Viper Energy Partners - Earnings Call - Q1 2020

Transcript

Speaker 0

Good day, ladies and gentlemen, and welcome to the Viper Energy Partners First Quarter twenty twenty Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Adam Lovelace, Vice President, Investor Relations.

You may begin.

Speaker 1

Thank you, Lisa. Good morning, and welcome to Viper Energy Partners' First Quarter twenty twenty Conference Call. During our call today, we will reference an updated investor presentation, which can be found on Viper's website. Representing Viper today are Travis Dice, CEO and Kate Van Toff, President. During this conference call, the participants may make certain forward looking statements relating to company's financial condition, results of operations, plans, objectives, future performance and businesses.

We caution you that actual results could differ materially from those that are indicated in these forward looking statements due to a variety of factors. Information concerning these factors can be found in the company's filings with the SEC. In addition, we will make reference to certain non GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon. I'll now turn the call over to Travis Glass.

Speaker 2

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners' first quarter twenty twenty conference call. Before we get started, I'd like to take a minute to extend our thoughts and prayers to all those affected by the COVID-nineteen pandemic. The challenges presented so far in 2020 are unprecedented, but our perseverance is evident from the decisive actions we've taken to preserve our strength through this cycle. Turning to the quarter, Viper grew oil production 6% sequentially and 37% year over year.

This solid production performance along with oil realizations of 99% of WTI unfortunately, has been overshadowed by the dramatic decline in commodity prices that began in March and has continued through today. Viper took action and hedged almost a 100% of expected 2020 oil production and over 50% of expected twenty one twenty twenty one production in the form of WTI collars, putting a floor under future oil price realizations and cash flow. The advantaged business model of Viper as a royalty company is highlighted during these times of depressed commodity prices in that our high cash margins, no capital requirements and limited operational costs drive continuous free cash flow generation through the cycle. To that end, even at current strip pricing, Viper is expected to generate an over 10% free cash flow yield assuming today's unit price. As it relates to the free cash flow from the first quarter of twenty twenty, we have made the decision to retain 75% of that cash flow to fortify the balance sheet.

The board intends to review the distribution policy each quarter. But with the uncertainty in the forward activity outlook and strip pricing, the prudent decision is to retain a majority of the cash flow to reduce leverage and protect the business. Viper remains in strong financial shape with $447,000,000 of liquidity after adjusted for the expected reduction in our borrowing base from $775,000,000 to $580,000,000 this spring. Looking forward, assuming there's a recovery in commodity prices, Diamondback expects to resume completions operations in the 2020 with the focus on high interest Viper owned royalty acreage. Viper's relationship with Diamondback also provides the added advantage of Viper benefiting from Diamondback's firm transportation on the EPIC and Gray Oak pipelines with pricing linked to the more liquid Gulf Coast and export markets and Spanish Trail production linked to MEH pricing.

In conclusion, I want to underscore the fact that mineral ownership remains the safest asset in the oil industry because it's a perpetual real property interest that's a high margin business that requires zero capital requirements. Within the mineral subsector, Viper is further distinguished due to our relationship with Diamondback as our primary operator. Times like these emphasize that relationship as Diamondback focuses its operations on areas where Viper owns the minerals due to the lower consolidated breakeven economics. Operator, please open the line for questions.

Speaker 0

Your first question comes from the line of Brian Downey with Citigroup.

Speaker 3

Good morning. Thanks for taking the questions. I guess my first one is on the distribution policy. Could you provide guideposts on how you're thinking about that payout ratio on a go forward basis? Understandably, may be some leverage ratio implications with the senior notes, but how you're thinking about balance sheet goals, whether that's leverage ratio versus absolute leverage, just trying to think how we should be dimensioning that payout ratio through the rest of the year.

Speaker 4

Yes, Brian. I mean, it's a good question. We really only have the data that we have in front

Speaker 2

of us, which is a strip. And

Speaker 4

we have to make the tough decision based on the first quarter being one of the biggest cash inflows that we're going to have over the next five or six quarters based on where the strip is today. And that resulted in us cutting the distribution to 25% of available cash. And I think it's gonna be a very fluid process. You know, I can only really, you know, use the baseline of of 25% for now. But, you know, I will say, you know, we run sensitivities every every quarter with the board, and and the board is gonna have to have, you know, real conversation about about that policy going forward.

You know, I think, you know but I think overall, you know, our best our best indication is where we are at strip. And if we pay off 25% at strip today, we're not messing with our secured leverage covenants at the revolver level.

Speaker 3

Got it. And then I guess how should we think about leverage reductions that pertains to revolver paydown versus opportunistically buying back debt, if available?

Speaker 4

I think that's the keyword. It's opportunistic. We don't have a lot of experience buying back bonds in the open market. It seems like our bonds trade a little bit, but but not much. You know, it's certainly, you know, probably gonna be a combination of both, you know, parking cash and and paying down the revolver and using the opportunity to buy back debt below par if the bonds are still trading below par.

Speaker 1

Got it. Appreciate the color. Thanks, everyone. Thanks Brian.

Speaker 0

Your next question comes from the line of Derrick Whitfield with Stifel.

Speaker 4

Hello, good morning all. Hey, good morning Derrick.

Speaker 5

With regard to your 2020 guidance, we're backing into an implied Q4 guide that's materially above the Street. Is that a reasonable interpretation based on the expected resumption of Diamondback activity in the second half?

Speaker 4

Yes, Derby. That's the key, right, is are we getting back to activity? And then, you know, as we said on the Diamondback call, you know, we need to first, you know, bring back our curtailed volumes and then get back to work. Now, you know, the base case is that that happens. And, you know, the way we have it modeled right now, Viper has exposure to about 80% of Diamondback's future completion, you know, at at about a seven or or more percent interest.

So those are some pretty, you know, pretty meaningful numbers, when you look at at Viper's production, and And we hope that that's the case. Now if things remain weak and Diamondback doesn't get back to work, then that only pushes that out a quarter or two.

Speaker 5

Understood. And as my follow-up, could I ask you to comment on your broader views on the M and A market for the balance of 2020? I suspect the Q1 acquisitions were largely a function of work in progress.

Speaker 4

Yes, that's correct. I mean we closed everything in the first quarter with all those PSAs that have been signed in November, December and January. And we certainly weren't going to walk on a PSA that we signed and we honored our commitments. But right now, our acquisition machine is silent for the foreseeable future. Mineral owners tend to be stickier with respect to perception of value, and there's often less leverage in the mineral space.

So I think it's going to be pretty quiet here for the next couple of quarters.

Speaker 5

Helpful color. Thanks for your time, guys.

Speaker 4

Thank you, Derek.

Speaker 0

Your next question comes from the line of Will Thompson with Barclays.

Speaker 6

Hey, good morning. Travis, wanted to

Speaker 4

get your thoughts on the push pull dynamics between E and

Speaker 6

Ps and mineral norms in terms of shut ins and continuous drilling obligations. You know, FANG is guided to relatively modest contaminants, I think the shut in aspect is less of an issue for FANG operated acreage. But maybe for non op acreage and the modest override royalties that Venom has, how do you expect the do you expect the lease lease to determine if EEPs continue to shut in production and or don't activate rigs and frac crews in the near term? I'd love to hear your thoughts there.

Speaker 4

Yes. Mean, I think I can really only speak to the you know, Diamondbacks portion of that. You know, we've we've been very focused at Viper in in buying mineral interest versus overrides. And, you know, on top of that, you know, most of our overrides are at the at the Diamondback level, and I can assure you that, you know, we we expect to retain all of our production and and and leases that have a meaningful Viper component to it. You know, I think as you think about Viper's production, you know, we certainly modeled in some some curtailments.

I think Viper will be hit a little less than Diamondback, from a percentage basis, just given, the nature of the two working together to focus on the higher interest properties, staying active. Okay. And then maybe going back

Speaker 6

to Brian's question, understanding that covenants restrict Venom's distributions in the twelve month trailing aspect of debt to EBITDAX metric, how do you think about managing the payout ratio as production stabilized and oil prices improve? Are you comfortable going past 3x leverage temporarily? I appreciate that 3x leverage for Venom is less cumbersome than 3x leverage for an E and P such as Diamondback.

Speaker 3

So just curious to get your thoughts there.

Speaker 4

I think we're fortunate to be make distribution decisions halfway through the next quarter. And I think if we're seeing significant improvement in production and pricing that it's a little easier to lean in and make distribution at a higher leverage ratio. So I think it's all going be very fluid. But I think overall, we're going to be as flexible as possible and recognize that this business model is meant to distribute cash to shareholders, the largest being Diamondback. And that's still our primary objective here at the Viper level.

Yeah, Will, I just want

Speaker 2

to emphasize that. I VIPER is a yield company with Diamondback being the largest owner of that company. And you can bet that the VIPER level, we're focused on maximizing return of capital to our unitholders. Taking all these things into consideration, it's still about maximization of that return.

Speaker 6

Okay. Thank you.

Speaker 0

Your next question comes from the line of Brian Singer with Goldman Sachs.

Speaker 7

Thank you. Good morning. I wanted to follow-up on the debt and the covenants piece. You mentioned earlier the importance of the secured debt covenant. But can you talk a little bit more about the unsecured covenant and how that will impact the 3x would impact the timing of and the consideration for the distribution policy?

Speaker 4

Yes, Brian. The high yield covenant, the unsecured covenant is simply a restricted payment should you be above 3x leverage. But there are some baskets that you can distribute out of, and the biggest being, I think, you know, trailing net income that we can can look at. You know, on the on the secured piece, you know, your revolver is looking at at four times leverage at that covenant, and, you know, I think that's you know, that goes a little beyond restricting payments. So that's, you know, that's really the the impetus for the decision we made today is is we're not looking to mess with any secured covenants here.

Speaker 7

Got it. And then my follow-up is you talked earlier about some of the assumptions that go in from the FAANG operated acreage. What about what you're seeing activity wise and shut ins from operators outside FAANG? Can you talk about what your base case expectations are for the second and third quarters from a shut in perspective outside of FANG? And then what activity levels you can characterize on expectations as you go through the rest of the year?

Speaker 4

Yes. I can take activity levels first. We're assuming zero wells get completed on a non op acreage in the second quarter with a small return to work in the third quarter. We haven't modeled shut ins on non op acreage as shut ins, but we've been you know, we just we just take a bigger chop to the PDP decline that we're seeing on on non op acreage. So, you know, instead of our normal, you know, high single digits percent listing on on PDP, it's, you know, move closer to, high teens or mid teens percentage listing on the non op GDP.

Speaker 1

Great. Thank you.

Speaker 4

Thank you, Ben.

Speaker 0

Your next question comes from the line of Jeff Grampp with Northland Capital Markets.

Speaker 8

Good morning, guys. I was hoping you could maybe speak to longer term and kind of a more normalized stable commodity price world. Should we think that the payout for Viper moves back to that 100% type of strategy? Or would you guys maybe give some consideration to some sub-one 100% payout to maybe incrementally pay down more debt or organically fund some acquisitions when that starts ramping back up?

Speaker 2

Yes, Jeff, it's hard to predict what the future looks like. But I can tell you, I'll just reemphasize that point that I made, is the reason Viper is set up is because it's a yield company, but now it's actually its largest shareholder. So you can bet that our singular focus will always be maximizing that return of our capital to the unitholders.

Speaker 8

Understood. And for my follow-up, and I think in the slide deck, you guys kind of emphasize some too. It's kind of how the lease works is the Delaware Basin example. Can you guys kind of talk about what that economic opportunity set is this year? Do you see any opportunities for any kind of extension renewal type of payments flowing through to Viper?

And any, I guess, kind of high level characterization of what that economic opportunity could look like for you guys this year?

Speaker 4

Yes, Jeff. This slide is very important to where we are today because while we're not acquiring acreage, our team is focused on our highest value tracks and what are the lease requirements with respect to continuous development, primary development, or cessation of production. So we're really digging into all these leases and making sure we're communicating with the operators on their plans. And I don't think it's going to be big dollars coming into Viper. But in this market, every dollar matters.

And I think that's the benefit of being the mineral owner is that the acreage reverts back to you if the operator doesn't meet the obligations of the lease. And that's the strongest form of security in the oil field. And if the operator wants to let go of that acreage, you know, we can release it at some point. But, you know, most of the discussions we're having right now are about extensions, you know, extensions on obligations and extensions on, you know, continuous development.

Speaker 8

All right. Understood. I appreciate the time, guys.

Speaker 4

Thanks, Jeff.

Speaker 0

Your next question comes from the line of Gail Nicholson with Stephens.

Speaker 9

Good morning. Just any thoughts on how we should think about oil price realizations the remainder of the year?

Speaker 4

Yes, Gail. On the Diamondback operated side, Viper and Spanish Trail gets the Diamondback deal, which is kind of an NEH less $3, and, you know, that's about a third of of Viper's oil production. You know, the most of the rest of Viper's oil production on the Diamondback operated piece will get a Brent less pricing. And and there's just so much moving around on that front that, you know, in a normal world, it would be Brent less, you know, $6.06 or so dollars, but, it's probably a little higher today. And then, you know, on the rest of the acreage, you know, we get Midland pricing, and and that's why we've, you know, hedged that exposure and and hedged, you know, all of our WTI exposure.

Speaker 10

Okay. Great. Thank you.

Speaker 9

And then just on, like, a higher level question. You know, Viper has a durable free cash flow profile and really does provide security in this tumultuous world that we find ourselves in right now. But when you look at, today's environment and going forward, what do you think is the biggest challenge for the business?

Speaker 4

You know, I think the biggest challenge is is making sure, you know, we're getting paid for what we deserve to get paid and making sure our operators are are honoring these leases. You know, the the leasing boom in the Permian of the last ten years has put some pretty onerous terms into some of these leases, and and Viper, you know, needs to spend a lot of its time making sure those obligations are honored.

Speaker 10

Okay. Great. Thank you.

Speaker 4

Thank you, Yale.

Speaker 0

Your next question comes from the line of Jason Wangler with Imperial Capital.

Speaker 11

Hey, good morning. Case, you just had a couple of questions about it, but curious, Select seven talks about kind of 2021 being where the theoretical lease expires. Is that mostly kind of where we start to see that happen? Is 2020 kind of more of a year where you're going to see extensions and things, but 2021 is where you may well see more of that opportunity come up for you and for Diamondback?

Speaker 4

I would say so since we're already so far into 2020. But this was just an illustrative example. I mean, I think a lot of leases in the Delaware were taken in the 'fourteen, 'fifteen And if you prevent, they've either been extended by now or development has already occurred. And the question is how much continuous development is going to continue to occur on those properties.

Speaker 11

Okay. So something to kind of watch for going forward. Okay. I appreciate it. Yes.

Speaker 4

Definitely something to watch for. And this where our business development meetings used to be about what minerals are we looking to acquire. It's now about what are we hearing from our operators and what are the offers on the table for extensions or new leases.

Speaker 1

Thanks so much. Thank you.

Speaker 0

Your next question comes from the line of Leo Mariani with KeyBanc.

Speaker 12

On the leverage side here, just wanted to get a sense of whether or not you guys have kind of a leverage target for Venom. Fully get that it might have grown a little bit more than expected in this unprecedented downturn here. So just kind of wanted to get a sense of where do you guys kind of want to see that kind of debt to EBITDA going here maybe in the medium to long term?

Speaker 4

Yeah. I mean, think overall, you know, we've we've tried to be pretty conservative at at both the Diamondback, Viper and Rattler levels. And and on a consolidated basis, you know, I think, you know, given the the the weakness in commodity prices, leverage is going to look higher than we've traditionally been comfortable with. So I think overall, Leo, the business is probably going to have to look at, are we at 2x levered at $40 oil? Are we at a turn and a half of leverage at $40 oil because you can enter a year at $60 and be at $20 within three months.

So I think the volatility of this business is continuing to point towards lower leverage even with a business like Viper that has pure free cash flow.

Speaker 12

Well, that certainly makes a lot of sense for sure. And I guess just to that end, I know that the distribution policy is clearly an ongoing event. But from a high level, is it kind of fair to maybe think about some of this as when you think you kind of get the leverage a little bit more comfortable? That's when you can kind of play a little bit more offense on the distribution. Is that how investors should think about it?

Speaker 4

Yes, think that's fair. I mean, just as Travis said, this vehicle is set up to return cash to shareholders and that big shareholder being Diamondback, and we intend to get back to that as soon as we can.

Speaker 2

Yes. The driver is always maximizing unitholder value. We'll continue to emphasize that as we talk about distributions.

Speaker 12

Got you. Okay. And just a follow-up in terms of an earlier comment you guys made. I just want to make sure I sort of understood. So when you guys are looking at the guide here for Venom for the rest of the year, I don't if I heard you correctly, but did you guys say that there was assumption that there were no turn in lines in the second quarter of 'twenty and those resume in the second half?

Just want to make sure I understood that right.

Speaker 4

Yes, that's correct.

Speaker 12

Okay. And is that on both an operated basis and a non op basis? Or is there not really any line of sight on the non op right now?

Speaker 4

On non op, we're assuming zero. Diamondback, we're assuming the existing schedule, which Diamondback is not completing a lot of wells in the second quarter.

Speaker 12

Okay. Thanks, guys.

Speaker 2

Thanks, Leo.

Speaker 0

Your next question comes from the line of Pearce Hammond with Simmons Energy.

Speaker 13

Good morning, and thanks for taking my questions. Case, appreciate that you're not very heavily drawn on your revolver right now, but it definitely seems like the debt market has improved quite a bit with the Federal Reserve, the activity that they are engaged in. And so are you seeing opportunities to maybe go do a debt issuance and then pay down the revolver? And if you did that, would that give you a little bit more flexibility on the distribution?

Speaker 4

That's a good question, Piers. Unfortunately, not because the revolver covenant is based on total debt. So, you know, we can't be replacing secured with unsecured debt. And, you know, I think, you know, Viper's bonds are still trading a little below par, and and there might be an opportunity to to buy back some debt below par here.

Speaker 13

Okay. And then my follow-up is just a housekeeping. When do you expect to file the 10 Q?

Speaker 1

End of this week.

Speaker 13

Thank you.

Speaker 1

Thanks, Pierce.

Speaker 0

Your next question comes from Welles Fitzpatrick with SunTrust.

Speaker 4

Hey, good morning. Hey, Welles. Hey, Welles. Just one quick one for me. I mean, I would imagine that most of your leases are pretty ironclad force majeure clauses.

But do the shut ins, do they create any opportunity for incremental leasing revenue either from companies proactively trying to extend those leases that already exist or potentially from broken leases then being able to be released? Yeah. The lease the lease would have to be broken, and and it really depends on each lease and what the cessation of production clause is in that lease. So, you know, it's various forms of of, you know, cessation of production. And, you know, I will say, you know, with my Diamondback experience, where we're curtailing volumes, you're not getting close to those cessation of production issues.

Now I think if you're forced to shut in for two, three, four months consecutively, then you start to have start to trip those cessation of production clauses in the leases.

Speaker 2

Yeah. Well, as I can tell you just from a historical perspective, that's one of the first decision notes that our land organization goes through is cessation of production clauses and all these leases. And that's standard operating procedure for all operators. So the only time that would occur would be by omission or by accident from other operators. It's certainly nothing we can plan on.

Speaker 4

Okay. That's what I figured. Thanks, guys. Thank you all.

Speaker 0

At this time, there are no further questions. I would like to turn the call back over to Travis Stice, CEO.

Speaker 2

Thank you again to everyone participating in today's call. If you've got any questions, please reach out using the contact information provided.

Speaker 0

This concludes today's conference. You may now disconnect.