Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Transcript 2019-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the Viper Energy Partners’ First Quarter 2019 Earnings Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Adam Lawlis, Vice President of Investor Relations. Mr. Lawlis, you may begin, sir.

[Adam Lawlis, Vice President of Investor Relations]

Thank you, Rusty. Good morning, and welcome to the Viper Energy Partners’ first quarter 2019 conference Call. During our call today, we will reference an updated investment presentation, which can be found on our website. Representing Viper today are: Travis Stice, CEO; and Kaes Van’t Hof, 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 Stice.

[Travis Stice, Chief Executive Officer]

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners’ first quarter 2019 conference call. After delivering double-digit sequential production growth for four consecutive quarters, Viper experienced a 6% quarter-over-quarter decline in production in the first quarter of 2019. With that said, we continue to see robust activity levels across our acreage position, as evidenced by non-operated production outside of Spanish Trail, increasing by over 5% during the quarter and first quarter 2019 volumes increasing by 35% year-over-year.

Viper has many upcoming visible catalysts expected throughout the remainder of 2019. First, relating to production growth, Diamondback plans to complete 12 wells in Spanish Trail in the third quarter of 2019 with an average royalty interest of 22% net to Viper. Also, Diamondback plans to complete another five gross wells in the fourth quarter of 2019, each with a 25% royalty interest.

The net wells to be added from these two pads is more than double the total amount of net wells operated or non-operated, added during this first quarter. Second, oil realizations have improved for Viper beginning the second quarter of 2019, as Diamondback’s fixed differential contracts rolled off and converted to commitments on new-build long-haul pipelines, all have moved closer to the current Midland market, primarily in Spanish Trail and Pecos County.

At current commodity prices, oil realizations have already improved over $10 a barrel. In 2020, we expect Viper to realize 100% of WTI pricing. Lastly, we are actively working on a large drop-down transaction between Diamondback and Viper, which contains a significant amount of acreage, production and visibility, as it is almost 100% operated by Diamondback. The work for this transaction is underway, and we expect to work towards a mutually agreeable accretive transaction in the coming quarters.

Our business development operation continues to consolidate the fragmented private minerals market, having completed another 39 acquisitions for $83 million in the first quarter. Since our IPO in the third quarter of 2014, Viper has now closed over $1.3 billion in acquisitions across 335 transactions, and we continue to use our scale and expertise in the Permian Basin to complete deals that are expected to be immediately accretive to cash flow, production and reserves on a per unit basis.

For the full year, Viper is still expected to deliver 24% annual organic growth without the benefit of continued consolidation while also providing investors with a high single-digit implied free cash flow yield. The business model for Viper remains unmatched in terms of a combination of margins, return on capital, growth and an advantage to tax structure, of which we can offer tax-free distributions due to our unique relationship with our parent company.

I’ll now turn the call over to Kaes.

[Kaes Van’t Hof, President]

Thank you, Travis. Turning to Slides 5 through 7, we showcase the differentiated business model and investment opportunity presented by Viper. As shown on Slide 5, Viper offers an unmatched combination of expected future growth and free cash flow yield versus energy industry peers and across multiple yield-based alternatives.

Slide 7 provides a detailed assessment of Viper versus Precious Metal Streaming Vehicles, which have a very similar business model. Viper owns mineral rights in perpetuity on Tier 1 largely undeveloped acreage, with significant remaining reserve life, has a mid-teens corporate return profile with over 90% cash margins and 24% estimated organic growth, all metrics which compare favorably.

Slide 8 highlights the continued success of our acquisition machine and continuing to consolidate the fragmented private minerals market in the Permian Basin. Since our IPO in 2014, Viper has now closed over $1.3 billion of acquisitions across 335 transactions. The opportunity set for acquisitions in the Permian Basin remains extremely robust, and we believe Viper is in a unique position to continue to accumulate Tier 1 acreage through immediately accretive transactions given our unmatched size, scale and expertise.

Turning ahead to Slide 10. We detail the historical activity levels on Viper’s Permian asset base and the average NRI of the wells turned over to production at Viper, in particular, note the average royalty interest of wells completed by quarter. The first quarter was unnaturally low versus prior development, and thus, resulted in lower-than-expected production for the quarter. We expect this to return closer to average historical levels throughout the year, as our docks, active rigs and permits are converted to production as well as the addition of high-interest Diamondback-operated wells in the second half of 2019.

Slide 11 further highlights the premium nature of Viper’s Permian asset base. Assuming Viper owned its current asset base in January 2015, Viper would’ve grown production 200% relative to the Permian as a whole, growing 113% over the same time period. Viper has a unique acquisition strategy, in that we elect to take concentration risk under premier operators. Put simply, we would rather on a 100% of one section with visibility under a top operator than 1% of 100 sections.

The resulting concentrated acreage position can be subject to lumpiness quarter-to-quarter, but we believe in the long-term strategy, this will lead to consistent outsized growth just as it has over a short history as a public company. Our relationship with Diamondback, as the operator of a large percentage of this acreage, only provides further confidence in the long-term growth prospects of our assets.

Slides 12 and 13 detailed a highly undeveloped nature of Viper’s acreage position across both the Midland and Delaware basins and illustrates why we believe Viper can deliver robust organic production growth for many years without the need to complete one more acquisition or spend $1 of capital to grow. In total, we estimate our Permian acreage to be over 80% undeveloped, and contain over 330 million barrels of net undeveloped resource, using conservative spacing and type-curve assumptions.

Moving to Slide 15, we further showcase the benefits of Viper’s relationship with Diamondback and how it increases the visibility of future development. In total, there are currently 38 rigs operating at Viper’s acreage, which are expected to drill a total of 113 gross wells. Viper anticipated having an average 3.6% net revenue interest in these wells, which means these 38 rigs will drill a total of 4.1 total net 100% royalty interest wells. In terms of visibility outside of these active rigs, we highlight six selected Diamondback-operated pads in which Viper owns a material royalty interest, expected to return to production through the second half of 2019.

Next, on Slide 16, we provide an update on the remaining drop-down inventory currently held at Diamondback. Diamondback still owns almost 1,200 net royalty acres in the Southern Delaware Basin, and over 900 net royalty acres in the Midland Basin or almost 15% of our current acreage position. Over 90% of this acreage is operated by Diamondback, giving Viper a line of sight to years of organic production growth.

Additionally, Diamondback’s acquisition of Energen Resources has provide – provided another 250 net royalty acres of minerals and more importantly, a significant amount of production and associated cash flow that qualifies for a drop-down to Viper. We expect to continue working towards the drop-down transaction of some, if not all, of these assets at some point in 2019.

Turning ahead to Slide 18, we show an update on Viper’s financial position as well as forward guidance. Viper ended the quarter with a cash balance of $10 million and liquidity of $408 million. Viper is initiating average Q2 and Q3 production guidance of 19,000 to 21,000 BOE per day as well as reaffirming our full year production guidance of 20,000 to 23,000 BOE per day, the midpoint of which implies 24% year-over-year growth.

Separately, Viper’s Q4 2018 and Q1 2019 distributions have been reasonably determined to not constitute dividends for U.S. federal income tax purposes. The distribution should instead generally constitute non-taxable reductions to the tax basis.

With these comments now complete, operator, please open the line for questions.

[Operator]

Ladies and gentlemen, we’ll now begin the question-and-answer session. [Operator Instructions] Our first question from the line of Neal Dingmann from SunTrust. Your line is open.

[Neal Dingmann, SunTrust]

Good morning, all. Two questions, Travis, for you, Kaes, just the first around pricing. Could you talk about pricing? How you see this trending 2Q versus 1Q? And specifically, when I look at March to current pricing, it looks to be up about 22% or a little over $10 a barrel versus December through February. So I’m just wondering, is this how we should be thinking about it? Or are there other factors that should also be factored in? Thanks.

[Travis Stice, Chief Executive Officer]

Hey Neal, yes, we’re going to see a significant uptick in oil price realizations in Q2 through the back half of the year, even in a flat commodity price environment. So assuming oil stays where it is today and dips are where they are today, given the improvement in the Spanish Trail, fixed differential deal, April 1, and the improvement in our Pecos County deal, April 1, we’re anticipating Viper’s gross oil should increase by about $11 a barrel in Q2 and would stay pretty consistent at that level through the rest of the year.

[Neal Dingmann, SunTrust]

Very good. Okay. And then just secondly, a non-op activity. You mentioned in the press release about to continued non-op activity. I think, you said in the release that the activity outside of Spanish Trail was up 5% in 1Q. How do you all anticipate this growth continuing for the remainder of the year? Thanks.

[Kaes Van’t Hof, President]

Yes. We expect a non-op activity to be a little stronger in the first quarter, some higher interest pads, we thought would get completed in the first quarter, got pushed to the second quarter, which – we modeled the Diamondback production pretty consistently, so this non-op probably disappointed us a little bit between Q4 and Q1. 5% growth is still a good number quarter-over-quarter. I think you’re still going to continue to see non-op grow consistently. I just say that more outsized growth is going to come from large pads, operated by Diamondback with higher net revenue interest.

[Travis Stice, Chief Executive Officer]

And Neal, I’ll just add to that, that historically, Viper has an excellent track record of providing six-month and full year guidance. And just highlighted, as the Basin continues to migrate towards these larger multiple pads, particularly those that are operated by companies other than Diamondback where we don’t have the same visibility, these 90-day forecasts become increasingly difficult. It’s our responsibility and I get that. But that’s also the reason why we still only provide six months guidance and reaffirm – in this case, we reaffirmed our full year guidance.

[Neal Dingmann, SunTrust]

Yes, that’s totally understandable. I mean, we really shouldn’t be looking so much quarterly. Thanks, guys.

[Travis Stice, Chief Executive Officer]

Thank you, Neal.

[Operator]

Our next question comes from the line of Jeff Grampp from Northland Capital. Your line is open.

[Jeff Grampp, Northland Capital]

Good morning, guys. With curious if you can talk a bit on the Spanish Trail asset. Any, I guess, parent-child relationships you guys might be seeing on that asset. And if you guys have seen at the Diamondback level any, I guess, different type of development practices on that asset versus maybe some of the other assets where you guys have royalty exposure that are less developed? And maybe parent-child is less of a, I guess, issue to deal with, if you will.

[Kaes Van’t Hof, President]

Yes, Jeff, externally, a parent-child relationship for you guys to see should be something that a competent operator does take into account in their forecasting of what the future looks like. Particularly, for Spanish Trail, we’ve been drilling wells there now for six years. So we’re on child wells, we’re on grandchildren wells, we’re on great-grandchildren wells. And we’ve got a very clear understanding of what that relationship is between offset well and our current wells. And we’ve addressed that, starting a couple of years ago, by drilling larger and larger multiwell pads. And so we’ve got a good handle on what we feel like that, that relationship is, and we account for it in our forecasting.

[Travis Stice, Chief Executive Officer]

Yes. I’d say the one change between maybe last year and this year is that we are moving to – in October, it was eight-well pad, in Q3 this year, it will be a 12-well pad. That’s traditionally a bit higher than our traditional four-well pad in Spanish Trail. So from a timing perspective, that 12-well pad moving from kind of Q2 into the back half of the year did provide a significant change to Viper’s production growth, given the high interest in those wells.

[Jeff Grampp, Northland Capital]

All right. Understood. Appreciate those details. And for my follow-up, I’m curious [indiscernible] Disclosures on some of the NRIs for wells in process and things like that, so I’m curious. So looking at Slide 15 where you guys have the 3.6% average NRI on the rigs that are active. In the past, I’m curious, what your ability has been to I guess increase that from when you kind of see those rigs relative to when cash flow starts coming? Is that an opportunity for you guys to get to near-term cash flow? Or maybe that a little bit more of a competitive environment, once you have a rig on the asset? I’m just curious that if you guys were able to bolt that on, if at all?

[Kaes Van’t Hof, President]

Yes. The mineral market gets very competitive, the closer the rig gets to location in the Permian. So for us, we – on third-party acreage, we use the same information that anybody else has, and we do like to have that visibility and have permit visibility. And I will say it’s tough to get high interest in a particular section, which is why Spanish Trail is so unique. That asset was one of a kind. But over time, we certainly look at areas that have been successful for us or sections that have been successful or deals that have been successful, and looking that up. I mean, oftentimes, the sellers of these assets are selling a portion of their interest, and a year later, they will come back and say, hey, would you like some more on this particular section?

[Jeff Grampp, Northland Capital]

Got it, got it. Appreciate the time, guys. Thanks.

[Kaes Van’t Hof, President]

Thanks, Jeff.

[Operator]

Our next question comes from the line of Gail Nicholson from Stephens. Your line is open.

[Gail Nicholson, Stephens]

Good morning. Just curious on the back on hedging and has your strategy at all changed in the hedge world as you guys grow your production base larger?

[Kaes Van’t Hof, President]

Gail, it hasn’t changed materially. I’d say our opinion of protecting differentials in the out years for deals that are not operated by Diamondback, certainly garnering a lot more attention, and maybe some form of downside protection or port protection on some portion of our production, given how important the distribution is to us and our shareholders. I think, those conversations are ongoing. I certainly think the Permian is clearing up from a differential perspective, but over the long term, if we have no control over the differentials received on third-party volumes, it might make sense to hedge that differential exposure, but still leave the outside to the commodity.

[Gail Nicholson, Stephens]

Okay, great. And then just from the standpoint of your non-op – non-diner dock operators, when you look at all the industry activity that’s happening from the standpoint of acreages lost, has that caused any of your mineral acreage to change operatorship at all?

[Kaes Van’t Hof, President]

I’m sure, it has, just not in a material way. I mean most of the third-party deals that we buy have it uniformed by an operator, and have visibility with permits or docks or rig on location. So I’d say, certainly a lot of sloppiness has been having. Diamondback has been doing a lot ourselves. But from a material non-op perspective, we haven’t seen much.

[Gail Nicholson, Stephens]

Okay, great. Thank you.

[Operator]

[Operator Instructions] Our next question comes from the line of Betty Jiang from Credit Suisse. Your line is open.

[Betty Jiang, Credit Suisse]

Thank you, good morning. So question on acquisitions. The market seems to have gotten more competitive in the Permian, and even your acquisition price has ticked up, looking at the first quarter numbers. Can you just talk about what you’re seeing in the market, whether you are passing on more deals today due to pricing? And how well are you positioned to compete for deals?

[Kaes Van’t Hof, President]

Yes. I’ll take the competitive positioning. I firmly believe we’re the largest, if not one of the largest, mineral buyers in the Permian, so from a competitive positioning and cost of capital perspective, I feel like if it’s the right deal and it makes sense for us, that’s a deal we’re going to want to win. But the market is competitive. There’s been $6 billion or $7 billion of private equity money put into minerals, focused in the Permian. I’d say, it goes in fits and starts. And maybe two years ago this time, it was as hot as it has ever been. It’s starting to pick up again.

Speaking just to our price per acre that we paid, it all depends on the acreage, right. So Diamondback, with Energen merger gave us a lot more acreage to buy under at Viper. And in the first quarter, we did a large deal in the Reeves County area and Ward County, which are the highest of the high-returning areas for Diamondback now. And that probably resulted in the increase in the price per acre in the quarter.

[Betty Jiang, Credit Suisse]

Great, thank you. And then secondly, can you talk about the nature of the $60 million to $80 million cash flow related to the excess net revenue interest on the Energen asset? Is it concentrated in one area versus another? And I will be interested in what’s the decline profile of that cash flow stream versus on your current Viper production?

[Kaes Van’t Hof, President]

Yes. I can’t give that information now until we’ve worked on a trade. So I can’t answer that. I will say it’s pretty diversified across the entire asset base with a ton of active development and all operated by Diamondback.

[Betty Jiang, Credit Suisse]

Thank you.

[Kaes Van’t Hof, President]

Thanks, Wei.

[Operator]

Our next question comes from the line of Jason Wangler from Imperial Capital. Your line is open.

[Jason Wangler, Imperial Capital]

Hey, good morning, guys. Maybe a little bit different than the last question, but just curious, as now you’ve gotten back Energen for some time, have you been able to kind of see some of the acquisition opportunities under the operated acreage that you acquired from the Diamondback level for Viper and perhaps some other deals that you’re able to see in the first quarter?

[Kaes Van’t Hof, President]

Certainly. Two major areas where we’ve been acquiring minerals, three if you want to include the San Pedro area where we’re doing our drill tow with Carlyle. We’ve been getting a lot of minerals down there. But more importantly, after closing the Ajax acquisition and the Energen acquisitions, and now running 20 or 22 rigs and completing over 300 wells a year at the parent company, there’s a lot more visibility and a lot more acreage to buy under. So I’d say we’ve been most successful probably in the Martin County area under Ajax, and secondly, under the Energen acreage in Reeves County and Ward County.

[Jason Wangler, Imperial Capital]

Okay. That’s helpful. And then just as a follow-up, obviously the Eagle Ford acquisition, you guys brought a while back to, now you have it for some time, could you may be comment on how you’ve seen that performed versus your expectations? And kind of the outlook on that area as an opportunity going forward?

[Kaes Van’t Hof, President]

Yes. I’d say we model that deal very conservatively. I mean, we modeled that essentially a flat year-over-year production. Clearly, with the work kind of goes doing down there, and the work that – the new VH – sorry VP and Devon are looking to accelerate in the back half of the year. I think in the back half of the year that deal is going to exceed our expectations. The first half of the year, we molded it flat versus last year. Really, what’s impressed us down there is the LOS pricing and the higher oil price we’ve been receiving from that acreage, which has improved the yield from where we bought that trade.

[Jason Wangler, Imperial Capital]

Great. I appreciate it. I’ll turn it back.

[Kaes Van’t Hof, President]

Thank you, Jason.

[Operator]

Our next question comes from the line of Aaron Bilkoski from TD Securities. Your line is open.

[Aaron Bilkoski, TD Securities]

Thanks. Good morning, guys. You obviously talked about a very strong Diamondback activity in Q3 and Q4. I was curious, based on your guidance, how much of the ramp-up in production through Q4 of this year we anticipate to be from Diamondback? And how much of that production growth is anticipated to come from third parties?

[Kaes Van’t Hof, President]

Yes. I’ll take it a little separately from how you’re framing it, Aaron. I think the way we think about it is net wells added. And I expect, given the size of the Diamondback pads, the wells added should be about two-thirds or 75% of the total compared to the third-party wells. I think third-party would be a fairly consistent number, almost two wells per quarter, but the Diamondback wells are going to – are going to be the big driver of the growth.

[Aaron Bilkoski, TD Securities]

Perfect. Thanks, guys.

[Operator]

I would now like to turn the conference back to Travis Stice, the Company CEO.

[Travis Stice, Chief Executive Officer]

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

[Operator]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. Have a wonderful day. You may all disconnect.