Black Stone Minerals LP

NYSE:BSM

Earnings Call Transcript 2018-Q4

[Operator]

Good day, ladies and gentlemen and welcome to the Fourth Quarter 2018 Black Stone Minerals LP Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Brent Collins, Vice President of Investor Relations. Sir, please begin.

[Brent Collins, Vice President, Investor Relations]

Thank you, Norma. Good morning to everyone and thank you for joining us either by phone or online for Black Stone Minerals’ fourth quarter and full year 2018 earnings conference call. Today’s call is being recorded and will be available on our website along with earnings release, which was issued yesterday afternoon.

Before we start, I would like to advise you that we will be making forward-looking statements during this call about our plans, expectations and assumptions regarding our future performance. These statements involve risks that may cause our actual results to differ materially from the results expressed or implied in our forward-looking statements. For a discussion of these risks, you should refer to the cautionary information about forward-looking statements in our press release from yesterday and the risk factors section in our 10-K, which will be filed later today. We may refer to certain non-GAAP financial measures that we believe are useful in evaluating our performance. Reconciliation of those measures to the most directly comparable GAAP measure and other information about these non-GAAP metrics are described in our earnings press release from yesterday, which can be found on our website at blackstoneminerals.com.

The company officials on the call this morning are Tom Carter, Chairman and CEO; Jeff Wood, President and CFO; Holbrook Dorn, Senior Vice President of Business Development; Brock Morris, Senior Vice President of Engineering and Geology; and Steve Putman, Senior Vice President and General Counsel.

I will now turn the call over to Tom.

[Tom Carter, Chairman and Chief Executive Officer]

Good morning and thank you for joining us today. Black Stone capped off a great year with a strong fourth quarter. We set a new quarterly record for minerals and royalty production as well as total production. Our core minerals and royalty business is performing quite well. Quarterly mineral production grew 9% in the fourth quarter compared to the third quarter of 2018. For the full year, mineral and royalty production grew 45% in 2018 over 2017, much of that came from incremental drilling activity on our existing acreage. Even excluding the contribution from the Noble assets, we purchased at the end of ‘17, which was largest in our history, our mineral and royalty production grew by impressive 31% from ‘17 to ‘18. The strong performance on our mineral and royalty business more than offset the planned decline in our working interest program. The last of our direct investments in the Shelby Trough through Haynesville program occurred in mid ‘18. We successfully farmed out the working interest participation in that program and will benefit from the ongoing development of our minerals without having to invest significant drilling capital.

You can see this in our production split between royalty and working interest volumes. Royalty volumes as a percent of total production increased from 65% in the fourth quarter of ‘17 to 72% in the fourth quarter of ‘18. The strong performance on our minerals and royalty program is further demonstrated by our reserve numbers. Even though we are no longer replacing our working interest reserves, our total proved reserves were up 3% to 69.9 MMBoe bolstered by a 9% growth in our royalty reserves over the previous year. We had approximately 1,500 new wells drilled on our properties last year, representing about a 50% increase over the prior year on both the gross and net basis. On a net interest basis, approximately 20% of that activity was in the Midland and Delaware Basins, with the Haynesville, Bakken/Three Forks and Eagle Ford each contributing around 13% of our net well adds. And it maybe surprising to some of those on the call to know that approximately 40% of our new well additions in 2018 came from outside of those 4 resource plays: Permian, Haynesville, Bakken and Eagle Ford Shale and that 40% is consistent with what we have seen since being a public company.

The strong growth in our production profile helped us to grow the distributions for both the common and subordinated unitholders meaningfully during 2018 and we were able to do this while maintaining a healthy amount of coverage. Despite a challenging commodity environment, in the fourth quarter, we were able to hold our distribution flat with the prior quarter while posting a coverage ratio of 1.3x. Last year was also a successful year from an acquisitions perspective. We completed $150 million of acquisitions in ‘18, almost all of which was outside the broad auction process. The acquisition activity was focused on bolt-on acquisitions around our Shelby Trough acreage and expanding our position in the course of the Midland and Delaware basins. We were able to finance the majority of these acquisitions through retained cash flow, which allowed us to continue to grow the business in an environment where external financing at a reasonable cost was challenging for most of the year. Permitting activity on our acreage remained strong. By our estimates as of December 31, approximately 9% of all horizontal well permits filed in the last year have been on acreage in which we have an interest and that includes 13% of all permits in the Midland and Delaware basins and 25% of the permits in the Haynesville.

As of the end of January, there were over 100 drilling rigs operating on our acreage, including 65 Midland and Delaware basins and 10 in the Haynesville. I would also mention that we saw the rig count on our Bakken and Eagle Ford acreage increasing significantly in January. We continue to see a lot of activity on our acreage even in this environment of greater capital spending restraint by the producer community. Looking ahead, prospects for Black Stone are robust. Our strong performance over the last several quarters have put us in a position where we expect to fully convert the subordinated units at a ratio of 1 to 1 in mid-May, which will simplify our capital structure. We have a great diverse set of minerals and royalty assets that is poised to continue growing organically and we are well-positioned to maintain or expand on our recent acquisition activity. We have got a management team that is as experienced as anyone in the industry and we are on solid financial footing entering a really interesting time for the mineral and royalty space.

With that, I will turn the call over to Jeff.

[Jeff Wood, President and Chief Financial Officer]

Okay, thank you and good morning, everyone. As Tom mentioned, the fourth quarter capped off a remarkable year for Black Stone. Before getting into some of the detailed financial results for the quarter and some of our comments around our outlook for ‘19, I just want to highlight a few of the accomplishments for 2018 that we have got perspective on that full year. Production for ‘18 averaged 46,300 Boe per day, which was above our revised guidance level of 44,500 Boe to 45,500 Boe per day. Compared to 2017 levels, total production increased in 2018 by 25%. That’s hard to achieve for a company of our scale and that was driven by both organic growth and a number of successful acquisitions.

We accomplished that even as working interest volumes declined by 5% over the year, as a result of our decision to stop investing in working interest opportunities. Filling that void was a 45% year-over-year increase in mineral and royalty production. Royalty volumes represented about 70% of total production in 2018 and that’s up from about 60% in 2017. We expect this trend of growing royalty volumes and shrinking working interest volumes to continue into 2019 and I will touch on that more in a few minutes.

Finally, on the production front, our product mix was weighted more toward oil in 2018 as a result of increasing volumes in the Permian and the Bakken. The big increase in production, combined with a more constructive commodity environment resulted in total oil and gas revenues in 2018 of $559 million. That’s a 55% increase over 2017 levels. Adjusted EBITDA rose by 35% to $419 million and our cash available for distribution also increased by 35% to $368 million.

Now, focusing in on the fourth quarter, the story was very much the same. Production increased almost 50,000 Boe per day, which is a new quarterly production record. As we have discussed before on these calls, having such a large and diverse mineral portfolio subjects us to a lot of pleasant surprises. We clearly have some of those in the fourth quarter. While we had meaningful contributions from new well additions, we also had some notable revenue suspense releases, representing multiple periods of production and revenue that benefited our 4Q ‘18 production by approximately 3,000 Boe per day. We don’t typically have visibility into these production upticks until we are paid by the operator. So it’s not something we are able to bake into our forecast or our guidance. We posted over $155 million in oil and gas revenues and $7.6 million of lease bonus for the quarter. Realized prices before the impact of hedges were up slightly on a Boe basis with a 22% increase in natural gas prices overcoming a 13% decrease in realized crude prices during the quarter.

LOE increased in the fourth quarter to $5.6 million or $4.41 per working interest barrel and that increase is due to higher work-over activity on wells in which we have a working interest. Our production taxes were in line with our historical 11% to 13% of oil and gas revenues. Total G&A for the fourth quarter fell to $16.3 million, both cash and non-cash G&A decreased over the third quarter, but most of the reduction coming from expense related to non-cash long-term incentive awards.

Overall, adjusted EBITDA for the fourth quarter was $110 million, which represents a 4% decrease from last quarter and a 38% increase from the fourth quarter of 2017. Distributable cash flow for the quarter was $97 million. Several weeks ago, we announced our distributions attributable to the fourth quarter of ‘18 of $0.37 per unit to common and subordinated holders, that’s flat to last quarter and it’s an 18% increase over 4Q 2017 common distribution per unit. Distribution coverage remained robust in the fourth quarter at 1.3x and that equates [Technical Difficulty] of our distributable cash flow. We have retained almost $100 million of our DCF during the full year of 2018, which as Tom mentioned helped to finance a large chunk of our acquisitions done in the year, without stressing the balance sheet or causing us to issue an excessive amount of equity. It’s worth mentioning that our current yield of around 8.2% is not really comparable to our peers, who payout 100% of their distributable cash flow. On an apples-to-apples basis, our equivalent yield is approximately 10.4%, which as we have said before, we believe to be very attractive given the stability and growth potential embedded in our asset base.

We published our 2019 guidance last night and that reflects our expectation that mineral and royalty production will continue to increase even before the benefit of acquisitions. At the midpoint of our guidance, we expect royalty production to be up 12% over 2018. At the same time, we expect working interest deduction to decline at a more rapid rate in 2019 as the last of our significant working interest capital was spent by mid last year. The result is an expected total production profile that is up just slightly from ‘18, but one in which royalty production with no associated capital or LOE represents a much more meaningful portion of the total. The rest of the guidance is very consistent with our 2018 metrics, with the exception of lower exploration expense and lower total G&A. I want to stress that our guidance does not include acquisitions despite the expectation that we will continue to execute on a number of attractive acquisition opportunities over the course of the year consistent with our prior activity.

Now turning to the balance sheet, our overall leverage levels and liquidity position remain in great shape. As of the end of the year, we had $410 million of debt outstanding and our debt to trailing 12-month EBITDAX is almost exactly one-time. We had over $250 million of liquidity available to us at year end based on our $675 million borrowing base. As of this past Friday, we have paid the revolver down to $381 million, with resulting liquidity in excess of $305 million. We remain opportunistic around our equity. Over the course of ‘18, we issued about $23 million in equity directly to sellers for acquisitions and just over $40 million under our ATM program. As part of that total, we sold about $2 million through the ATM in the beginning of the fourth quarter at an average price of $18.36 per unit. As we announced last quarter, our Board has approved a $75 million share repurchase program and we were active under that program in the final days of the year repurchasing about $2 million of stock at an average price of $15.61 per unit.

In summary, we think we are well positioned to continue to grow the company through operator activity in our existing acreage and through what we expect to be a robust acquisition environment. We expect our subordinated units to fully convert to common units in May of this year that will result in a simplified capital structure and has the potential to provide for greater liquidity. As always, we appreciate the support of the investors and the analyst community.

And with that, Norma, we will open the call up for questions.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Brent Koaches of Raymond James. Your line is open.

[Brent Koaches, Raymond James]

Hey, good morning. Thanks for taking my question. Just thinking from a high level, a lot of focus recently has been on E&P operators slowing down activity in kind of managing their capital outspend. Can you guys maybe just comment on how you’re looking at – I guess, the state of affairs in the E&P world and kind of what that means for your outlook?

[Jeff Wood, President and Chief Financial Officer]

Brent, this is Jeff. I’ll start with that and see if others have comments. In general, we haven’t seen a slowdown in activity at this point and I think what’s important there is just being in the right spot. A lot of that operator capital when it’s cut down is taken away from more fringe areas, and frankly, we’re really happy with our core positions in all four of our major basins. And so fortunately, we have not really seen an impact from that greater capital discipline from operators to-date. And again, I think that’s just where our acreage is really where you want to be in those top plays, so, we’ve managed to avoid any impact of that to-date.

[Brent Koaches, Raymond James]

Okay, and then just on a follow-up, I noticed that you guys are going to be doing some seismic shoots in the Shelby Trough area. Can you maybe just give us some detail on kind of the areas that you’re going to be looking at, maybe what the timing is on results?

[Brock Morris, Senior Vice President, Engineering and Geology]

Yes, this is Brock Morris. So, in our program with both of our operators there, they are considering some seismic in 2019 as they expand their development programs. And as we have a working interest in that area, we may be participating in some of that. Now that ultimately gets farmed out, but it shows up as being capital that we’ll spend this year. It’s a relatively small amount though.

[Jeff Wood, President and Chief Financial Officer]

I would add that in large programs like the Haynesville and others, it is an option when these seismic shoots are done, whether we participate in them or not. And we look at that as a long-term investment in the lands, because it gives us a better idea of what’s going to be going on from a technical standpoint, both in the existing play and other plays in the future and we just think – when you have big blocks of land like that having better knowledge of your properties is better than less knowledge.

[Brent Koaches, Raymond James]

Sure. Well that makes sense. That’s it for me. Thanks. Thanks for taking the question and congrats on a great year.

[Jeff Wood, President and Chief Financial Officer]

Thank you, Brent.

[Operator]

Thank you. [Operator Instructions] Our next question comes from Philip Stuart of Scotia Howard Weil. Your line is open.

[Philip Stuart, Scotia Howard Weil]

Good morning, guys. Congrats on another good quarter.

[Jeff Wood, President and Chief Financial Officer]

Thank you. Good morning.

[Philip Stuart, Scotia Howard Weil]

I’m wondering if – I was – I appreciate the comments on the E&P activity that you guys are seeing on your mineral and royalty acreage, just kind of curious how you see the mineral and royalty production trending throughout 2019, obviously, you’re expecting 12% growth, I guess at the midpoint point year-over-year, it looks like 4Q ‘18 volumes are kind of in line with the midpoint of full-year ‘19 guidance. So, just kind of curious if you’ll see that kind of holding steady throughout the year or if there are any noticeable kind of production trends that you’re seeing in the mineral and royalty production?

[Jeff Wood, President and Chief Financial Officer]

Yes, Phil, no, this is Jeff. I appreciate those comments. I mean, I think what we’re – maybe a few things just on guidance, especially relevant to 4Q. As I mentioned in my remarks, we had some operators that had held some production in suspense and that happens all the time for various reasons.

And so we had sort of an abnormally large suspense release in the fourth quarter that we just don’t have a lot of visibility to until we get paid by the operator and so that that bumped up 4Q production by about probably 3,000 BOE per day of our overall total. So, as you mentioned, we’re expecting royalty volumes overall to increase about 12% over the year. Somewhat, we’ve – it’s been a bit of a victim of our own success in the fact that our ‘19 guidance is relatively flat to ‘18. One, I think we’ve just seen a faster acceleration of royalty production growth than we had originally anticipated, which is all great news. And then, of course, look, we fully turned off that capital spigot on the working interest volumes. So, we’re fighting I think at the midpoint of our guidance something like a 25%, 26% decline in our overall working interest volumes, again, that’s by design. So, we feel pretty fortunate to that increase in royalty volumes, fully makes up for that planned decline in working interest volumes. But, overall, I would think that, that royalty growth through the course of the year is relatively consistent, and again, what it is, it’s just fighting a pretty big decline on the working interest side.

[Philip Stuart, Scotia Howard Weil]

I appreciate the color there, that makes a lot of sense. I mean, obviously, the ability to grow the mineral and royalty production certainly highlights the quality of the underlying acreage there. I guess, one more for me, as we think about distribution growth going forward, should we still think about the 1.1 times coverage ratio is kind of the governor on any future potential distribution growth analysis. I guess, kind of looking at running sensitivities on how distribution growth could increase or decrease kind of given different commodity price scenarios?

[Tom Carter, Chairman and Chief Executive Officer]

Yes, this is Tom. I’ll take a shot at that. And once again, putting that question in the context of distributable cash flow with a looking forward 12% projected guidance and growth in royalty volumes, but a significant decline in working interest and also a significant decline in the CapEx that is associated with that. We are in a little bit of a transition cycle here and we continue to see a baseline 3% to 5% growth rate in our thoughts on distributions over the coming years. With respect to coverage, there’s been quite a bit of discussion and comments in our space around variable versus fixed distributions and coverage et cetera, et cetera, ranging from fully variable with no coverage to kind of the other extreme, which might be us, which is relatively high coverage and a consistent distribution. I would tell you this that if – as our ability to distribute grows, we do not have a problem contracting coverage, okay, but we like to see it on a long runway. We are not yet of a mind that we want to be variable on a quarter-to-quarter basis, and that’s just – that is our preference. I’m not saying one is more right than the other, but that’s kind of where we see it. And also I think we would have a bias to a higher coverage ratio in the current environment, where the capital markets for E&P and energy companies are not what anybody wants them to be. And so maybe, we use a little bit more of our internally generated cash flow through higher coverage ratio to continue to be acquisitive. And – but that’s in the context of still having a yield on our share price in the 8% range, which is pretty robust. So, I hope that answers that question. I mean, we’re not in a hurry to go fully variable at all and we have a bias towards higher coverage than lower, but we also like growing our distribution over time.

[Philip Stuart, Scotia Howard Weil]

Yes, I know, I think that makes a ton of sense, especially, given the volatile commodity environment that we’re all dealing with. I appreciate the time guys. That’s all from me.

[Jeff Wood, President and Chief Financial Officer]

Thanks, Philip.

[Operator]

Thank you. [Operator Instructions] And at this time, I have no other callers in the queue for questions. I’d like to turn the call back over to Mr. Tom Carter for closing comments.

[Tom Carter, Chairman and Chief Executive Officer]

Well, we thank you all again for joining today and we’re excited about 2019. And we look forward to speaking with you again at the next quarter. Thank you.

[Operator]

Ladies and gentlemen, thank you for your participation in today’s conference. You may disconnect. Everyone have a wonderful day.