want distribution coverage to be, how much of the capital that's at Anadarko will we want to move down to West?
Obviously, water is one option, there may be a couple other options as well, that will be the critical decision to be made as we go into budgeting for next year.
That's helpful. Thanks, Ben.
Sure.
The next question comes from Gabriel Moreen of Bank of America Merrill Lynch.
It's actually Deutsche Bank, anyway, good morning, everyone. I had a couple of quick follow-up questions. One was the Midland-to-Sealy Pipeline. Clearly, there's a bit of open capacity there in terms of walk-up volumes. I think your other operator of that pipeline has talked about hedging out some of the barrels on that pipeline. Can you talk a little bit about what your approach might be to, I think, the exposure you might have to that spread?
Sure, Gabe, welcome back. Obviously at non-op, we don't have a lot of decisions around that, and obviously the option right now is subject to final documentation. What I can tell you is that we'll have 20% share of a JV. We'll have our proportionate profits and losses of that JV. That JV will be involved in marketing activities, but we expect that those activities will be limited to really certain activities that are directly on the pipe.
Gotcha. Then just curious in terms of clearly it's been in service for a while, the decision to hold off, I guess, disclosing this for a while, was that just to wait sort of until, hey, you have to exercise the option, or was there any other thought process behind, I guess, disclosing the stakes here and at Cactus?
Those are contractual requirements.
Understood. Great. Thanks, Ben.
Our next question will come from David Heikkinen of Heikkinen.
Morning, guys. Ben, back to the water margin. Can you just help us from a modeling perspective think about that liquids margin per barrel line item and how that will change throughout the year as you continue to add water volume to that segment?
Yeah. Water gathering is a lower margin business, a significantly lower margin business than long-haul transportation, right? Because it's a gathering business, you're seeing lots and lots of volumes, and that impacts the throughput mix of the barrels that we have. This decline is no surprise to us, and we would expect it to trend downward from here as those water volumes continue to grow and be a bigger share of the throughput mix relative to the long-haul transportation.
Okay, maybe any thought about an exit margin per barrel, liquids margin per barrel or just from a where it is 1Q and where you might exit this year?
I don't know. I'd say from where we are, we'll probably trend towards $1.50.
That's helpful. Thanks. Then sticking on the water business, you had mentioned that you're seeing some change to term on the third-party contracts, that they're getting longer and looking more midstream-like. Is that continuing, and do you see that becoming more of a norm as you pick up more third-party business?
Yeah. Everything that we're under negotiation for really looks like a gathering contract, which is five years and out MVCs and not particularly discernible from an oil or gas gathering contract when you look at the key terms. Obviously, you're drilling a well at the end of the process, and obviously the returns are higher because you're trying to risk adjust for that downhole risk.
That's great. Thanks. Appreciate it.
The next question comes from Mirek Zak of Citigroup.
Hi, good afternoon, everyone. Just one quick one from me. What other factors went into initiating or executing those initial purchase options at the WES level versus Anadarko, beyond simply WES's scale today allowing it to fund such endeavors or was that the only reason?
I hope I understand your question correctly, Merrick. This is Anadarko's leverage as a meaningful shipper that is able to negotiate these options. I don't think WES as a standalone midstream entity would have the type of leverage to actually get a stake in these projects. Anadarko has done this a handful of times over the years. There's been times they've built it out on their own balance sheet, dropped it to WES. There's been times like these where they've asked WES to just fund the capital and basically transferred that option to WES. WES's decision to actually fund the projects is just a simple risk versus return basis. Our threshold is mid-teens unlevered on any dollar we spend, and these projects exceed that margin quite comfortably.
Okay. Am I right to assume that the execution of these options had been assumed when you previously put out your two-year distribution growth guidance?
No, I think we were very clear when we issued guidance that it did not include any potential exercise of equity options.
Okay, great. Thanks. That's all for me.
The next question comes from Dennis Coleman of Bank of America.
Yes. Just a couple of quick ones also on the options. First, you mentioned one other potential option that was under negotiation. I'm wondering, is that of a similar size? Anything you can tell us about the scope of that investment, what it might be?
No, that one's too early.
Okay.
There's really nothing that I can say meaningfully about it at this stage.
Okay. Just on the accounting treatment, in terms of whether it's a net or added as gross, is that a point of negotiation between you and Enterprise, or is that strictly an internal West decision?
It's a internal West decision in conjunction with our auditors.
I see. Okay. That's it for me. Thanks.
The next question comes from Barrett Blaschke of MUFG.
Hey, guys. Just a little follow-up on the two announcements about the option exercises with Cactus and Midland-to-Sealy. Where do these fit strategically in terms of as you're looking at your growth for the next two years? Are there opportunities around them that you see being able to tack onto these, or how do you view it?
Great question, Barrett. I would say similarly to the other options that we've exercised in the past, where we have wellhead exposure, and if we can participate in the economics down the value chain, that diversifies our cash flow and helps our full value creation story. We started in the DJ Basin as simply a gatherer and processor and worked from there to having an option in crude takeaway, NGL takeaway, and then ultimate fractionation. I think as the Delaware Basin gets started, we're trying to follow the same model, just as we are in so many other factors, replicating that success we had in the DJ now in the Delaware.
Thank you.
Sure.
Next we have a question from Christopher Tillett of Barclays.
Hey, guys. Good afternoon.
Hi, Chris.
Just, I guess two quick questions here. First is on the Cheyenne Connector and Red Bluff options. Can you just remind us what the timing is on those in terms of your decision to exercise or not?
Red Bluff should be by the end of the year, Cheyenne's a 2019 decision.
Okay. Separately, I know Anadarko has a fair amount of security in terms of their future product takeaway capacity out of the Permian. Not all the producers there have been that proactive. If you guys continue to build out in the region, are you noticing or anticipating any change in your third-party producer behavior related to some of the infrastructure constraints in the region that people have been discussing?
Too early to say that we've noted any changes. I'll just remind you that back when we got into the basin through the Nuevo Midstream acquisition, one of the things we loved about the acquisition was a high-quality customer base. These were blue-chip customers like Concho, Cimarex, Chevron, Conoco, BHP, et cetera. Those are the types of producers that tend to mitigate this type of risk the best, just as you've seen with Anadarko. That value that we recognized at the time of acquisition is paying off in spades today.
Okay. That's helpful. Thank you.
The next question comes from Selman Akyol of Stifel.
Thank you. Most might've been asked and answered, just one quick one, just from a modeling standpoint. As you think about going into the second quarter, I understand distribution coverage in excess of 1.2 times for the full year. Just thinking about it, have we seen the low-end distribution coverage for the year with this quarter?
That's a fun question, Selman. I'll just reiterate our previous guidance, which is first half between 1.0 and 1.1, then second half significantly higher than an exit rate of over 1.2.
Very good. Thanks.
Sure.
This concludes our question and answer session. I would like to turn the conference back over to Benjamin Fink for any closing remarks.
Thank you, everyone. I really appreciate your interest in our quarter, and we look forward to talking to you again in three months' time. Have a great day.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.