Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Transcript 2021-Q3

[Operator]

Good day and thank you for standing by and welcome to the Viper Energy Partners Third Quarter 2021 Earnings. [Operator Instructions] I would now like to hand the conference over to your speaker today, Adam Lawlis, Vice President of Investor Relations. Please go ahead.

[Adam Lawlis, Vice President, Investor Relations]

Thank you. Good morning and welcome to Viper Energy Partners’ third quarter 2021 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 related 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. Reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon.

I will 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’ third quarter 2021 conference call. During the third quarter, Viper saw third-party operated net wells turned to production on our acreage bound to their highest level since the first quarter of 2020. As a result of our continued strong production and further enhanced by our high margin exposure to increase in commodity prices, Viper’s cash available for distribution increased 50% quarter-over-quarter to $0.54 per common unit. With this strong cash flow, Viper will pay a $0.38 per unit distribution on top of the $14 million we deployed through our unit repurchase program last quarter. In total, the combined return of capital between the distribution and buyback represents $0.47 per unit, or an 8% yield based off yesterday’s closing stock price.

Following the recent closing of the Swallowtail acquisition, Viper has unprecedented high confidence visibility into Diamondback’s forward development plan that is expected to bolster oil production for Viper, not only for the next several quarters, but also for years to come. More specifically, Diamondback plans to complete over 400 wells on the acquired Swallowtail acreage over the next 5 years for an amount that represents over 17 net wells for Viper over this period.

Looking at near-term production, Viper initiated average production guidance for Q4 of 2021 and in Q1 of 2022 that implies over 17,000 barrels per day of production at the midpoint. Additionally, we increased our full year 2021 oil production guide by over 2% at the midpoint. Based on the average Q4 2021 and Q1 2022 production guidance, assuming production is held flat at the stated midpoint of the range, Viper is expected to generate roughly $375 million of annualized free cash flow in the fourth quarter of 2021, assuming $75 WTI. Importantly, given these same assumptions, we are expected to generate over $475 million of annualized free cash flow in the first quarter of 2022 as our defensive hedges placed in 2020 roll off. This 2022 free cash flow amount equates to greater than 11% free cash flow yield as a percentage of our enterprise value or almost 13% based on our current market cap.

In conclusion, the third quarter of 2021 was another strong quarter for Viper that once again highlighted our high-quality asset base, best-in-class cost structure, and overall differentiated business model. As our balance sheet has continued to strengthen, we have evolved our hedging strategy so that we can maximize upside exposure to commodity prices, while also protecting against extreme downside. With our strong inventory of work-in-progress and line-of-sight wells, we look forward to continuing to generate robust amounts of free cash flow and subsequently using that cash to both reduce debt and increase returns to our unitholders.

Operator, please open the line for questions.

[Operator]

Thank you. [Operator Instructions] We have our first question coming from the line of Neal Dingmann with Truist Securities. Your line is open.

[Neal Dingmann, Truist Securities]

Hey, good morning guys. Travis, my first one is just on sort of private activity, I mean, obviously, the bulk, I know you have been in this related to Diamondback and some other public. There has obviously been a notable sort of increase from some of the privates out there. I am wondering how that might shape the profile of Viper if at all?

[Travis Stice, Chief Executive Officer]

Certainly, the privates have really leaned into this commodity price and their activity levels continue to increase month over month and we have – we try to conservatively take that into account as we forecast future volumes, but volume growth will, in those small part, be influenced by the – by private operators.

[Neal Dingmann, Truist Securities]

Got it. And then for you, Kaes, just it’s a nice payout to $0.38. I think you talked about being about 70% of cash from distribution being up, I think almost 15% or more. I am just wondering, is that kind of a good ballpark where you would like that to continue to float or when you think about that payout, what is – what should we think about on a go forward?

[Kaes Van’t Hof, President]

I think we like 70% is kind of the minimum yield for cash distributions. I think generally, we have the size and scale to take on a little bit of debt, but we want to pay that debt down with free cash flow and we took on some debt with the Swallowtail acquisition and want to pay that down over the next couple of quarters before we start ratcheting up the 70%. I think we have also talked about more prudent hedging policy where we bought puts to protect the extreme downside, which is kind of 2x leverage at the max and therefore still able to distribute a lot of cash and not have the balance sheet flow out. So 70% is kind of the baseline for now, supplemented with the share repurchase program in times of weakness and the rest of the cash going towards deals are paying down debt.

[Neal Dingmann, Truist Securities]

Sure. That makes a lot of sense. Thanks. Thanks, guys.

[Kaes Van’t Hof, President]

Thanks, Neal.

[Operator]

We have our next question coming from the line of Chris Baker with Credit Suisse. Your line is open.

[Chris Baker, Credit Suisse]

Hey, good morning guys.

[Travis Stice, Chief Executive Officer]

Good morning, Chris.

[Chris Baker, Credit Suisse]

Good morning. Just on – just with the improvement in commodity prices and the cash flow outlook, could you just talk a bit about how you are thinking about the fixed debt balance, which I believe becomes callable late next year? And just at this point, how you are thinking about the appropriate level of leverage for the business longer term?

[Kaes Van’t Hof, President]

Yes. I think 2x is the max, Chris, and we have tried to protect that with hedges and we’ll continue to do so. The debt that we have or the bond that we have outstanding is callable in about a year from now and we did take on a revolver balance with the Swallowtail acquisition. I’d like to, in an ideal world, work that revolver balance down a bit over the next three or four quarters and then be able to refinance all that debt at a lower interest rate. The businesses, has proven that. The bonds have traded well. So we will see where we stand in the year, but right now, it makes sense to refinance that cheaper if we could.

[Chris Baker, Credit Suisse]

Okay, great. And then just as a follow-up, with the release talking about the unprecedented visibility following the Swallowtail acquisition, could you just maybe talk about how that influences your M&A outlook, I guess, if at all, going forward? Thanks.

[Kaes Van’t Hof, President]

Yes. I mean I wouldn’t say they are too related. It is pretty unprecedented how much visibility we have given Diamondback’s intentions to keep production flat. It kind of means the plan is the plan. And so the projects that are on schedule in ‘22 and ‘23 and beyond are more than likely to happen. Unless we have an experience like we did in 2020, which gives you just a lot of confidence in the earnings forecast for the business probably since we first started in Spanish Trail back 5 or 6 years ago, 7 years ago. So it won’t impact M&A strategy. I’d say M&A strategy is still fairly consistent, high visibility, Diamondback-operated properties, and we’re still on the lookout for those. It’s just that Swallowtail is an opportunity to get a lot of Diamondback-operated properties at one-time.

[Operator]

Thank you. We have our next question coming from the line of Jeanine Wai with Barclays. Your line is open.

[Jeanine Wai, Barclays]

Hi, good morning, everyone. Thanks for taking our questions.

[Travis Stice, Chief Executive Officer]

Hi, Jeanine.

[Jeanine Wai, Barclays]

Good morning. Maybe just following up a little bit on Neal and Chris’s question, I know you just said your M&A strategy doesn’t change. Can you just share your view maybe on the most current acquisition landscape? How you view that? And in particular, if there is any difference in the bid-ask spreads between smaller versus larger deals?

[Kaes Van’t Hof, President]

The smaller deals are still very, very competitive in the Permian, almost a nice size to get the smaller deals. I’d say we have probably a little bit of an advantage on Diamondback on permitted properties, but the permitted small deals are still very competitive throughout the basin. What was unique is that Swallowtail, outside of probably the drop-down that we did from Diamondback, is probably the largest mineral deal I’ve seen in a long time. And that just highlights the size and scale we have that we can put that much cash into a deal and that Blackstone was willing to own a good amount of stock in Viper.

[Jeanine Wai, Barclays]

Okay, great. Thank you. That’s very helpful. Maybe on a slight housekeeping item on cash taxes, I think there is about $360 million remaining on the tax agreement that you’ve got with FANG. And given where that agreement was struck and oil prices being a lot higher now, can you just talk about how we should think about the cash tax components for 2022, which might get accelerated and then the trajectory for maybe ‘23?

[Kaes Van’t Hof, President]

Yes. It’s a good thing that commodity prices have gone where they have gone at the time. In 2020, we extended the tax sharing agreement over a period of multiple years, anticipating lower for longer oil prices. I think there is probably a conversation to have with the Viper Board and the Diamondback Board about moving that sharing agreement up into 2022. Just from a PV perspective, probably the best way to utilize our tax base, but certainly getting closer to cash taxes. If we can’t get that adjusted in 2022, we will pay some cash taxes and more so on ‘23 if the – if commodities stay where they are.

[Jeanine Wai, Barclays]

Great. Thank you.

[Kaes Van’t Hof, President]

Thanks, Jeanine.

[Operator]

We have our next question coming from the line of Derrick Whitfield with Stifel. Your line is open.

[Derrick Whitfield, Stifel]

Good morning, all.

[Travis Stice, Chief Executive Officer]

Hi, Derrick.

[Derrick Whitfield, Stifel]

With regard to your 6-month trajectory, the guidance implies relatively flat bill volumes for Q4 and Q1. As we think about 2022 based on your prepared comments and near-term inventory, how should we think about the growth trajectory throughout the year?

[Kaes Van’t Hof, President]

Yes, Derrick, I think, generally, we’ve been pleasantly surprised with the non-op volumes we acquired from Swallowtail 1 month into closing the deal, so that’s been very positive. I think as we talked about when the deal was announced, those non-op volumes are going to hold us over until Diamondback, Sale and Robertson ranches development kicks off and then you’ll start to see a significant amount of growth on Diamondback-operated properties. So I think the guide that we have out there for Q4 and Q1 ‘22 is a good baseline. And then as that development starts to kick in at the end of ‘22 and into ‘23, start to see a little bit of growth on the operating side.

[Derrick Whitfield, Stifel]

Terrific. And as my follow-up, would it be reasonable to assume the ‘18 to ‘19 net near-term inventory level referenced on Page 10 is a good run rate at current prices based on Diamondback’s 2022 outlook and third-party activity levels?

[Kaes Van’t Hof, President]

I think so. I mean, I think we’re still going to be fairly conservative modeling the non-op, but that’s kind of a 20% increase in visibility from where we were a quarter ago. And I think that’s pretty reasonable. I think the benefit, as we look into the end of ‘22 and ‘23, like I just said before is the larger high-interest pads on the Diamondback side, but good to see the non-op visibility go up 30%, 35% in the quarter.

[Derrick Whitfield, Stifel]

Great update. Thanks again for your time.

[Travis Stice, Chief Executive Officer]

Thank you, Derrick.

[Operator]

Thank you. We have our next question coming from the line of Leo Mariani with KeyBanc. Your line is open.

[Leo Mariani, KeyBanc]

Hey, guys. Just wanted to ask about, I know it’s a difficult question to answer, but you made some comments that you’ve got some high confidence here in oil growth over the longer term. I guess when you look at the composition of the Viper properties, and I certainly understand there is an increasing emphasis on saying operated production. But clearly, the operating outlook from a FANG perspective is flat oil. Can you kind of help us at all in terms of what it can look like over the next couple of years for Viper? Are we talking kind of mid-single digits because of the ability of FANG to kind of focus more on the properties that kind of Viper owns here? Just anything you can kind of help out with from a longer term perspective.

[Kaes Van’t Hof, President]

I think we wouldn’t be doing our jobs as a combined management team if we weren’t looking at combined returns of properties with Viper interest, combined with Diamondback interest. So Diamondback is staying flat. It’s the best capital efficient use of Diamondback dollars is to stay flat with wells that are drilled on Viper properties. And we gave a pretty big number out there for the Swallowtail deal saying that we’re going to get to 5,000 barrels a day in 5 years. Just for reference, right now, we’re doing 9,000 to 10,000 barrels a day on Diamondback properties. And so even if there is some natural decline on that, the Diamondback growth itself on Sale and Robinson ranches is going to outweigh the declines or even anything we see on the non-op side. So it’s safe to say there is likely growth at Viper even if Diamondback stays flat. I don’t want to commit to multiyear guidance here, but that’s our intention is to focus on the highest interest and highest consolidated return to our shareholders.

[Leo Mariani, KeyBanc]

Okay. That’s helpful and obviously, a very nice increase in the distribution this quarter. So it certainly sounds like there is more to come as hedges roll off as we get into next year. But I also wanted to ask on the buyback side, certainly noticed that kind of was a little bit more of a buyback here in the third quarter. And I also talked about paying off some debt that you brought on, on the Swallowtail deals. So how do you think about kind of buybacks versus debt reduction here as we head into ‘22?

[Kaes Van’t Hof, President]

Yes, good question. The buyback we have goes through the end of this year, and then we have – we need to talk to our board about what to do next on that. But really, the focus is probably debt reduction in the near-term over the buyback just because we did – we closed that Swallowtail deal and the cash has left the system. We don’t like having a big balance on our revolver. I think paying that balance down a little bit before refinancing our – all of our debt, hopefully, in a year is probably the best use of capital without – we’re still having a buyback there in times of weakness.

[Leo Mariani, KeyBanc]

Okay, thanks guys.

[Travis Stice, Chief Executive Officer]

Thank you, Leo.

[Operator]

Thank you. There are no further questions at this time. I will now turn the call back over to Travis Stice for any closing remarks.

[Travis Stice, Chief Executive Officer]

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

[Operator]

This concludes today’s conference call. Thank you for participating. You may now disconnect.