Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. And welcome to the Viper Energy Partners Second Quarter 2020 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. [Operator Instructions] Please be advised, that today’s conference is being recorded. [Operator Instructions]

I now like to hand the conference over to Mr. Adam Lawlis, VP, Investor Relations. Please go ahead.

[Adam Lawlis, VP, IR]

Thank you, Sharon. Good morning, and welcome to Viper Energy Partners' second quarter 2020 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 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 second quarter 2020 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 Diamondbacks 15 completions having more than an 80% 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 on almost three months break from all completion activity in the second quarter of 2020. Looking toward the second half of 2020, 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 advantage 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 2020 guidance levels, Viper is expected to generate more than $180 million in free cash flow in 2021 or a greater than 11% free cash flow yield. This is expected to be a roughly 2 percentage point increase from our second half of 2020 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 2020, we 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 $436 million of liquidity, and we'll continue to look for avenues to accelerate the de-leveraging 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 2020 average production guidance, implying greater than 6% growth relative to Q2 2020 average daily oil production, even with the challenging macro backdrop.

Operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from Will Thompson with Barclays.

[Will Thompson, Barclays]

Hey, good morning. For Travis or Kaes, 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 NRI as we say in 2Q, would it be fair 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?

[Travis Stice, CEO]

Yeah. Well, you know, I think certainly it's a possibility, particularly from the exit Q4 number. But, you know, I think on a year-over-year basis with Q1 being as high as it was, I think it'd be tough to grow on a year-over-year basis. We have to see some more activity on the non-op side, but you're exactly right. I mean, you know, even though Diamondback is not pursuing a large growth strategy in 2021, 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 through , you know, 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 you know 2021 has some optimism, but we've got to finalize the completion schedule at this point.

[Will Thompson, Barclays]

Okay. It'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 that’s its kind of three times 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. I'm just – 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 loan growth?

[Travis Stice, CEO]

Yeah, we have a few buckets in the indenture that allow us to distribute even if we're above three times leverage. We're not above three times leverage today. But I think, you know, as the Board went through the conversation on the Q2 distribution, given that total free cash flow is about $0.12 a unit, and we're distributing 25% of that, you know, really, there's not a huge delta between paying out 100% and 25% 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, you know, going to get close to four times and we're closer to below three times, then above it, I think there's a chance to increase that distribution, looking into the second half of this year and into 2021.

[Will Thompson, Barclays]

Okay. Thank you very much.

[Operator]

Next question comes from Chris Baker with Credit Suisse.

[Chris Baker, Credit Suisse]

Yeah, good morning. Just in terms of - on the topic of Diamondback’s ownership of Viper, which came up on the call earlier today, 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?

[Travis Stice, CEO]

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 where we're - what our ownership position is in Viper.

[Chris Baker, Credit Suisse]

Great…

[Kaes Van't Hof, President]

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.

[Chris Baker, Credit Suisse]

It's helpful. And then just a follow up, you mentioned, looking to accelerate the de-leveraging process, I am just curious how you're thinking about levers, you know, that you could potentially pull beyond maintaining that lower payout ratio?

[Kaes Van't Hof, President]

Yeah. Chris, I mean, obviously the payout ratio is most visible, but there's a lot going on in the back - the backdrop of, you know, doing work on our asset position, making sure we're getting paid for what we deserve to get paid on, working down the accounts receivable balance. But also probably more importantly, working to bring some cash in by selling some undeveloped acreage positions.

You know, 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, you know, those are kind of smaller packages here and there that we're looking to sell, if it's not reducing our cash flow.

[Chris Baker, Credit Suisse]

Great, thanks.

[Travis Stice, CEO]

Thanks, Chris.

[Operator]

Next question comes from Derrick Whitfield with Stifel.

[Derrick Whitfield, Stifel]

Hey. Good morning, guys.

[Travis Stice, CEO]

Hey, Derrick.

[Derrick Whitfield, Stifel]

With regard 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 operated completions?

[Kaes Van't Hof, President]

I think that's fair, Derrick. I think we tried to come out strong with the forward guidance and also maintain guidance on like a lot of our peers who aren't even providing it. Certainly with the high interest wells coming on, 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.

[Derrick Whitfield, Stifel]

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

[Kaes Van't Hof, President]

Yes. Weirdly enough, Derrick, 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 is 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, you know, 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.

[Derrick Whitfield, Stifel]

That makes sense. Thanks, all.

[Kaes Van't Hof, President]

Thanks, Derrick.

[Operator]

Next question comes from Brian Singer with Goldman Sachs.

[Brian Singer, Goldman Sachs]

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 VNOM level? Or is there comfort with VNOM having higher leverage ratio relative to Diamondback?

[Kaes Van't Hof, President]

Well, you know, I think it all depends on where the forward outlook goes on commodity price. But overall, given that VNOM 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 VNOM level. You know, I still think we think about leverage on a consolidated and a deconsolidated basis, so we have to be careful there.

But you know, just like Diamondback, there's no set target on the VNOM 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, and raise capital. And, you know, I think that's probably changing a little bit. 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.

[Brian Singer, Goldman Sachs]

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 somewhat you're talking about, either from a divestiture perspective or acquisition perspective on Diamondback-operated properties?

[Kaes Van't Hof, President]

Yeah. I mean, we're not focused on any acquisitions right now, but certainly divestitures are, you know, 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, you know, a lot of people like to bet on future development and with no development today, those assets kind of follow the front of what we could sell.

[Brian Singer, Goldman Sachs]

Thank you.

[Kaes Van't Hof, President]

Thanks, Brian.

[Operator]

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

[Operator]

Next question comes from Gail Nicholson with Stephens.

[Gail Nicholson, Stephens]

Good morning. On page five with 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?

[Kaes Van't Hof, President]

Yeah, Gail, I mean, it really depends on the Brent-WTI spread, you know, if Brent-WTI widens out a little bit more than it is right now, its pretty narrow, then you 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, you know, 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 picks up in the first half of 2021 and you get a pretty solid free cash flow yield based on today's strip [ph].

[Gail Nicholson, Stephens]

Okay, thank you.

[Kaes Van't Hof, President]

Thanks, Gail.

[Operator]

Next question comes from Leo Mariani with KeyBanc.

[Leo Mariani, KeyBanc]

Hey, guys. Just wanted to get maybe a little better quantification if possible on second half activity. Just wanted to get a sense, you guys mentioned a little bit more insight into the kind of non-op activity. Are you guys baking anything in on the non-op side into the second half, you know, ‘20 production guide and then roughly how many second half ‘20 net well tie-ins are you expecting?

[Kaes Van't Hof, President]

Yeah, I think on the non-op side, we're still going to be pretty conservative. You know, 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 and we're baking in a little bit of non-op, not growth, but a few more - a little over one net wells coming on the non-op side in Q4.

So really driven primarily, you know, almost 65%, 70% on activity on the Diamondback back side, because we have a lot of confidence in that. So, if the non-op tends to surprise to the upside, then that's gravy for Viper shareholders.

[Leo Mariani, KeyBanc]

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 VNOM supports more levers [ph] than certainly any traditional E&P company does. But, you know, 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 is there some kind of leverage level out there, whether it's kind of, you know, fair bit below that three times coming in, if it's 2.5 times or less, where you feel like there's a lot more flexibility on the Viper level, either to payout a much more meaningful level of cash flow and/or to kind of resume any M&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&A?

[Kaes Van't Hof, President]

Yeah, I mean I think the balance sheet is most important, holding us back from M&A. I mean, if we saw the best deal in the history of minerals, we'd have to think 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 18 months, with the board in detail every quarter and if we see the strip, you know, materially improving and we're not getting hit on hedge losses, you can see that our path to delevering is naturally going to happen then we're going to bump that distribution back up.

[Leo Mariani, KeyBanc]

Okay. Thanks, guys.

[Kaes Van't Hof, President]

Thanks, Leo.

[Operator]

Next question comes from Phil Stuart with Scotiabank.

[Phil Stuart, Scotiabank]

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

[Kaes Van't Hof, President]

That's probably fair Phil. The couple deals we've gotten done are in the Delaware's, not to say that there's not Midland opportunities, but I think, you know, 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.

[Phil Stuart, Scotiabank]

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 by under consideration as an asset to sale you know., to sell if the bid was there?

[Kaes Van't Hof, President]

I think any assets is for sale if the bids there, but there's really not - I don't think there's going to 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 you know, overall, I think the job of a capital allocator is to be able to buy and sell and you know, 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.

[Phil Stuart, Scotiabank]

Okay, guys. That's it for me. I appreciate the time.

[Kaes Van't Hof, President]

Thanks, Phil.

[Operator]

Next question comes from Welles Fitzpatrick with SunTrust [ph]

[Unidentified Analyst]

Hey. Good morning.

[Kaes Van't Hof, President]

Hey, Welles.

[Unidentified Analyst]

It seems like the 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?

[Kaes Van't Hof, President]

Yeah, you know, it's really probably two thirds Diamondback production exiting the year. I think we're somewhere a little below that today, you know, probably close to 55% today, and then we're probably going to move up another 5% or 10% to Diamondback production.

I think from an activity perspective, what we're modeling wells is essentially 75% Diamondback activity in Q3 and in somewhere around 55%, 60% in q4. So you're basically averaging 65%, 70% Diamondback activity in the back half of the year.

[Unidentified Analyst]

Okay, okay. That makes sense. And 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?

[Kaes Van't Hof, President]

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.

[Unidentified Analyst]

Perfect.

[Operator]

Okay. At this time, I'll turn the call over to Mr. Travis Stice.

[Travis Stice, CEO]

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

[Operator]

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