Viper Energy Partners - Earnings Call - Q2 2020

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to the Viper Energy Partners Second Quarter twenty twenty Earnings Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to Mr.

Adam Wallace, VP, Investor Relations. Please go ahead.

Speaker 1

Thank you, Sharon. Good morning,

Speaker 2

and welcome to Viper Energy Partners' second quarter twenty twenty conference call. During our call today, we will reference an updated investor presentation, which can be found on our website. Representing Viper today are Travis Stice, CEO and Kate Vanthoff, President. During this conference call, the participants may make certain forward looking statements relating to the 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 Foss.

Speaker 3

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners' second quarter twenty twenty conference call. During the second quarter, Viper had limited completion activity on our acreage as operators reacted quickly to oil price volatility by cutting capital expenditures, ceasing completions, and in some cases curtailing existing production. However, Viper's production during the quarter was supported by 14 of Diamondback's 15 completions having more than an 8% average royalty interest net to Viper. Further, and as it relates to our second half production outlook, nearly all our curtailed production has come back online as commodity prices have improved in recent months.

Importantly, Diamondback has recently bought back three completion crews to work after taking an almost three month break from all completion activity in the second quarter of twenty twenty. Looking toward the second half of twenty twenty, Diamondback expects to focus on its completion activity on areas where Viper has significant mineral ownership, primarily in the Midland Basin. This increased completion activity by Diamondback will be supported by Diamondback ending the second quarter with approximately 165 DUCs, roughly 65% of which Viper expects to own a meaningful royalty interest. This current DUC backlog, along with increasing visibility into third party operators' anticipated activity levels, will support Viper's production profile for the coming quarters. 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, at $40 oil and production held flat relative to our second half twenty twenty guidance levels, Viper is expected to generate more than $180,000,000 in free cash flow in 2021 or a greater than 11% free cash flow yield. This is expected to be a roughly two percentage point increase from our second half twenty twenty annualized free cash flow yield as some of our hedges roll off. As it relates to the free cash flow from the second quarter of twenty twenty, we've made the decision to retain 75% of that cash flow to fortify the balance sheet. The board reviews the distribution policy each quarter. But with the continued depressed oil prices and uncertainty in the energy industry, the prudent decision is to retain a majority of cash flow to reduce leverage and protect the business.

Viper remains in strong financial shape with April of liquidity and will continue to look for avenues to accelerate the deleveraging process and get back to returning a more meaningful amount of cash flow through our distributions. In conclusion, I want to underscore the fact that mineral ownership remains the safest asset in the oil industry because it is a perpetual real property interest that is high margin and 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 the relationship as Diamondback focuses its operations on areas where Viper owns the minerals due to the lower consolidated breakeven economics. This relationship is evident by the midpoint of our second half twenty twenty average production guidance implying greater than 6% growth relative to Q2 twenty twenty average daily oil production even with the challenging macro backdrop.

Operator, please open the line for questions.

Speaker 0

Your first question comes from Will Thompson with Barclays.

Speaker 4

Hey, good morning. For Travis Arcase, it seems pretty clear that Diamondback doesn't plan to pursue growth unless we see a much higher forward curve. Given the concentration of activity in Midland where Viper has high NRIs we saw in 2Q.

Speaker 5

Would it be fair

Speaker 4

to assume Viper could see oil growth in 2021 that could provide upside to the free cash flow sensitivity provided in the slide deck? Just curious on your thoughts on maybe the trajectory for Viper next year.

Speaker 1

Yes. Well, I think certainly it's a possibility, particularly from the exit Q4 number. But I think

Speaker 2

on a year over year basis with Q1 being as high

Speaker 1

as it was, I think it'd be tough to grow on a year over year basis. We'd have to see some more activity on the non op side. But you're exactly right. I mean even though Diamondback is not pursuing a large growth strategy in 2020 the concentration and the focus on Viper Minerals, which I think has been accelerated due to the low commodity prices, will benefit Viper and hold Viper up what is a pretty uncertain time. So I think growth can continue from Q4.

Right now, what we can see is growth into Q3 and certainly growth into Q4 from Q3, all held up by Diamondback. And then I think 2021 has some optimism, but we've to finalize the completion schedule at this point.

Speaker 4

Okay. That's helpful color. And in terms of the payout ratio, you guys obviously stressed that that's reviewed on a quarterly basis. I can appreciate there is some restrictions in terms of debt covenants on the payout ratio. I understand it's just kind of 3x leverage.

But correct me if I'm wrong, there is some flexibility in terms of, I don't know, buckets of carve outs that allow you to exceed that. And just help us understand how you're thinking about the payout ratio going forward as we see kind of a better strip outlook and just in terms of the line growth.

Speaker 1

Yes. We have a few buckets in the indenture that allow us to distribute even if we're above 3x leverage. We're not above 3x leverage today. But I think as the Board went through the conversation on the Q2 distribution, given that the total free cash flow is about $0.12 a unit and we're distributing 25% of that, really there's not a huge delta between paying out 10025% for this quarter. But certainly, going forward, we're going to have some detailed conversations about what we can do.

And if we have confidence in the forward outlook that we're not going to get close to four times and we're closer to below three times than above it, I think there's a chance to increase that distribution looking into the second half of this year and into 2021.

Speaker 0

Next question comes from Chris Baker with Credit

Speaker 6

Just in terms of on the

Speaker 5

topic of Diamondback's ownership of Viper, which came up on the call earlier today,

Speaker 6

it sounds like the Board is comfortable with where things are currently, but just curious what the thinking is longer term as it relates to Viper.

Speaker 3

Yeah, certainly, Chris. If you look at our prior behaviors at the Diamondback level, every opportunity we've had, we've increased ownership in Viper. And I think we're very comfortable with at the Diamondback level, we're what our ownership position is in Viper.

Speaker 1

Yeah. I mean, listen, it's certainly a support to the debt at Diamondback. And that's kind of the point we were hammering. I think there's no intention today to sell any sell down any ownership in Viper. And on top of that, I think just look at our actions where we've increased the share count of what we've owned since IPO.

Speaker 6

That's helpful. And then just a follow-up. You mentioned looking to accelerate the deleveraging process. And just curious how you're thinking about levers that you could potentially pull beyond maintaining that lower payout ratio.

Speaker 1

Yes, Chris. Mean, obviously, the payout ratio is the most visible, but there's a lot going on in the backdrop of doing work on our asset position, making sure we're getting paid for what we deserve to get

Speaker 2

paid

Speaker 1

on, working down the accounts receivable balance. But also, probably more importantly, working to bring some cash in by selling some undeveloped acreage positions. We've had a couple unsolicited bids on completely undeveloped properties where private equity is making a bet on next two or three year development, and that doesn't provide a lot of value to Viper today. So those are kind of smaller packages here and there that we're looking to sell if it's not reducing our cash flow.

Speaker 0

Next question comes from Derek Wixia with Stifel.

Speaker 7

With regards to your 2020 guidance, we're backing into an implied Q4 that is materially above the Street and on the higher side of your second half range. Does that square with your views based on the expected timing of Diamondback operating completions?

Speaker 1

I think that's fair, Derek. I think we tried to come out strong with the forward guidance and also maintain guidance unlike a lot of our peers who aren't even providing it. Certainly, the high interest wells coming really starting about now and through the end of the year, we feel really good about the growth profile at Viper into the back half of the year.

Speaker 7

Great. And then perhaps for yourself or Travis, certainly based on your earlier Diamondback call, I know the environment for public or private M and A is challenging for working interest acquisitions. Perhaps if you guys could speak to the broader view on M and A for the mineral sector, is a bit more fragmented and perhaps less mature.

Speaker 1

Weirdly enough, Derek, it's probably harder on the mineral side. I think there's still a lot of private money that likes this asset class. And therefore, the numbers that we're seeing on the opportunity set are still too high. There's just such a bid ask spread that I think other people are paying for a recovery in oil prices. And that's kind of why we decided to sell some assets that aren't developed.

We're getting prices that we thought were reasonable and well above our acquisition cost of that particular asset. And that kind of spurred the conversation of, hey, maybe we should sell a little bit here and there.

Speaker 7

Next

Speaker 0

question comes from Brian Singer with Goldman Sachs.

Speaker 8

Thank you. Good morning. First question is on the balance sheet and the dividend payout percentage. Can you just talk about how you see that evolving and where you see on a longer term basis that payout percentage? And the same thing for the balance sheet.

Do you have a goal now of having a similar leverage at the Diamondback and Venom level? Or is there comfort with Venom having higher leverage ratio relative to Dennebec?

Speaker 1

Well, I think it all depends on where the forward outlook goes on commodity price. But overall, given that Venom is pure free cash flow and doesn't have to spend $1 on CapEx that we should feel a little more comfortable with a higher leverage ratio at the Venom level. I still think we think about leverage on a consolidated and a deconsolidated basis. So we have to be careful there. But just like Diamondback, there's no set target on the Venom side.

We do want to get that payout. I think the first step is to get the payout up from 25% to 50% and then have real conversations with the Board on what the future holds. I think overall, relying on capital markets for all of your acquisition activity is probably not the most prudent thing to do. But we've had a history of being able to acquire and raise capital. And I think that's probably changing a little But overall, we still want this to be a vehicle that pays out the majority of its free cash flow to our shareholders, the largest being Diamondback.

Speaker 8

Great. And then a follow-up on the divestiture opportunity and then potential acquisitions. Would these both be focused or would both divestitures and any potential acquisitions be focused on operators outside of Diamondback? Or is some of what you're talking about either from a divestiture perspective or acquisition perspective on Diamondback operated properties?

Speaker 1

Yes. I mean we're not focused on any acquisitions right now. But certainly, divestitures are acreage positions not operated by Diamondback that we have no line of sight to development. If there's line of sight or cash flow that's producing on that asset, then it's not up for sale. But the unique nature of the Minerals business is that a lot of people like to bet on future development.

And with no development today, assets kind of fall to the front of what we could sell.

Speaker 0

Next question comes from Jeff Grampp with Northland Capital. Jeff, your line is open. Please go ahead. Next question comes from Gail Nicholson with Stephens.

Speaker 9

On Page five of the free cash flow sensitivity analysis, you guys are assuming a 95% WTI realization. Can you just talk about what factors could adjust that expectation on a go forward basis?

Speaker 1

Yeah. Gail, I mean, it really depends on the Brent WTI spreads. If Brent WTI widens out a little bit more than it is right now, it's pretty narrow, then you'd probably realize a little bit higher percentage of WTI. And I think for us, that 95% is a good conservative number for the back half of the year. And really, we're trying to hammer the point across here that while we're a little bit hamstrung by hedging losses in the back half of the year, the free cash flow really kicks up the first half of twenty twenty one, and you get a pretty solid free cash flow yield based on today's strip.

Speaker 0

Great. Thank you.

Speaker 1

Thanks, Gail.

Speaker 0

Next question comes from Leo Mariani with KeyBanc.

Speaker 10

Hey, guys. Just wanted to get maybe a little better quantification, if possible, on the second half activity. Just wanted to get a sense, you guys mentioned a little bit more insight into kind of non op activity. Are you guys baking anything in on the non op side into the second half twenty twenty production guide? Then roughly how many second half twenty twenty net well tie ins are you expecting?

Speaker 1

Yes, Leo. I mean, I think on the non op side, we're still going to be pretty conservative. We had 1.3 net wells in the second quarter, and we're expecting that number to go down in the third quarter. But the Diamondback side more than doubles on the net wells completed on the Diamondback side in Q3. So that supports the Q3 growth.

And then as you look into Q4, you're still completing a good amount of Diamondback wells, we're baking in a little bit of non op, not growth, but a few more a little over one net wells coming on, on the non op side in Q4. So really driven primarily almost 65%, 70% on activity on the Diamondback side because we have a lot of confidence in that. So if the non op tends to surprise to the upside, that's gravy for Viper shareholders.

Speaker 10

Okay. That's helpful. And I guess I certainly understand that you guys don't have kind of a hard and fast leverage target and fully agree that Venom supports more leverage than certainly any traditional E and P company does. But clearly, you guys have made the decision to go on the defense here on distributions and only pay out roughly 25% of the cash flow. Is there some kind of leverage level out there, whether it's kind of a fair bit below that 3x covenant, if it's 2.5 times or less where you feel like there's a lot more flexibility on the Viper level either to pay out a much more meaningful level of cash flow and or to kind of resume any M and A activity out there.

Certainly noticeable that there were no deals in the second quarter. I know you guys said the bid ask spread is wide right now, but just wanted to get a sense around kind of balance sheet governors as well to future M and A.

Speaker 1

Yes, mean, I think the balance sheet is most important, holding us back from M and A. I mean, if we saw the best deal in the history of minerals, we'd think have hard about it. But unfortunately, those deals just aren't out there. And then on the leverage side, it really depends on the forward outlook. And we go through the next eighteen months with the Board in detail every quarter.

And if we see the strip materially improving and we're not getting hit on hedge losses and can see that our path to delevering is naturally going to happen, then we're going to bump that distribution back up.

Speaker 0

Next question comes from Phil Stewart with Scotiabank.

Speaker 11

Good morning, guys. I wonder if we could just circle back on the divestiture comments. Just curious if you all are if the interest is more skewed to the Delaware over the Midland, just given that it's, you know, less developed. If you guys have any comments on that.

Speaker 1

That's that's probably fair, Philip. You know, the couple deals we've we've gotten done are are in the Delaware. It's not to say that there's not Midland opportunities, but I think overall, our Midland position is in areas that have a lot of active development or a lot of visibility, whereas the Delaware is a little less developed and not as clear on the path to forward development.

Speaker 11

Okay. And then I guess just one follow-up. I know you guys said that you're not focused on selling cash flowing assets. But given the Eagle Ford position is outside of the Permian, would that be under consideration as an asset to sale if the bid was there?

Speaker 2

I think any asset

Speaker 1

is for sale if the bid is there. But there's really not I don't think there's going be a bid there that we would want to move that asset. Certainly, we felt like we bought into that at a good price, and it is in one of the few areas where there's actually activity in the Eagle Ford. But overall, I think the job of a capital allocator is to be able to buy and sell. And we're going to take responsible bids.

And if someone hits the bid, we'll sell it. But right now, I don't think that's going to be a position that's up for sale.

Speaker 0

Next question comes from Wells Fitzpatrick with Truist.

Speaker 2

Hey, good morning.

Speaker 1

Hey, Welles.

Speaker 2

It seems like the

Speaker 5

work in progress wells are perhaps unsurprisingly skewed towards Diamondback. Could you maybe give your thoughts on where you guys see exiting the year sort of percent Diamondback activity or percent Diamondback production?

Speaker 1

Yes. It's really probably twothree Diamondback production exiting the year. I think we're somewhere a little below that today, probably close to 55% today. And then we're probably going to move up another 5% or 10% to Diamondback production. And then I think from an activity what we're modeling well is essentially 75% Diamondback activity in Q3 and somewhere around 55%, 60% in Q4.

So you're basically averaging 65%, 70% Diamondback activity in the back half of the year.

Speaker 5

Okay. Okay. That makes sense. And then if I remember correctly, it's pretty minimal. But can you talk to any federal exposure you might have on third party acreage, particularly in the Delaware?

Speaker 1

I mean, Diamondback has none, but Viper, the mineral owner, would be the federal government. So they don't we don't have any exposure unless we had a small override, but I don't think we have any of those.

Speaker 2

Okay. Perfect.

Speaker 0

At this time, I will turn the call over to Mr. Travis Stice.

Speaker 3

Thank you again to everyone participating in today's call. If you have any questions, please contact us using the contact information provided.

Speaker 0

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