Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the Viper Energy Partners Second Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Mr. Adam Lawlis, Director Investor Relations. Sir, you may begin.

[Adam Lawlis, Head of Investor Relations]

Thank you, Lisa. Good morning, and welcome to Viper Energy Partners second quarter 2018 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; Tracy Dick, CFO; 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 on 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 and Director]

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners second quarter 2018 conference call. 2018 has been an exceptional year so far for Viper as we have continued to grow production at industry-leading rates and recently announced our 7th consecutive company-record distribution.

We grew production 16% quarter-over-quarter and generated an annualized return on average capital employed of over 18%. Also, pro forma for the acquisitions closed were committed through July 23, our assets have grown by 30% compared to the first quarter of 2018 and over 80% compared to a year ago. The most significant portion of this asset growth is from the first announced drop down of Pecos County mineral assets from Diamondback to Viper. This transaction, which is expected to close this month, will make Pecos County Viper's largest core area in terms of both net royalty acres, as well as Diamondback operated net royalty acres, surpassing our Spanish Trail assets.

We expect this to be the first of a series of drop-downs from Diamondback to Viper as Diamondback will continue to drop down mineral assets as production increases and the cash flow is accretive to Viper's distribution. As a result of these accretive acquisitions, we are initiating average production guidance for the third and the fourth quarter of 2018 of 17,500 to 19,000 barrels of oil equivalent per day, as well as raising full year 2018 production guidance to 16,500 to 17,000 BOEs a day, up 5% from our previous full-year guidance and representing over 50% year-over-year production growth.

I'll now turn the call over to Kaes.

[Kaes Van't Hof, President]

Thank you, Travis. Turning to Slide 6, we show our year-over-year growth on several key financial metrics as well as give an update on our rolling 6-month and annual production guidance.

Importantly, we show the potential range of our 2018 distribution, given our updated production guidance range, current commodity mix and a range of realized oil prices. Slide 7 illustrates Viper's position as an industry leader in both return on and return off capital. Since going public Viper has cumulatively distributed over $4.65 unitholders. And our distribution has now quadrupled in the last nine quarters.

The second quarter was an exceptional quarter for Viper, as we achieved average return on capital employed of over 18% with our seventh consecutive company-record distribution of 0.60. Slide 8 is important, in that it illustrates the unique value proposition that Viper now presents to a much larger investor base.

Viper is expected to return well over 12% of its current market caps to unitholders, simply by holding our second quarter 2018 distribution flat and assuming consensus 2019 estimates while not spending any capital. Flipping ahead to Slide 10, we provide an update on Viper's acreage position and inventory.

This shows a breakdown of Viper's pro forma acreage by county, both Diamondback and third-party operated as well as our exposure to active permits filed within the past six months from the most active operators in the Permian Basin and the Eagle Ford.

Following the closing of the drop-down from Diamondback, Pecos County will be Viper's largest asset in terms of both total acreage as well as Diamondback operated acreage and will be a second quarter driver of growth along with Spanish Trail.

Slide 11 provides some detail on Viper's exposure to various operators in the Permian Basin. As a mineral owner, Viper is subject to the underlying takeaway position of its operators, which is why we have been selective about which operators we buy minerals under. Diamondback, who operates the majority of our production, has taken proactive steps to secure firm transportation to fix discounts to Gulf Coast pricing through this period of Permian takeaway tightness.

During the second quarter, Viper's realized oil price was roughly $4 above the Midland market price, reflecting the positive pricing arrangements of our largest operators, including the exposure to the premium LLS pricing provided via our Eagle Ford asset.

Slide 12 provides further detail on the previously mentioned Pecos County drop down from Diamondback. This acreage has visible active development with 29 wells drilled or expected to be drilled in 2018 and over 50 anticipated in 2019, primarily for leasehold requirements. This activity gives us confidence in the accretive next 12 months expected yield of 10%. Diamondback still holds more minerals that will be dropped down as production increases and cash flow allows.

Slide 13 and 14 highlights the acquisitions that we have made since the end of the first quarter. Over the last five months, we've acquired $340 million worth of minerals, with two-thirds operated by Diamondback, providing forward cash flow visibility. All of this acreage has active development as seen through the permit and rig count exposure, and we expect the cash flow on these assets to grow over the next 12 months. The opportunity set for acquisition in the Permian Basin remains extremely robust and we believe Viper's in a unique position to continue to accumulate Tier 1 acreage through immediately accretive acquisitions.

Moving to Slide 15. We give an update on the latest well results and performance of our Eagle Ford acquisition closed at the beginning of the year. Operators continue to delineate the Austin Chalk and Upper Eagle Ford, while actively developing the Lower Eagle Ford across the acreage block. Production continues to exceed expectations, and the asset is currently providing exposure to premium LLS pricing.

With these comments now complete, I'll turn the call over to Tracy.

[Teresa Dick]

Thank you, Kaes. Viper's second quarter 2018 net income was $99.4 million or $0.35 per diluted share. This includes the benefit for income taxes set up as a result of Viper's conversion from a pass-through entity to being taxed as a corporation, which closed in the second quarter. The large benefit recorded in net income this quarter and offset as a deferred tax asset is due to the difference in basis between book and tax values of Viper at conversion. From a tax perspective, Viper carried over from the public unitholders' its high tax basis, which allows for future deductions of depletion for tax purposes.

Our operating income for the quarter was $75.4 million, up 21% from $62.4 million in the first quarter of 2018. Viper's average realized price per BOE for the second quarter was $50.10, our highest realization in 14 quarters. During the quarter, our cash G&A cost were $1.18 per BOE, while non-cash G&A was $0.31 per BOE.

As shown on Slide 19, Viper ended the second quarter with a cash balance of $33 million and liquidity of $158 million. On July 31, 2018, Viper announced a public offering of 10 million common units for total net proceeds of approximately $305 million. Pro forma for this offering and all committed deals as of July 23, Viper has $242 million available under its revolving credit facility and $259 million in liquidity.

With these comments complete, I'll turn the call back over to Travis.

[Travis Stice, Chief Executive Officer and Director]

Thank you, Tracy. In closing, we look to continue to be an industry leader in terms of return on and return of capital. We look forward to maintaining our leadership position and consolidating the fragmented private minerals market in the Permian Basin through accretive acquisitions that continue to grow our distributions, production and reserves on a per unit basis.

Operator, please open the line for questions.

[Operator]

Thank you, Sir. [Operator Instructions] First question is coming from Neal Dingmann from SunTrust. Your line is open.

[Neal Dingmann, SunTrust Robinson Humphrey]

Good morning, all. Kaes, my question for you is, with dropdowns, can you tell me the potential overall you see today? I mean, including Ajax and how you sort of think about timing behind each of that. I guess, you obviously could really drop down kind of at your discretion, so how do you all sort of view the timing, when and if?

[Kaes Van't Hof, President]

Yeah, Neal, I use an example of the dropdown we just completed. We're very patient on timing of when those minerals needed to be dropped down to Diamondback. And we really wanted to make sure, on a forward-basis the cash flow multiple paid was accretive to Viper's distribution. And as you'll see here, we paid about 10 times forward cash flow for these assets from Diamondback. So it's a good trade for both companies, fit well between the multiples of both companies.

And also the forward visibility is really high. We know that there is going to be 50 wells drilled on this acreage next year, which gives us a lot of confidence in the future growth plans on the mineral assets. Pro-forma for the Ajax acquisition, Diamondback will probably have somewhere around 2 to 2.5 times the size of - or sorry - 1 to 1.5 times the size of the first dropdown remaining. Again, we don't like holding minerals at the Diamondback level and we think they're best served in the hands of Viper.

So as soon as there's enough development and the price looks fair compared to other deals we've done in the area, then we'll certainly look to drop that down.

[Neal Dingmann, SunTrust Robinson Humphrey]

And, Kaes, how does that play into how active, I know you all see a ton of deals, I mean, even on a weekly basis. How does that sort of depending of or potential number of dropdowns play into how acquisitive you might be on external acreage or external minerals?

[Kaes Van't Hof, President]

Yeah, having more acreage to buy under Diamondback is the best acreage we can buy. Unfortunately, it's not all for sale, so I think we branched out to a lot of third-party operators, under third-party operators in the Permian, guided that trust won't be able to move the barrels and to grow their production with a forward visibility. So it's great when Diamondback acquires acreage, because the Viper team then has a new playground, so to speak, to buy minerals under.

As you can see with what they've done in Pecos County in a short amount of time, it certainly bodes well for the future.

[Neal Dingmann, SunTrust Robinson Humphrey]

And then, just lastly on that unit, on the Slide 7, how do you all think about is or sort of a set sort of target yield you're looking at or when you think about sort of raising distributions, how you think about that?

[Kaes Van't Hof, President]

Yeah, our philosophy is still to distribute all cash every quarter. So we distribute essentially almost all the EBITDA of the business, distribute the cash flow of the business every quarter. And we anticipate that will continue to grow as oil price improves and our production improves.

[Neal Dingmann, SunTrust Robinson Humphrey]

Great. Sounds like a solid time. Thanks, guys.

[Kaes Van't Hof, President]

Thanks.

[Operator]

The next question comes from Jeff Grampp from Northland Capital. Your line is open.

[Jeffrey Grampp, Northland Capital Markets]

Good morning, again, guys.

[Travis Stice, Chief Executive Officer and Director]

Hey, morning, Jeff.

[Kaes Van't Hof, President]

Good morning, Jeff.

[Jeffrey Grampp, Northland Capital Markets]

Kaes, I think you touched on this in your prepared remarks, but wanted to drill down a little deeper. When you guys are underwriting acquisitions in this environment in the Permian, how do you think about how those barrels are priced like? Do you guys differentially avoid minerals that are priced in their oil and basin, or are you guys more indifferent, then it's just kind of implicitly baked into the underwriting based on stripper or whatever? And if you guys can get a good deal on a good asset and it reflects wide differentials, you guys are kind of indifferent. Is that a fair or just can you talk about that dynamic little bit?

[Kaes Van't Hof, President]

I think over the long-term differentials were normalized, as you can see in the strip. But a big driver of deals that we look for is near-term cash flow, and that near-term cash flow needs to be reflected at a Midland market price. And, usually, we essentially use the Midland realized strip over the next 12 months until the takeaway situation gets sorted out and use that as a baseline for our near-term yield accretion on anything we bought.

We also are very careful to buy under the better-capitalized, bigger operators that we know are going to be able to move the barrels through this period.

[Jeffrey Grampp, Northland Capital Markets]

Okay. Great, that's helpful. And then, for my follow-up, kind of building on that comment to the extent Viper, obviously, backing the better, more capitalized operators. And the trends seems to be for bigger and larger scale pad projects. So do you guys kind of reference wells being permitted? Are you noticing a change in timing from when you see a permit from when a well goes to production just given these larger scale projects? And does that change at all your line of sight for Viper's growth?

[Kaes Van't Hof, President]

We really look at it on an operator-by-operator basis. And we look at how that operator's been developing their resource in nearby acreage and what size pads and what the timing looks like between when the well is drilled and when it comes on to production. So certainly, we're seeing bigger pads across all the Permian. It's really a case-by-case basis on how that operator is looking to develop that acreage. In some cases, they're looking to hold acreage so they just drill one well for all the acreage. But obviously, with my Viper hat on, we prefer more wells at the same time, a few on the minerals under that acreage.

[Jeffrey Grampp, Northland Capital Markets]

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

[Kaes Van't Hof, President]

Thank you, Jeff.

[Operator]

Next question is coming from Jason Wangler from Imperial Capital. Your line is open.

[Jason Wangler, Imperial Capital]

Good morning, all.

[Travis Stice, Chief Executive Officer and Director]

Good morning, Jason.

[Jason Wangler, Imperial Capital]

I was curious, obviously, you guys have been successful on the M&A side the last couple of months in the spaces of differential issues or whatever you want to call them. Has that been something that's been helpful for you as far as maybe seeing some more opportunities or maybe even just prices that you thought were more relevant? Or is that more just kind of more coincidental?

[Kaes Van't Hof, President]

Yeah, it's really a function of timing. I mean, if you look back a year ago, second quarter was our biggest quarter from an acquisition standpoint. I think, obviously, the market is very competitive on the mineral side and we lose a lot of deals. There's a lot of private equity-backed minerals companies working in the Permian today. And a lot of times, we do end up getting beat. But what's unique about the amount of deals we did in Q2 and Q3 is how much Diamondback operates. Usually, those are the deals that we can win, because we have a lot of comfort in the drill schedule.

So two-thirds of the deals we did in Q2 are operated by Diamondback. And then, obviously, 80% of the drop down's operated by Diamondback, which is very beneficial to us in the long-term growth prospects.

[Jason Wangler, Imperial Capital]

And it would be curious now a few months after the conversion just how you're seeing investor response or anything. You talked about during that conversion of seeing that bigger pool of the folks that talk to you. I mean, has that really seemed to work out? Certainly, the stock has been doing quite well, but just curious how you guys have seen maybe a shift in your day-to-day lives on this side of the fence.

[Kaes Van't Hof, President]

Yeah, Adam and then the IR team has been a little bit busier talking about Viper now. So it's been great talking to some of our top 10, top 20 shareholders on the Diamondback side who are now doing their work on Viper and really highlighting the unique value proposition we have ahead of ourselves at the Viper level. We raised 10 million units of - last week and raised it at a very narrow discount versus when we were in MLP, it was a lot harder to raise that capital. So very excited to welcome some new top 10 shareholders post the conversion.

[Jason Wangler, Imperial Capital]

I appreciate the color. Thank you.

[Kaes Van't Hof, President]

Thank you.

[Operator]

[Operator Instructions] There are no further questions. I would like to turn the call back over to Travis Stice, CEO.

[Travis Stice, Chief Executive Officer and Director]

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

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.