Viper Energy Partners LP

NASDAQ:VNOM

Earnings Call Analysis

Viper Eyes Growth Following GRP Buy and Conversion

Viper Energy is shifting to a Delaware corporation to unlock mineral asset value and enhance investor appeal with a slated increase in trading liquidity. The recent GRP acquisition, a benchmark deal due to its asset quality and potential, bolsters Viper's daily production to over 25,000 barrels of oil with around 32,000 net royalty acres in its portfolio. This positions Viper for steady growth, as underscored by an almost $100 million leased bonus for future development opportunities. The company's policy earmarks 75% of free cash flow to equity and 25% to the balance sheet, maintaining a balance of capital returns and financial vigour, aiming to be below one times leverage by end of 2024.

Viper Energy's Conversion to Delaware Corporation and Forward-Looking Statements

Viper Energy introduced their third quarter 2023 results with an announcement about converting into a Delaware corporation, which will take effect in November. This strategic move aims to enhance corporate governance and potentially unlock the full value of their mineral and royalty assets. The company also cautioned investors about forward-looking statements, reminding them that actual results might differ due to various factors.

Production Growth and Development Rights

The company has observed production growth of approximately 5% for two consecutive quarters and anticipates continuous annual growth. Their preliminary guidance suggests this upward trend will extend into the full year 2024. They highlighted the significance of modern lease terms which can result in the reversion of development rights back to Viper as a mineral owner if certain conditions are not met by operators.

Opportunistic Acquisitions and Asset Base Expansion

Viper Energy emphasized their ability to capitalize on mergers and acquisitions, drawing upon a recent lease agreement that benefitted Viper with lease bonuses and royalties across new zones. They plan to continue to expand their mineral ownership in the Midland Basin, exploiting deeper and shallower zones that would benefit the company in the long term.

Capital Allocation Strategy and Future Growth

Regarding capital return to shareholders, the company expressed a preference for distributing cash through fixed plus variable distributions rather than stock buybacks. However, they are open to repurchasing stock in unique situations when advantageous. Viper sees undeveloped units in the Midland Basin as the next focus area to drive growth in the coming decade.

Test Activities in the Barnett and Woodford

Industry activity in the Barnett and Woodford has attracted Viper's attention, and while they generally adopt a 'fast follower' approach, they anticipate some testing operated by Diamondback over the next one to two years. Full-scale development in these regions is not expected until around 2025 to 2026.

GRP Acquisition and Exploration of Market Opportunities

The GRP acquisition represents a strategic move without an immediate Diamondback angle, designed to capture high-quality acreage with undeveloped potential. Going forward, the company will continue to selectively pursue opportunities that can compete with the quality of their existing assets.

Conversion to Corporation and Potential Inclusion in Indices

Viper's conversion to a corporation is set to occur soon, with expectations to be eligible for inclusion in significant indices before year-end. Such inclusion would likely attract more buying due to the relatively low public float of the company, a path previously followed by Diamondback as it grew in exposure to large index funds.

Lease Bonus Payments and Future Expectations

The Spanish Trail is seen as a unique and generational asset, with its lease bonus payments not commonly recurring. Viper anticipates that many deep rights throughout the basin will be taken up in the next 12 to 24 months, albeit on a smaller scale compared to Spanish Trail's large lease payment.

Tax Implications Following Corporate Conversion

The conversion to a Delaware corporation is not expected to alter the tax positions for public unitholders becoming stockholders. The change will provide more liquidity without affecting the tax treatment, as Viper had been effectively operating with full corporate income taxes since the expiry of Diamondback's tax shielding in 2022.

Production and Cost Guidance for Upcoming Quarters

Viper indicated that reported production is set to increase from Q4 2023 to Q1 2024 due to the full contribution from the GRP assets. Despite a pro forma slight sequential decline in production, they expect a significant growth particularly in the second half of 2024, as they own an interest in about 60% of Diamondback's completions. The company also noted that they have managed to maintain cash G&A expenses steady, leading to lower costs on a per-unit basis as production increases.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, and thank you for standing by. Welcome to the Viper Energy Partners Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

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

[Adam Lawlis, executive]

Thank you, Antoine. Good morning, and welcome to Viper Energy Partners' Third Quarter 2023 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; Kaes Van'’t Hof, President; and Austen Gilfillian, General Manager.

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, executive]

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners' Third Quarter 2023 Conference Call. .

There were several important updates made yesterday with our earnings announcement, so I will start with our upcoming conversion into a Delaware corporation first.

The Board of Directors approved the conversion on November 2, and we expect that it will become effective on November 13. When completed, this conversion will deliver increased corporate governance rights to our limited partners and is intended to position Viper, such that the value of our mineral and royalty assets can be fully recognized.

Further on that point, we expect the conversion to result in an increase in Viper's trading liquidity and potential investor universe. Given Viper's current status as a partnership, we estimate that approximately 2% of our public float is held by index funds. This compares to a select group of our peers averaging around 30% ownership.

Fundamentally, we believe this conversion is the right thing to do for our unitholders and that it will provide numerous benefits, but the foundation of the decision is to fully highlight the advantage nature of mineral ownership and the unique value proposition that Viper presents within the space.

As a separate, recent event, Viper announced last week the closing of our GRP acquisition. This acquisition was a truly unique opportunity, and that it checked all the boxes we look for in an acquisition, immediate accretion to all relevant financial metrics, substantial undeveloped inventory to support long-term returns and significant scale that results in a pro forma business that is both bigger and better.

What differentiates this acquisition, however, is both the quantity and quality of the undeveloped inventory, particularly in the Northern Midland Basin. Following the closing of this acquisition, Viper now owns roughly 32,000 net royalty acres in the Permian Basin, and our production will be over 25,000 barrels of oil per day.

Looking ahead, we have an unparalleled growth runway of high-quality, undeveloped acreage. And as the largest player in the public minerals market, we expect to play a meaningful role in consolidating the highly fragmented space as high-value proposition opportunities like GRP present themselves.

Turning to the results of the business. The third quarter was another strong quarter for Viper, as production grew roughly 5% for the second consecutive quarter. While growth will not always be ratable from quarter-to-quarter, given we own varying interest in what is mostly large-scale development in the Permian Basin, we expect the trend of meaningful growth on an annual basis to continue, as evidenced by their preliminary full year 2024 production guidance that we provided.

Additionally, during the third quarter, Viper announced an almost $100 million leased bonds, which will allow for the future development of deeper zones on certain acreage in the Midland Basin. As mentioned in our rationale for converting into a corporation, there are many structural advantages to mineral ownership beyond just the cost-free royalties, and this significant lease bonus is just one specific example.

As owners and lessors of the subsurface property, modern lease terms can dictate development requirements of operators. And when those terms are not met, leases can expire and have the full development rights revert back to us as the mineral owner. As deeper zones are tested throughout the basin, we believe this is an advantage that will only be further highlighted in the years to come.

As a final point, Viper remains committed to a sustainable and growing return of capital through cash distributions over the long term. We have the balance sheet strength, durable cash flow profile and undeveloped inventory base to support many years of significant return of capital through the cycle.

Activity on our asset base continues to be strong, and we believe we are positioned to execute on opportunistic M&A to further complement what is already a unique value proposition, both in terms of return on and return of capital.

Operator, please open the line for questions.

[Operator]

[Operator Instructions] Our first question comes from Neal Dingmann from Truist Securities.

[Neal Dingmann, analyst]

My first question, guys, is just on the lease bonus. Is that the impressive one you all recently received? I'm just wondering, could you speak to if all that bonus was tied likely to the deeper zones? And wondering, do you all believe you have -- many of your other assets have potential for similar type bonuses maybe in those type of areas?

[Kaes Van't Hof, executive]

Yes, Neal, good question. I'll answer part of it and give it to Austen to talk about the rest of the asset base.

I think, high level, we kind of added a slide in the deck to kind of show that even in an area like Spanish Trail, highly developed on the traditional [ Wolfberry ] play that we all know, but now moving back in and developing Barnett, Woodford and some of the Wolfcamp D across the position, the mineral honor gets the benefit there, right? They get a lease bonus and they get a royalty on all of the new zones.

So I think we're going to be slow to test it. I think it was a convenient time to get that lease done between Diamondback and Viper as it provided a lot of cash to Viper to help close the GRP deal. But I think just generally, we're trying to highlight that we own a lot of minerals in the Midland Basin, and there's a lot left to do in terms of other zones, deeper zones, shallower zones. And all of that benefits the mineral owner, whether you can model it today or not.

And Austen, do you want to talk about the asset base?

[Austen Gilfillian, executive]

Yes. No, the monitoring and enforcing these type of returns is a really important part of what we do now, especially kind of where we are in the industry and in these modern leases and some of the terms that they could have. So this specific lease with Spanish Trail represented about 10% of our total net acres.

When we kind of go through and look at the lease -- specific lease provisions that are included across the acreage that we own, we estimate about 50% of our acreage had a similar lease language, that where if the deeper rights haven't been developed that, that acreage would kind of fall out and will become available. So I don't think that's a story for tomorrow, but certainly, as things play out over time and the zone becomes more developed and it kind of expands across the basin, I think it's something that you'll see more about going forward.

[Neal Dingmann, analyst]

Yes, I like that upside. And then just a quick second one on cap allocation. I'm just wondering, given the current leverage post the deal and obviously, the great production guide for next year, I'm just wondering, any thoughts on -- if capital allocation would change? Or will that payout type continue?

[Kaes Van't Hof, executive]

No. It's a good question, too. I mean I think our payout philosophy is the same. 75% of free cash flow goes to equity, 25% goes to the balance sheet. We know we put a good amount of cash in this GRP deal, but we have the balance sheet capacity to do it. We also have kind of a small balance on our revolver after closing the deal. So that will be easy debt paydown.

And kind of strip prices, we're still going to be likely below 1x leverage at the end of 2024, even if we do pay out 75% to equity. I think Viper is kind of gone back and forth on how we're returning capital to shareholders. I think we'd probably prefer to distribute more cash via the fixed plus variable distribution than buybacks, but there might be opportunities to buy back stock in unique situations over the coming year. But I think our preference on that 75% that gets returned shareholders or unitholders is through the base plus variable dividend.

[Operator]

Our next question comes from Derrick Whitfield from Stifel.

[Derrick Whitfield, analyst]

With respect to the recent GRP acquisition, this was one of the first we've seen you pursue where there wasn't a Diamondback angle or immediate Diamondback angle. Thinking about your prepared remarks and consolidation opportunities you're seeing, could you speak to what you're seeing in deal flow and the bid-ask spreads for minerals, which could lead to incremental opportunities?

[Kaes Van't Hof, executive]

Yes, I'll talk about the GRP deal and Austen can talk about the market right now. I mean this deal was kind of the one we've been waiting for. This team built this asset base over 8 or 10 years. And I think it can be best summed up very unique in that it'd be impossible to build that position today, and so we needed to buy that position.

And the reason why we like it is it's a lot of -- the Midland Basin is the core asset. There's a lot of undeveloped units in the Midland Basin, and it's all in acreage that we would cover. So while there isn't a huge Diamondback-operated component to it, we put our operator hat on and said, "Would we like to own exposure to the core of the basin under competent operators like Pioneer, Endeavor, now Exxon, et cetera?" And that is second to none and in our mind, can't be built through the ground game. And so we used our size and scale to be able to put a good amount of cash in the deal and get it across the finish line.

[Austen Gilfillian, executive]

Yes, Derrick, there's been quite a few deals that have come to market and have transacted this year. We've really been pretty selective in the last couple of years, with the primary focus on Diamondback operated like you mentioned, or secondarily, as Kaes kind of highlighted, if it doesn't have the high Diamondback-operated percentage, then it's just really high-quality acres with clear undeveloped inventory where we can have that confidence in what the long-term development is going to look like. .

I think going forward, it's going to be a similar viewpoint for us, and we see an opportunity for quite a few more deals to come to market. But for us, it's always a pretty high hurdle given the quality of acres that we have today, the development that we see going forward, and it kind of has to compete for that, right? Just being accretive day 1, not enough for us. We kind of have to have confidence in that development outlook over year 2, year 3, year 4, et cetera. And that's always the hardest hurdle to clear.

[Kaes Van't Hof, executive]

And one last comment on the Diamondback-operated piece. It certainly has been beneficial to have that Diamondback-Viper relationship for a significant amount of our production. As the business has gotten bigger, and we chased the same decline rates that the E&Ps do, it's been -- it's harder to find sizable packages under Diamondback that will move the needle for the next 5, 6, 7 years.

So I think, generally, we have a great position operated by Diamondback, but the next leg of the stool is going to be undeveloped units, particularly in the Midland Basin, like what we found with GRP that drive growth into the next decade.

[Derrick Whitfield, analyst]

Perhaps actually picking up with where you ended there, Kaes, because I think the opportunity that you guys have the deep rights under Spanish Trail could be quite remarkable. But I would love to -- if you guys could share what the opportunity you see with the Woodford and Barnett and those at present? And how soon you could see meaningful activity and that would clearly benefit Viper given the elevated NRIs you have in that area?

[Kaes Van't Hof, executive]

Yes. There's certainly a lot of industry activity in the Barnett and Woodford. And traditionally, our mentality has been to be a fast follower. But I think there will be some tests, particularly operated by Diamondback, in the next 12 to 24 months. .

I don't think it will move to full-scale development until kind of 2025, 2026, but all indications are pointing to those zones being very productive covering a lot of the basin. And it works at a price, right? It's going to be a little more expensive to the operator. Wearing my Viper hat, we don't really care as long as there's a lot of resource. And I think all indications are pointing towards significant resource in those deeper zones.

[Operator]

Our next question comes from Paul Diamond from Citi.

[Paul Diamond, analyst]

Just a quick one on the Delaware corp conversion. You talked about currently 2% of the public float is held by index funds versus about 30% by peers. Just wanted to get a little bit deeper on that to see how you guys are envisioning any trend towards that higher rate post conversion?

[Kaes Van't Hof, executive]

Yes, great question. We've done a little bit of work on it. The deals -- the conversion is supposed to close next Monday, and then we'll be a corporation. There's some details in there for shareholders, so they know what's going on. But from what we can tell, there's a couple of indices that we could be eligible for even before the end of the year. And those are pretty significant indices.

I think Vanguard-related indices as well as then eventually some of the S&P-related indices. And as the market knows, that's a lot of buying for a company that has a lower public float. And so we're going to start working with them right away after getting this thing closed and getting as many indices as possible and kind of follow the path of hopefully, what Diamondback followed years ago as that business grew and got more exposure to large index funds. And do you want to add anything there, Austen?

[Austen Gilfillian, executive]

Yes, Paul, the main pretty benchmarks are kind of your S&P Chris and Russell, S&P and Chris quarterly rebalanced this. So they'll both [ decline ] middle of December. So the conversion will be done by then. So we'll be in communicating with them and see if that's something that can happen this year. And then Russell does the rebalance annually in June.

And then additionally, you'll have something that's more criteria-based or subjective, like the S&P 600, where we'll have to have some communication with them. But all signs point to being eligible right away and hopefully getting included pretty soon. But certainly, we meet the criteria now as being a corporation as opposed to being a partnership.

[Kaes Van't Hof, executive]

Yes. And the strategy there is also exposure, right? There's a lot of other investors that, I think, are limited in their exposure to minerals. And we've already had some success converting some shareholders -- potential shareholders on the road to look at the story.

I mean, I envision and Travis envision a world where this mineral space and this business is competing with the likes of some of the mid and -- the SMID and mid caps on the E&P side. And this business certainly shows a safer way to play the Permian Basin or oil exposure with no capital requirements and just upside.

[Paul Diamond, analyst]

Understood. I appreciate the clarity there. Just one more quick follow-up, just more on the lease bonus payments. How are you guys envisioning that going forward? Is it more tend to be chunkier? Or do you see it as just a consistent growth over time?

[Kaes Van't Hof, executive]

Well, Spanish Trail's unique, right? I mean this was a unique asset -- a generational asset that doesn't come around very often. So this was certainly the big one. I think it's logical that a lot of the deep rights throughout the basin are going to get leased up over the coming 12 to 24 months. But for us, they'll all be smaller than this large payment, which was a pretty significant amount of acreage.

[Operator]

Our next question comes from Leo Mariani from ROTH MKM.

[Leo Mariani, analyst]

I wanted to ask whether or not you see any kind of material change in the tax rates for Venom following this kind of corporate conversion? I did see you had this kind of soft sort of not really guidance, but just kind of the numbers that you kind of rolled out for 2024 outside of production where you talk about kind of an effective tax rate. But I know you've got kind of multiple classes of units historically. I know you're going to have maybe more than one class of shares. But just trying to get a sense, are we going to see any material difference in kind of cash taxes in '24 versus '23?

[Kaes Van't Hof, executive]

No, nothing should change at all for the public unitholders that will become public stockholders. So tax position didn't change. And I think they'll just provide them more flow and more liquidity.

[Austen Gilfillian, executive]

That's why the conversion made so much sense is that we became a tactical partnership back in 2018. And there, for a couple of years, Diamondback is effectively shielding us from corporate taxes, and that agreement ran out end of last year. So here in 2023, we have a partnership with paying full corporate income taxes and getting all the downside effectively being a corporation, but you don't have any of the upsides. So it just made a lot of sense to do that today given in large part, the kind of tax situation that we're in.

[Leo Mariani, analyst]

Okay. That's helpful. And then just wanted to kind of ask on a couple of other sort of numbers here. So I think you guys are kind of expecting production to come down a little bit in the first quarter. I'm assuming that's all just kind of timing-related, but just wanted to maybe get a little color around that.

And then also just noticing that your cash G&A per barrel guidance also came down nicely as well. Is it at a function of spending kind of less than you expected there? Or maybe just perhaps production results have been better? And with the acquisition, you're seeing the BOEs go up and you're just able to spread the cost out over more barrels?

[Austen Gilfillian, executive]

On the production side, first, reported production will actually go up from Q4 to Q1. Q4, you're going to have 2/3 of contribution from the GRP assets. So we have the midpoint there of 24.5. And then going into the first quarter, actual reported production will go up, given you have a full quarter of those assets contributions.

But we're trying to be intellectually honest there, look at it on a pro forma basis. And that's kind of what we're pointing to there, with a slight sequential decline. And really, in context, that follows back-to-back quarters the 5% growth that we've had here, and it's mainly a result of just kind of the timing of some of these really large Diamondback pads, where we have really high interest.

And we put in Slide 9 of the deck, where we kind of show the visibility to the Diamondback schedule. The way that we kind of see 2024 right now with the Diamondback side is having -- owning an interest in about 60% of Diamondback's completions next year with about a 6.5% interest within those wells, but that will be split roughly 40-60 between first half of the year and the second half of the year.

So still significant growth coming, especially on the Diamondback operative side. Is it mostly significant second half weighted given some of the bigger pads? And then on the cost items, I mean, those are all very minimal. We've kind of been spending $6 million, $7 million, maybe $8 million a year in cash G&A. As production goes up, we grow the business, we're not really having to add any people. So on a per unit basis, but those should continue to trend down even further over time.

[Operator]

Thank you. At this time, the Q&A session has now ended. I will now turn the call over to Travis Stice for closing remarks.

[Travis Stice, executive]

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

[Operator]

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