Sitio Royalties Corp

NYSE:STR

Earnings Call Analysis

Sitio Royalties Q3 2023: Steady Operational Growth

Sitio Royalties demonstrated resilience in Q3 2023, with production largely unaffected by industry slowdowns, reporting daily oil output of 17,576 barrels and 36,900 BOEs. Financially, adjusted EBITDA rose 12% to $142.4 million, and discretionary cash flow surged nearly 24% to $117.3 million, benefiting from new acquisitions and a tax credit from a merger. Dividends continued at $0.49 per share, a 65% payout ratio. Strategically, a definitive agreement was made to divest Appalachian and Anadarko basin assets for $117.5 million, refining the asset portfolio. Financing activities strengthened the balance sheet, with a borrowing base increase to $850 million and the issuance of $600 million in notes, contributing to lowered interest expenses and bolstered liquidity. Looking ahead, the company expects moderate growth reflecting broader industry trends.

Resilient Operational Performance Amid Industry Slowdown

Sitio faced a broader industry slowdown with horizontal rig counts declining by 7% and 11% across the Permian Basin and the United States, respectively. Despite this, the company's daily oil production remained consistent with their guidance at 18,219 barrels per day which is 50% of total volumes. They managed to turn in line 9.5 net wells, predominantly in the Permian and DJ Basins, a shift from the previous quarter where focus was almost exclusively on the Permian. Line-of-sight wells, crucial for future drilling, remained relatively flat compared to the prior quarter, indicating the company's replenishment capacity.

Financial Growth and Stability with Commitment to Shareholders

Sitio's adjusted EBITDA rose by 12% to $142.4 million compared to the previous quarter, fueled by the output of 5 acquired assets and higher commodity prices. Discretionary cash flow followed suit with an almost 24% increase to $117.3 million. Sitio continued its shareholder-friendly approach with a $0.49 per share dividend, maintaining a 65% payout ratio for the sixth consecutive quarter, leading to a significant return on their public market trajectory since June 2022.

Strategic Refinancing and Divestiture for Streamlined Efficiency

The firm bolstered its financial flexibility by extending its borrowing base and issuing $600 million in notes, reducing annual interest by $11 million. They aim to reach a leverage ratio of less than 1x EBITDA while actively pursuing accretive acquisitions. In line with simplification, Sitio sold off its less-profitable Appalachia and Anadarko assets, which only marginally contributed to its operations, for $117.5 million.

Laying the Foundation for Future Growth

With a well-diversified asset base, Sitio is less susceptible to localized industry disruptions and poised for steady growth. The company's high volume of line-of-sight wells signals the potential for production expansion in line with single-digit growth trends in the broader Permian Basin.

Technological Advances Paving the Way for Scale

Sitio made significant investments in automation and data management that enable efficiency and scalability, moving from more manual processes to sophisticated analytics for better revenue tracking and operations management. This technology-driven model can support a larger asset base without the corresponding increase in general and administrative expenses.

Navigating Industry Consolidation with Equanimity

Company remarks indicate a mixed impact from industry consolidation, with some mergers such as Oxy and Anadarko negative for mineral owners due to decreased activity. However, recent consolidations, like that of Exxon and Pioneer, had a more neutral to positive outlook, with expectations of maintained or even improved activity levels, benefitting Sitio's interests.

Earnings Call Transcript 2023-Q3

[Operator]

Hello, and welcome to the Sitio Royalties Third Quarter 2023 Earnings Call. My name is Alex. I'll be coordinating the call today. [Operator Instructions] I now hand over to your host, Ross Wong, Vice President of Finance and Investor Relations. Please go ahead.

[Ross Wong, executive]

Thanks, operator, and good morning, everyone. Welcome to the Sitio Royalties Third Quarter 2023 Earnings Call. If you don't already have a copy of our recent press release and updated investor presentation, please visit our website at www.sitio.com, where you'll find them in our Investor Relations section. With me today to discuss third quarter 2023 financial and operating results is Chris Conoscenti, our Chief Executive Officer; Carrie Osicka, our Chief Financial Officer; and other members of our executive team.

Before we start, I'd like to remind you that our discussion today may contain forward-looking statements and non-GAAP measures. Please refer to our earnings press release, investor presentation and publicly filed documents for additional information regarding such forward-looking statements and non-GAAP measures. And with that, I will turn the call over to Chris.

[Christopher Conoscenti, executive]

Thanks, Ross. Good morning, and thank you for joining Sitio's Third Quarter 2023 Earnings Call. We have a very productive third quarter across multiple aspects of our business. Operationally, our assets have continued to perform well despite the slowdown of drilling and completion activity across the Permian Basin and broader United States where quarter-over-quarter horizontal rig count was down by 7% and 11%, respectively.

For the third quarter, we reported average daily oil production of 17,576 barrels per day and average daily total production of 36,900 BOEs per day. When excluding prior period adjustments, our oil production in period was 18,219 barrels per day or 50% of total volumes, which is in line with both the midpoint of our guidance for implied oil barrels and percent oil. We estimate that during the third quarter, there were 9.5 net wells turned in line on our assets with 72% and 19% of the overall activity in the Permian and DJ Basins, respectively. This was a shift from second quarter activity where 87% of our turned in line wells were in the Permian Basin, and there was minimal activity on our DJ Basin assets.

As of September 30, we had 50.9 net line-of-sight wells and despite healthy development activity across our acreage during the quarter, our net line-of-sight wells remained essentially flat relative to June 30, implying full replenishment of our line-of-sight inventory. The Permian Basin continues to account for approximately 80% of our total line-of-sight wells and is where we expect the majority of our operator activity to occur in the next 12 to 16 months.

Turning to financial results. We generated $142.4 million of adjusted EBITDA in the third quarter which was up by 12% relative to the second quarter primarily due to additional volumes from the 5 previously announced acquisitions and higher realized unhedged commodity prices. We reported third quarter discretionary cash flow of $117.3 million, which is up by nearly 24% relative to the second quarter. This was driven by the increase in adjusted EBITDA I just commented on and a decrease in cash taxes, which were $7.8 million lower than the second quarter because of a corporate tax credit related to the Brigham merger.

Our Board declared a third quarter cash dividend of $0.49 per share of Class A common stock based on a 65% payout ratio. The dividend is payable on November 30th to stockholders of record at the close of business on November 21st. This is now the sixth consecutive quarter that we've declared a dividend to shareholders using a 65% payout ratio and in aggregate, we have declared total dividends per share of $3.42 since we became public in June of 2022, which represents approximately 14% of our 30-day volume-weighted average stock price.

Going forward, we plan to use accrued interest expense instead of cash interest expense paid during each quarter in our calculation of discretionary cash flow, which will help smooth out discretionary cash flow because the interest expense on our new notes is paid semiannually. On the strategic front, our 4 previously announced cash acquisitions closed in July and August. I'm also pleased to announce that we have signed a definitive agreement to sell our entire Appalachia and Anadarko Basin assets, which generated $3.8 million of oil, gas and NGL revenues in the third quarter for $117.5 million in cash, subject to customary closing adjustments.

Our position in each of these basins was subscale relative to our company size, and the margins from these assets are substantially lower than our company average, given the gassier nature of the commodity mix. These assets had 0.7 net line-of-sight wells as of September 30. So our line-of-sight inventory will be 50.2 net wells pro forma for the divestiture.

In aggregate for 3Q 2023, Appalachia and Anadarko contributed only 0.4 net wells turned in line out of 9.5. This compares to Appalachia and Anadarko wells turned in line of 0.1 out of 8.1 total in 2Q of 2023. The divestiture has an effective date of September 1 and is expected to close near the end of the year. Pro forma for this divestiture, our total debt as of November 3 would be approximately $864 million and our liquidity under our reserve-based loan would be approximately $588 million, assuming a flat borrowing base of $850 million.

Turning to financing activity during the quarter, we increased our borrowing base from $750 million to $850 million, which is a 13% increase. And we issued $600 million of senior unsecured notes due in 2028, which allowed us to refinance our existing senior unsecured notes, decreased our expected interest expense by $11 million per year and free up additional liquidity under our revolver. We currently remain focused on reducing our leverage to our long-term target of 1x EBITDA or less and working on accretive acquisitions. That concludes my prepared remarks. Operator, please open up the call for questions.

[Operator]

[Operator Instructions]

Our first question for today comes from Derrick Whitfield of Stifel.

[Derrick Whitfield, analyst]

For my first question, I wanted to focus on your Q3 production and your 6- to 12-month production trajectory. Regarding the quarter, we've heard from several operators in the industry that they've experienced production impacts from elevated competition in brownouts in the Delaware. I wanted to ask if you're seeing evidence of that in your data?

And then regarding your trajectory, your implied Q4 guide at the midpoint in your line-of-sight activity versus maintenance activity, both in for meaningful production growth. How would you frame your production trajectory over the next several quarters?

[Christopher Conoscenti, executive]

Just first on the Q3 production question. We heard some of the same comments, but fortunately, with an asset base like ours, which is much more diversified, any impacts like that are going to be far less pronounced than for somebody with a much more concentrated asset base. And given that we have assets across the entire Permian Basin and several other basins, localized issues like the ones you described, just don't show up in a meaningful way in our results. So that's the power of diversification across our asset base.

On your second part of your question about the production trajectory, you're correct. The line-of-sight inventory of 50.9 net wells or 50.2 pro forma for the divestiture we announced is a healthy volume of line-of-sight wells. And as we look at our wells required to keep the production flat on our asset base, it's in the high single-digit net wells per quarter. And so with 50.2, that's above the high single digits per quarter, on average if these wells are getting turned in line in the next 12 to 16 months. So it does imply some growth from where we are today.

Again, given how diversified our asset base is, you should expect the growth of our assets to reflect the broader Permian Basin. And Permian Basin is not growing at double digits, it's growing at single digits, and that's what our line-of-sight inventory implies and what our guidance implies.

[Derrick Whitfield, analyst]

Terrific. And for my follow-up, I wanted to ask if you could elaborate on some of the technical projects you referenced in your prepared remarks and the impact they could have on your organization?

[Christopher Conoscenti, executive]

Sure. We're very excited about the investments we're making in our business, and these are all in an effort to be able to manage a much, much larger asset base than we have today without adding to G&A in the future. So we made these initial investments starting years ago when we built our data management system so that our land, engineering and accounting systems all talk to each other automatically every single night. They scrape the public domain every single night for updates on our asset and across assets we don't own.

And that allowed us to continue to add more data to our system seamlessly. What we're doing now is investing in automation so that as we see more and more data coming out every single month on more wells, our people are freed up from doing more manual tasks to doing more interesting things like pursuing missing revenue from operators. So some of the automation projects we've focused on this year are centered around things like revenue and division orders from operators.

There's a significant amount of revenue data that comes out every month on over 20,000 gross wells. And we get hundreds of division orders every month, and there's no need for human hands to touch every single one of those pieces of information, computers are perfectly capable of processing that information with the right systems in place and without losing the granularity of detail that we expect that we need for pursuing missing payments. So when we track our data, we're tracking it at the API level and we're tracking it by commodity, by production period and by operator.

So in order to do that, you have to have an exceptional level of granularity, and we don't lose that with these automation tools that we're building ourselves.

[Operator]

[Operator Instructions]

Our next question comes from Noel Parks of Tuohy Brothers Investment.

[Noel Parks, analyst]

So of course, in the last month, we've had a couple of big transactions, the majors doing some bulking up again. And I was just curious, in scenarios like that, generally, just curious what happens sort of with land and royalty accounting. I could see it either going to the majors being sort of not very attentive to that or possibly having big staff to throw at that. So I just wondered if that might have any indications for what -- things that might come to the market as they sort of rationalize portfolios?

[Christopher Conoscenti, executive]

Yes. So in terms of behavior we've seen in the past, it really varies, and it's hard to make any sweeping generalizations across every transaction. Just in terms of activity levels, we've seen mergers among E&P companies in the past that were not good for us. So for example, when Oxy and Anadarko got together, that was bad for us because they came together at a time of declining commodity prices and they have elevated leverage on a combined basis and they cut their combined capital program. So that was not good for the mineral owners.

The more recent vintage of E&P consolidation, I would say, is neutral to positive for the mineral owner, particularly when you look at some of the commentary coming out of folks like Exxon following their Pioneer announcement, where they didn't signal any decrease in activity, which is the most important thing for the mineral owner and they are actually signaling operational efficiencies, which is positive for us.

Now in terms of the specific question you asked about their focus on us and the attentiveness of things like revenue remittance. Again, we don't see any meaningful difference in behavior. There are small private independents that are slow and inattentive. There are large public comp companies that are slow and inattentive. And likewise, there are large and small companies that are very good at what they do in terms of handling the revenue in division orders. So it just varies by company.

And frankly, it varies over time by company depending on how their focus shifts. So really don't have any general observations to make in terms of the attentiveness to the revenue and division order work from consolidation.

[Noel Parks, analyst]

That was interesting. And you mentioned something that was next on my mind, just that the remark from Exxon was that they didn't seem to be cutting rigs. I understand what you're saying about Oxy, Anadarko having been the exception. But of course, these recent deals are, I think, both all stock. So it -- there aren't overnight implications for leverage that create pressure on them. So it -- I mean, it would seem like that's a good sign going forward if they're looking to do efficiency kind of operationally instead of just cut rigs to sort of flatten out their groove and harvest cash flow?

[Christopher Conoscenti, executive]

Yes. That's a great point. And the fact that the E&P companies have really made tremendous progress on improving the capitalization and the capital discipline, it's encouraging that these companies are coming together at this time where there are no balance sheet impacts, like you described.

And candidly for the specific transaction we're talking about with Exxon and Pioneer, Pioneer has best-in-class assets, best-in-class acreage. And so it feels like that's going to compete well for capital within Exxon's portfolio, and we're excited about continued exposure there.

[Noel Parks, analyst]

Good deal. And then just my last one, of course, you had transaction announcement today of selling of Appalachia and the Anadarko and just curious how long that was in the works, whether it was something we came together pretty easy or kind of a lot of back and forth?

[Christopher Conoscenti, executive]

Yes. These things are never perfectly smooth, and there is a lot of back and forth. You want to make sure you're getting the best price for your shareholders. And so it's been in the works for a while now. But what we did is we looked at the money we were spending for the activities we made this year for cash, and this was a nice way to sort of fund a portion of that and fit nicely in the capital program this year.

[Noel Parks, analyst]

Right, right. The simplification, certainly must be welcomed some degree makes the story and so your focus a little bit more contained.

[Christopher Conoscenti, executive]

Yes. Our land and accounting folks are doing cartwheels. It's an interesting dynamic when you have assets in a region that are small relative to other regions that we have. And so just having subscale positions in these basins required a disproportionate amount of attention from the internal team, so it does simplify our work quite a bit.

[Operator]

[Operator Instructions]

Okay. At this time, we currently have no further questions. So that concludes today's conference call. Thank you all for joining. You may now disconnect your lines.