Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Transcript 2022-Q1

[Operator]

Good day. Thank you for standing by, and welcome to the Viper Energy Partners First Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today’s conference call is being recorded. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Adam Lawlis, Vice President of Investor Relations. Thank you. Please go ahead.

[Adam Lawlis, VP, IR]

Thank you, Cherry. Good morning, and welcome to Viper Energy Partners’ First Quarter ‘22 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 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, CEO]

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners’ First Quarter 2022 Conference Call. During the first quarter, Viper continued to build on its track record of delivering strong financial and operating results highlighted by the 43% quarter-over-quarter increase in our distribution to $0.67 per common unit. This distribution represents approximately 70% of the total cash available for distribution and implies a 9.5% annualized yield based on yesterday’s unit closing price. Additionally, we repurchased 1.6 million common units during the quarter at an average price of $24.84 per unit for a total cost of $39 million. Combined with the distribution, this represents a return of approximately 95% of free cash flow to our unitholders.

Looking ahead, we continue to focus on maximizing long-term returns to our unitholders and believe we are differentially positioned to do so with our best-in-class cost structure that enables investors to participate in the recent strength seen in commodity prices via the highest margins in the public oil and gas industry. Importantly, with 0 capital requirements and only limited operating costs, Viper will not face the inflationary cost pressures being seen across the industry and broader economy.

As a result of the strong production seen during the first quarter as well as continued strong levels of activity across our acreage position, we have increased our guidance for oil production for the full year by roughly 1.5% at the midpoint. Our 23.5 net wells currently with visibility to development is a company record and underscores our confidence in this forward outlook. This record amount of activity, which is enhanced by Diamondback’s continued focus on developing our concentrated royalty acreage, demonstrates both the quality of our acreage as well as our ability to grow production without having to spend a single dollar of development or acquisition capital.

Based on the midpoint of this full year 2022 production guidance, Viper is expected to generate over $3.75 per unit in distributable cash flow, assuming $95 WTI or a greater than [13]. With a 70% payout and an opportunistic unit repurchase program, Viper offers a competitive cash return yield that provides maximum exposure to commodity prices with limited operational risk.

In conclusion, the first quarter was an outstanding quarter that was record settings on almost every metric. The record results of our business highlight our quality asset base, best-in-class cost structure and overall differentiated business model. Given the strength of our balance sheet, we have evolved our hedging strategy so that we can maximize upside exposure to commodity prices while also protecting against the extreme downside. We look forward to continuing to generate robust amounts of free cash flow and maximizing returns for our unitholders.

Operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Neal Dingmann from Truist Securities.

[Neal Dingmann, Truist Securities]

Nice results. Kaes, maybe for you or Travis, just for a product like this, how do you all think about -- I noticed you had a few -- a bit of buybacks in there as well as continue to hit what was a record payout on the distribution. So I’m just wondering, how do you sort of think about that differently on the mineral business? Or do you think about that any differently on mineral business versus when you’re thinking about that diversification I’m saying?

[Kaes Van’t Hof, President]

Yes. Good question, Neal. Listen, I think Viper is one of the original cash distribution vehicles in North American oil and gas, right? So if you go back when this business went public in 2014, that was when E&Ps were still spending 100% of cash flow, outspending cash flow to grow and Viper was a beneficiary of that while still distributing cash to its investors. So I think we still have debt, so we’re not going to distribute 100% of the cash that we have every quarter, but I think the deal market is tough right now. So there is a lot of extra cash beyond that 70% of free cash being returned via the distribution to pay down debt, get our revolver closer to 0. And then we’ll have a discussion on more shareholder returns.

I think the buyback authorization has been very positive for the story. It’s -- there’s been a lot of volatility in this space, so we’ve had opportunities to buy back shares. So having that out there as a nice defensive mechanism is positive and Exhibit A is what we did in Q1 with buying out some of the Blackstone units that we gave them in the Swallowtail deal. So generally, 70% is the baseline. That’s the cash number. I think as long as the balance sheet continues to improve and the unit price continues to rise, then we’ll be aggressive on continuing to distribute more than that on a quarterly basis.

[Neal Dingmann, Truist Securities]

Okay. And then just lastly on the confidence on boosting the production. Is that just on the visibility you’re seeing most of the -- I mean, you know what, of course, Diamondback’s going to do on third party or there’s nothing assumed in there. I don’t assume you have any dropdowns left remaining that you could do from Diamondback. Is it just primarily third-party upside for the rest of the year?

[Kaes Van’t Hof, President]

Yes, Neal. For the most part, it’s just having that increased visibility to the non-offside. We don’t like to be too aggressive in making assumptions with timing that we can’t control. So typically, we put out that rolling 6-month guidance because that’s a rough time line for when the well gets spud to when it gets through to production. So as we fast forward through the year and activity remains strong, we just have further visibility to the back half of the year, and that gave us the confidence to increase that outlook.

[Operator]

Your next question comes from the line of Chris Baker from Credit Suisse.

[Chris Baker, Credit Suisse]

Congrats on the quarter, solid cash flow and cash return update. If I could ask sort of a similar question, maybe perhaps a different angle here. So last year, it looks like the buyback plus the variable dividend return roughly 80% of cash available. I’m just wondering if that’s a fair baseline try to think about the pace of the buyback for the rest of the year?

[Kaes Van’t Hof, President]

Yes. I still think that the buyback, Chris, is going to be opportunistic. So I don’t want to say that we’re going to hit a certain amount of units a month or a trading day or a quarter. Kind of like we said on a call earlier today, this market has provided us a lot of opportunities to buy back shares opportunistically. And I think we’re going to have that opportunity at Viper. But we do want to adhere to a top. But I think right now, where Viper’s trading, we’re going to have chances to buy back shares. I think it would be fair to say 80% or 85% of total cash gets returned through the dividend plus the buyback. But if we get another opportunity to buy a big chunk of stock, like we did with the Blackstone trade in Q1, we’ll entertain that opportunity if it presents itself.

[Chris Baker, Credit Suisse]

Great. Yes. No, that makes a lot of sense. And as a follow-up, I appreciate the additional color in the deck around the bank operated inventory. I’m just curious, how many third-party locations would you add on top of there? And sort of on a related -- if I could squeeze one -- a third one in, how many net completions do you view needing to generate, say, mid-single-digit oil CAGR? I mean it sounds like maybe north of 20 years. So just curious how you would frame that up on the inventory side.

[Kaes Van’t Hof, President]

Well, I think the inventory question, you can take the Diamondback inventory and assume most operators in the basin are using similar spacing and economic zones to Diamondback. So you could roll that up on the non-op side. We certainly have a lot more confidence in the pace of development on the Diamondback side and we can get those net wells drilled faster, so your pace is a little slower in the non-op piece. But the inventory wise, it’s still there.

And then on growth, I think we’re projecting some growth this year. Obviously, the forward visibility is as high as it’s ever been and growth is balancing that. I don’t know, Austen, how many net wells a year keeps you growing?

[Austen Gilfillian, IR]

Yes. So this year, we’re kind of looking at something like 11 to 12 net wells on -- from the Diamondback side and maybe 5% to 6% on the non-op side. And if you look at where we exited last year, pro forma for the Swallowtail acquisition, I would say that, call it, ballpark 17 net wells will give you what’s looking like 5% organic growth. I think our base decline has come down a little bit, too, since this activity slowed down a bit over the past couple of quarters. So when you fast forward to 2023, I would put it somewhere in the 16-or-so net wells a year to kind of maintain production flat. And with our current activity levels and what the forward outlook looks like, you’re probably getting some growth with that.

[Chris Baker, Credit Suisse]

Great. Yes. It sounds like definitely differentiated inventory depth. Appreciate the update, guys.

[Kaes Van’t Hof, President]

Yes. I think I’ll add on that is that the Swallowtail deal gets developed, that confidence in the Diamondback growth is only enhanced. I think when we announced the deal, we said we’ll get to 5,000 barrels a day net by 2025, and that looks on track. So that’s going to help the growth profile of the rest of the business.

[Operator]

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

[Derrick Whitfield, Stifel]

With my first question, I wanted to touch on the Ward County acquisition that Diamondback announced yesterday. In light of its elevated NRI and the premium paid for it, is the incremental NRI with that asset something that you’d envision dropping down at some point to Viper?

[Kaes Van’t Hof, President]

Yes. I think that’s logical to have that discussion. We’re doing our work now. I don’t think there’s a rush necessarily, given that Diamondback is just starting developing that position. So you won’t see much production until the end of the year or next year. But there’s probably a time where Viper and Diamondback can get together to get a deal done here. It’s just not priority #1 today in Q2.

[Derrick Whitfield, Stifel]

That makes sense. And then kind of looking out over the balance of the year and even further out into 2023, how should we think about your cash tax exposure for distributions in light of the current higher prices that we’re seeing?

[Kaes Van’t Hof, President]

Yes. So if you -- just to wind back the history books here when Viper converted to a taxable partnership from an MLP, we did a deal with Diamondback to shield those investors, potential cash tax burden when the conversion happens. And there was a big special allocation of income that helped that shield. With commodity prices where they are, that shield is going to run out this year. So outside of depletion protection, it’s likely that Viper becomes a significant cash tax payer in 2023 and beyond. Austen, do you want to add anything to that?

[Austen Gilfillian, IR]

Yes. And Derrick, listen, what’s important for this year is we put out that guidance of 10% to 15% on effective cash tax rate, but that’s only for the income that’s retained at the Viper LP level. So as Kaes outlined, we still have that special allocation of income going back to Diamondback.

So if you look at it this quarter, 85% of the pretax income went into Diamondback and they paid the taxes at that level. Then the 15% remains at the Viper LP level, which is then subject to that tax rate that we put out guidance for. Going ahead to next year, Diamondback will just get their pro rata ownership 54% to 55% of the pretax income. So there’ll be more absolute dollars at the LP level, and we’ll probably pay a slightly higher rate on that as well.

[Operator]

Your next question comes from the line of Jeanine Wai from Barclays.

[Jeanine Wai, Barclays]

Our first question, maybe just hitting back on the minerals market. You mentioned there may not be as many deals out there as there was before, so that skews the cash distribution higher, which is terrific. But can you just provide a little bit more color on what’s going on out there in the market, in particular for differently sized deals?

[Kaes Van’t Hof, President]

Yes, it’s just tough. There’s been a lot of consolidation in the mineral space. And as commodity prices rise, particularly on the front end, mill owners are receiving massive checks on a monthly basis. And us, as a buyer, staying disciplined, aren’t going to pay for that strip -- well, not only strip but certainly not [indiscernible] type multiples. So I think we’ll still be very competitive in larger packages like the Swallowtail deal. It’s just that we haven’t had a lot of success doing significant transactions in 2022 yet. Austen, what else you want to add to that?

[Austen Gilfillian, IR]

Yes. No, that’s all fair. I mean, we’re still seeing things transact even with the higher commodity prices, but most of the deals are packages that have visibility, whether it be through ducts or permits. And given that most of that production is going to come online with the higher prices, at least you would assume with where the strip is today, we’re still underwriting lower price decks that we haven’t been -- and we’re competitive on those.

And also, we’re not incentivized necessarily to be trying to look that near term, we’re trying to look over longer term. So we’re trying to be creative and we’re working with Diamondback for what the development plan is going to look like in the next 2, 3, even 4 years out, and try to add some inventory on the back there where we can also underwrite a little bit lower price deck. And we’re having to be patient and will be creative, but I think there’s potentially some smaller deals to be done here and there.

[Jeanine Wai, Barclays]

Okay, great. And then for a follow-up question, I apologize for hitting back on cash returns again, but maybe following up on Neal and Chris’s question. In terms of the expanded buyback program, can you just talk a little bit more about how you decide between the buyback and the payout ratio? I know at FANG, you talked a lot about mid-cycle pricing. It’s not necessarily about intrinsic value, relative value. You’re looking at the track record of buybacks in the industry is not so great, and you guys want to buck that trend. So can you just talk a little bit more about how you’re thinking about that for VNOM?

[Kaes Van’t Hof, President]

Yes. I mean, Viper, the 70% is there, right? So that’s coming out in terms of -- in the [fixed fix], but a variable distribution. In the rest, I think we have an internal view of NAV at Viper. We also look at what can we buy minerals in the market -- in the stock market through Viper stock versus in the private market. And I think the private market is very, very hot. And therefore, the stock and the implied dollar commitment acre for what is better acreage with higher visibility is lower than that. So that gives us confidence that we can buy reserves through our stock -- through our unit price rather than through deals in the ground.

[Operator]

Your next question comes from the line of Kyle May from Capital One Securities.

[Kyle May, Capital One Securities]

Just a quick question looking at unit costs. It looks like in the first quarter, unit costs were lower versus your guidance. So just kind of curious how we should be thinking about those trending through the year.

[Kaes Van’t Hof, President]

I think we’re in good shape. There’s a little bit of noise in G&A throughout the year. So I think we feel like we’re going to hit those numbers there. Now if we’re able to continue to pay down interest expense or bid on our revolver aggressively, then we could be towards the lower end of our interest expense guidance throughout the year.

[Austen Gilfillian, IR]

Yes. The good thing, Kyle, is most of those cost items are pretty sticky. We’re not getting faced with inflation there. So hopefully, if the performance continues to outperform, they trend lower on a dollar per BOE basis. But generally, if you model them on an absolute basis, I think that will be pretty fair.

[Kyle May, Capital One Securities]

Okay, great. That’s helpful. And also on the hedging front, it looks like you removed the oil collars that were in place for 2Q. Just wanted to get your latest thinking around hedging at Viper.

[Kaes Van’t Hof, President]

Yes. It’s kind of evolving to a similar story for -- as we did at the Diamondback level, buying plus and protecting that extreme downside, we certainly don’t want to go back to a world where we have to think about our distribution policy changing. And so buying $50, $55-plus, protecting that extreme downside needs in a Draconian world, leverage doesn’t roll out, and we’re still paying significant distributions and trying to maximize upside exposure by buying puts rather than the wider collars.

[Operator]

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

[Leo Mariani, KeyBanc]

I wanted to follow up on one of the prepared comments here. Obviously, you all bought a nice chunk of stock from Blackstone in the first quarter. Just so I heard you right, it sounds like you guys would be very open to doing more deals like that if the opportunity presents itself?

[Kaes Van’t Hof, President]

Yes. But price sensitive, Leo, we’re not looking to just flow through our buyback program just to do it. We’ve got a big advantage of pullbacks in the market. And I think we’ve got opportunities here over the last couple of months to do so.

[Leo Mariani, KeyBanc]

Got it. Okay. And then just lastly, I just wanted to clarify on cash taxes, if I heard it right. It certainly sounds like you would expect the rate to be up next year and then your cash tax shield roughly speaking, I think you guys said was something around 55%. Just wanted to maybe understand that part. And I guess that’s maybe the ownership interest of VNOM -- of FANG essentially?

[Kaes Van’t Hof, President]

Yes. Basically, high level, the shielded income from the parent company to the public unitholders is going away next year. This is the last year of it. And so a small amount of cash taxes this year, but stepping up pretty meaningfully next year.

[Operator]

[Operator Instructions] All right. I’m showing no further questions at this time. I would now like to turn the conference back to Travis Stice.

[Travis Stice, CEO]

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

[Operator]

This concludes today’s conference call. Thank you all for your participation. You may now disconnect.