Kimbell Royalty Partners, LP Q4 FY2021 Earnings Call

Greetings and welcome to the Kimbell Royalty Partners Fourth Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rick Black with Investor Relations. Thank you, Rick, and you may begin.

Thank you, Operator. And good morning, everyone. Welcome to the Kimbell Royalty Partners conference call to review financial and operational results for the fourth quarter and year-end 2021. This call is also being webcast and can be accessed through the audio link on the Events and Presentations page of the IR section of KimballRP.com. Information recorded on this call speaks only as of today, February 24th, 2022. So please, be advised that any time-sensitive information may no longer be accurate as of the date of any replay, listening, or transcript reading. I would also like to remind you that the statements made in today's discussion that are not historical facts, including statements of expectations or future events, or future financial performance are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. We will be making forward-looking statements as part of today's call, which by their nature are uncertain and outside of the company's control. Actual results may differ materially. Please refer to today's press release for our disclosures on forward-looking statements. These factors, as well as other risks and uncertainties are described in detail in the company's filings with the Securities and Exchange Commission. Management will also refer to non-GAAP measures, including adjusted EBITDA and cash available for distribution. Reconciliations to the nearest GAAP measures can be found at the end of today's earnings press release. Kimbell assumes no obligation to publicly update or revise any forward-looking statements. Now, I would like to turn the call over to Robert Ravnaas, Kimbell Royalty Partners, Chairman and Chief Executive Officer. Bob.

Thank you, Rick. And good morning, everyone. We appreciate you joining us on the call this morning. With me today are several members of our senior management team, including Davis Ravnaas, our President and Chief Financial Officer, Matt Daly, our Chief Operating Officer, and Blayne Rhynsburger, our Controller. I will begin today's discussion by providing comments about the year and the quarter before turning the call over to Davis to walk you through our financials in more detail. We are very pleased with the company's performance in 2021. This year marked another very strong year of new milestones for Kimbell, including multiple records for production, revenue, adjusted EBITDA, distributable cash flow per unit, and net income. We also completed a highly attractive and accretive acquisition in December, increased the company's borrowing base, and elected commitment on the credit facility, increased our PDP reserves, and completed the full redemption of the Series A preferred stock. In addition, and perhaps most importantly, I'm very proud of the release of our detailed portfolio review in May, which identified approximately 19 years of drilling inventory at 4.5 net wells completed per year. The level of which we believe our production remains flat. Finally, we paid out $1.14 in tax-advantaged quarterly distributions in 2021 and paid down approximately $23.3 million on our credit facility by allocating 25% of cash available for distribution for debt pay down. Turning now to the fourth quarter, we achieved record oil, natural gas, and natural gas liquids revenue, and net income. As of December 31, 2021, Kimbell had 61 rigs actively drilling on our acreage, up from 60 rigs in the third quarter, representing 10.7% market share of all rigs drilling in the continental United States. Tailwinds continue in the global energy sector and fundamentals across the U.S. energy complex continue to improve. Inventory levels are low, rig count growth is tepid, and operators continue to focus on balance sheet strength and free cash flow generation. Having said that, we do see drilling activity from private operators outpacing that of public company operators as they move more quickly to capitalize on higher commodity pricing and build scale. As of the end of the fourth quarter, private operators comprised 43% and public operators 57% of our active rig count. We were positively impacted by surging commodity prices, especially natural gas, which contributed to our record quarter and the operational momentum we experienced in the second half of 2021 as Kimbell is in an excellent position entering 2022. The oil and natural gas royalty sector is particularly well positioned to benefit from the inflationary cycle that has recently accelerated in the U.S. since royalty companies participate in the upside from commodity price inflation and do not experience a significant service cost inflation currently impacting the upstream sectors. As we enter 2022, we see a bright future as we continue to act as a major consolidator in the U.S. oil and natural gas royalty sector. The asset class for mineral and royalties is enormous at over 700 billion in market size with only a handful of public entities in the U.S. and Canada that have the financial resources, infrastructure, and technical expertise to complete large-scale multi-basin acquisitions. We believe that we are still in the early innings of this consolidation and will actively seek out targets that fit within our stringent acquisition profile. Furthermore, all data points from the U.S. land rig count, which is still well below pre-pandemic levels to commentary for major EMPs indicate U.S. oil production will once again be roughly flat during 2022. Our current view of this new world is that production stability and flat decline rates will be the new theme of energy investing rather than the hyper-growth models of the past. With our high-quality, low PDP decline and diversified royalty portfolio, Kimbell was built for these conditions. We're very excited about the opportunities to expand on the future and deliver unit holder value for years to come. And with that, I'll now turn the call over to Davis.

Thanks Bob, and good morning, everyone. We are very pleased to report record performance during both the year and the fourth quarter. In addition, today we are also providing our full-year 2022 guidance. Beginning with the fourth quarter, total revenues were a record $55.7 million, and net income was a record $30.7 million. Net income attributable to common units was also a record at $20 million or $0.46 per common unit. Based on sustained positive trends and cash flows in the quarter, we announced a cash distribution of $0.37. As we have done in previous quarters, the company will utilize 25% of its Q4 cash available for distribution to pay down a portion of the credit facility. Since May 2020, excluding the expected upcoming pay down from the remaining 25% of Q4 2021 projected cash available for distribution, Kimbell has paid down approximately $44.5 million in outstanding borrowings under its secured revolving credit facility by allocating a portion of its cash available for distribution for debt pay down, and we expect this capital allocation strategy to continue. For the fourth quarter of 2021, the company's oil, natural gas, and natural gas liquids revenues were $52.2 million, up 9.7% sequentially from Q3. This primarily reflected a higher fourth quarter average realized prices of $74.79 per barrel of oil, $4.19 per Mcf of natural gas, and $38.31 per barrel of NGLs, for a combined per BOE pricing of $39.11. Fourth quarter 2021 average daily production was 14,479 BOE per day on a 61 basis, which consisted of 456 BOE per day related to prior-period production recognized during the quarter and 14,023 BOE per day of run rate production. The prior period production recognized this quarter was primarily due to new wells outperforming estimates. The fourth quarter run rate daily production includes 25 days of production from the $57 million acquisition closed on December 7th, 2021. Including a full Q4 2021 impact of production which the company was entitled to receive, run rate production was 14,521 BOE per day, again, on a six to one basis. We had 61 active rigs at the end of the fourth quarter, led by the Permian and Haynesville basins, which was up from 60 rigs at the end of Q3. Our continental U.S. rig count represents 10.7% of total market share for rig drilling in the Lower 48. As of December 31st, Kimbell's major properties had 794 gross and 2.25 net drilled but uncompleted wells, as well as 670 gross and 2.48 net permits on a day acreage. This data does not include our minor properties, which we estimate could add an additional 20% to the DUC and permit inventory. On the expense side, general and administrative expenses were $6.7 million in the quarter, $4.3 million of which was cash G&A, or $3.33 per BOE. Unit-based compensation in the fourth quarter of 2021, which is a non-cash G&A expense, was $2.4 million or $1.89 per BOE. Fourth-quarter consolidated adjusted EBITDA was $32.8 million, compared to $33 million in the prior quarter. You will find a reconciliation of both consolidated adjusted EBITDA and cash available for distribution at the end of our news release. Commenting further on our balance sheet and liquidity, on December 7th, 2021, the borrowing base and aggregate commitments on our secured revolving credit facility were increased from $265 million to $275 million in connection with our fall re-determination. As of December 31, 2021, Kimbell had approximately $217.1 million in debt outstanding under its secured revolving credit facility. We had net debt to fourth quarter 2021 trailing 12 month consolidated adjusted EBITDA of approximately 1.7 times and was in compliance with all financial covenants under its secured revolving credit facility. Kimbell had approximately $57.9 million in undrawn capacity under its secured revolving credit facility. We're also pleased to have redeemed all remaining Series A cumulative convertible preferred units outstanding during the quarter, further simplifying the capital structure and reducing our cost of capital. Today, we are providing full-year 2022 guidance, which includes production guidance that, at its midpoint, reflects roughly flat daily production relative to our fourth quarter 2021 daily production, including a full quarter of the acquired production. We believe that most operators will focus their 2022 budgets on resting declines with a goal of flat to low single-digit production growth in 2022. We do not expect Kimbell to pay a material amount of federal income taxes for 2021 through 2027. And also importantly, we expect that substantially all cash distributions paid to common unit holders from 2022 to 2025 will be free of dividend income taxes and instead be considered a return of capital. We are unaware of any oil and gas company that has given this level of detail with their tax guidance and believe it provides a highly compelling competitive advantage in terms of generating superior after-tax returns to our unit holders. We believe that Kimbell offers a compelling investment opportunity, a robust distribution yield, and continued opportunities for growth. Kimbell's current asset base, as well as global energy sector tailwinds across the broader U.S. energy sector continue to give us confidence in our ability to generate strong operational results and cash distributions for unit holders for many years to come. As Bob said, we believe this energy up-cycle will last longer than previous cycles, and forecasted modest increases in investments by U.S. operators expected in 2022 will only serve to replace the significant depletion in ducks rather than lead to much in the way of new production growth in the continental United States next year. Kimbell, unlike many others in this sector, was built for this environment and will significantly benefit from commodity price inflation without significant downside risk of service cost inflation, which is truly unique to our model. Kimbell will continue with our goal and focus of generating long-term value and cash generation with transparency to investors for many years to come. Lastly, as I'm sure all of you saw earlier this month, the Kimbell sponsored SPAC, Kimbell Tiger Acquisition Corporation, successfully priced at initial public offering on the New York Stock Exchange, raising approximately $230 million. Kimbell Tiger intends to search for a target company in the energy and natural resources industry in North America.

We are now ready for questions.

Hi, guys.

Morning, John.

Hey, John.

The first question I had was now that we've got the leverage ratio with a one handle on it, and just given the obviously favorable commodity environment we've got this year where that ratio is going to come screaming lower over the next 12 months. I know that for '22 you'll maintain that 75% payout ratio. Do you think longer-term, is that the right payout ratio or do you think of it as somehow tied to that leverage ratio as that goes lower, the sub one times or whatever, that that payout ratio starts to go up or should just assume 75 is the right number?

John, thanks for your question. This is likely the topic we discuss the most at the board level. I believe we will maintain a 75% payout ratio for this year. You’re correct that the ratio will continue to decrease as our cash flow increases, meaning that 25% of that cash flow will lead to a further decline in leverage over time. A few years ago, we would have said an appropriate leverage level for a royalty business was anything under two times debt to EBITDA, which was the general guideline for upstream E&P businesses. For a mineral company without capital expenditure obligations, less than 2x seems reasonable. However, given the current environment and best practices in governance for E&P companies, that threshold has shifted to probably less than one times. We are approaching that point, and when we get close to one times, it will become a crucial topic for discussion at the board level. While no decisions have been made yet, we are open to all possibilities. There’s a chance we could increase the payout ratio or consider keeping it stable as we aim to reduce leverage. This is still somewhat uncertain, but we recognize the significance of this issue and welcome investor feedback regarding the best path forward.

I appreciate that. I've noticed that in this quarter, there has been prior period production recognized again due to the wells exceeding estimates. Reviewing the last couple of years over leases, it appears you've had three consecutive quarters of upward revisions on prior period recognition after about a year without that happening. Before the second quarter of 2021, the last significant loss of production seemed to be in the second quarter of 2020. I'm trying to understand if there's anything you're doing that better captures this data, or if a specific field is influencing the production mix. Or maybe I'm just overanalyzing this, which has happened before.

Great insight as always. I'll hand it over to Blayne Rhynsburger, our accountant, shortly. My impression is that we have added significant high-interest units through acquisitions over the past couple of years. Natural gas drilling has been limited, especially in the Haynesville, which has some attractive high enterprise. For about the last 18 months, drilling activity there has not been particularly strong. As that picks up, we can expect some quarterly fluctuations in production. It wouldn't surprise me if we see production increase by a couple of percent in one quarter and then decrease by 0.5% or 1% in the following quarter due to natural decline in those high-interest wells. This is partly due to the production mix as we have grown and added unconventional assets. Blayne, do you have anything else to add? I don't believe there has been a change in methodology, but I want to emphasize that we have been conservative and have made upward revisions over time, which is positive. Blayne, do you have any additional thoughts on this?

Yes. Yes, John, that's a good question. I knew this was going to come up. We've invested that I'd say the first part of your question to comment on Q4. Specifically, we had 4 EOG wells in Lea County, New Mexico that we got paid on this quarter with production dating back to 2020, and that's been a theme that we've seen the last couple of quarters like you pointed out. And really, I would say the reason that's happened like we mentioned in the last few quarters, is we have invested land resources on the personnel side where their sole responsibility is to find operators who have us unnecessarily spend. And so really we invested in that a couple of years ago and it's paid off every quarter since then and I think you'll continue to see that going forward. On top of what Davis mentioned, we are also conservative in our revenue accruals, but I would say the main reason for that is that we've hired personnel to go get us out of the spend where we shouldn't be.

That's great. I appreciate all that, guys and very happy to see the market finally rewarding your stock these last few weeks. So hopefully that continues. Thanks again, guys.

Grateful to you, John. Thanks for the questions.

Yes, thanks, John.

Thanks. And good morning to all.

Hey, Derrick.

Over the last few months, we've seen a few larger deals announced in the mineral space, including the one you guys closed late last year. How would you characterize the current competitive landscape at present for both smaller and larger opportunities, and where do you see the greatest opportunity?

Great question. I want to start by saying that mergers and acquisitions have been quite challenging for our industry, and this is something that many of our peers would likely echo. As a sector, we are undervalued, which impacts how much we can offer private companies for their assets. Last year, there were a few significant transactions, particularly those over $50 million, but overall, the M&A activity was somewhat disappointing. All of us hope to engage in more acquisitions moving forward. However, the reality is that we are trading at a free cash flow yield around 13% to 15%, and this is similar for our peers. When you're operating at such low multiples on cash flow, it limits what we can pay for assets from private sellers. The cost of capital has been higher than we anticipated. Looking ahead, the requirements for mineral companies to go public continue to escalate, which means firms with portfolios valued between $500 million and $750 million might need to merge with public companies. To facilitate these deals, they will likely have to accept a significant amount of stock. It’s unlikely any of our peers would be willing to issue that much stock for cash. Therefore, the key will be finding private partners willing to take stock as currency, something we have successfully navigated before. Historically, we have completed significant deals where stock played a major role, such as our earlier partnership and our recent deals with NCAP and NGP, both involving substantial stock components. The biggest opportunities seem to lie in larger acquisitions, typically those exceeding $50 million, although these can be harder for private equity firms to pursue due to the higher stakes involved. There are some transactions currently available that we are evaluating, but the threshold for closing a deal remains high. We are not in a rush to make any deals at this moment. We're in a strong position and want to grow while achieving economies of scale, enhancing our liquidity, and pursuing valuable M&A opportunities. However, we are cautious and won't pursue any ill-advised deals. While it is challenging to execute successfully, I believe that any potential transactions would likely involve larger deals rather than smaller ones, especially given the competitive nature of the smaller opportunities in the Permian Basin.

Got it, that makes complete sense. And for my follow-up, referencing Slide 13, you guys have historically performed well with your rig count, market share statistics, and certainly that's a testament to your asset quality. While Q4 remains strong, is there anything you're seeing in the data that would explain the slight dip in Q4? And do you have a view on maybe the areas where you're outperforming at market share measures and where you're potentially underperforming?

That's a good question. I'll turn that over to my team on the latter question. I'd say on Q4, look, we never like to have a quarter where you have a little bit of a drop in production. The reality is we're a royalty business and you see like in Q3, for example, that was the best quarter we've ever had. Production was outstanding. We did across the board with great results. I think Q4 was setting up for a tough sequential quarter-over-quarter comparison. And again, you're going to see some lumpiness with big wells coming on, and that's going to scream production higher for that quarter, and then it's going to go lower. We do have line of sight on some high-interest wells that we knock on wood hope we start to get some data on some cash flow on here in the near term I wouldn't say there's any major theme that's dictating anything other than to say that we're seeing operators maintain more discipline across the board, focusing more on keeping production rates flat to growing very slightly. But is there anybody matter, Blayne, do you want to jump in?

Yeah, I've got some commentaries.

On maturities? Terrific.

Yes. Going back to Q120, on Slide 13, you can see that our rig count market share has consistently ranged between approximately 11% and 12% each quarter. It was 10.7% in Q4 and 11.7% in Q3. So we expect to maintain that 11% to 12% market share into Q1, which should lead to an increase in our rig count as overall rig counts rise. Notably, our rig count includes 57% public and 43% private operators. The private operators have been more aggressive in drilling, even during the pandemic, to build scale and hold leases, particularly when oil prices were low. This blend of public and private operators has contributed to the stability of our rig count, and we anticipate growth over time.

Great point. You guys actually might have the highest within the mineral space on the private side as well. But very helpful guys and thanks for your time.

Thanks, Derrick. Good question.

Yes, thank you.

Hey, good morning.

Morning, Chris.

Hey, Chris.

Most of my questions have been answered, but I just wanted to ask on M&A maybe in a bit of a different way. Any color around gas versus oil-focused opportunities, just in terms of the opportunities that you see in front of you today?

I'll start by restating our philosophy on gas versus oil for everyone listening. We remain agnostic to commodity and have always maintained this approach since we began in 1998. Our focus is on quality and value. If we can secure a natural gas deal in the Haynesville that delivers higher returns for our investors, we would prefer that over an oil-focused deal in the Permian or the Eagle Ford, simply emphasizing liquids. We are always searching for the most efficient ways to deploy our capital. Currently, I wouldn't say we are seeing a significant increase in opportunities in either direction. As I review our pipeline of potential acquisitions, it appears quite mixed. Over the past 18 months, there has been a slight uptick in activity in the Haynesville, especially as natural gas prices have risen from very low levels. Overall, I'd say there is a balanced distribution between the commodities, and having actionable opportunities is beneficial as well.

So, yeah. And I'd say also we're seeing, fortunately, more multi-basin packages, which are our specialty that we can underwrite.

That's good to see.

This is Bob. I want to add that we continue to see a tremendous amount of deal flow, both large and small. We are currently evaluating about 15 to 20 deals, which has been consistent throughout the year. This highlights our selectivity. We announced one large deal last year, but we are constantly looking at and evaluating deals in the market.

That's great color, thank you. And just as a follow-up, great to see the continued progress on the Kimbell Tiger front. How should we think about the broader strategic implications for Kimbell as a whole?

Thank you, Chris. I appreciate the opportunity to elaborate. Now that we have priced the SPAC, we can discuss this further. Our mandate is quite expansive; we aim to identify a cash flow generating business at an appealing valuation. We're focused on real companies that produce genuine cash flows. If we are successful in the De-SPAC process, as you understand how SPACs function, it would provide a significant benefit to KRP unit holders. More importantly, from a strategic perspective, we hope to discover a valuable asset or a group of assets that will allow us to establish a partnership with an operating business. This partnership would provide us with a clear developmental path for the first time. There are numerous advantages to the mineral business that apply to us and our competitors. One major risk in the mineral model is the lack of developmental control. By forming a relationship with a sister company or operator, we could jointly acquire minerals or secure override interests from high net revenue properties. We value the predictability of cash flows; conventional assets often have leases with lower royalty rates. It's not unusual to see net revenues of 87.5% or higher in some fields that have consistently produced hydrocarbons over the years. This approach would open new strategic avenues for Kimbell, potentially on a national scale, allowing us to acquire overrides with an operator. Joint bidding could lead to a more favorable cost of capital, as our mineral company could raise equity at lower rates than an operator. Sharing the net revenue stream wisely would enable growth without compromising drilling economics while providing us visibility into asset development. Achieving this would be an ideal outcome for the company, and we're eager about the prospects. That said, I acknowledge that the de-SPAC environment is complex, but we're dedicated to this effort, and success could lead to exciting opportunities for all of us.

Great, I appreciate the color, guys.

Hey, good morning. Maybe just a follow-up.

Good morning, TJ.

How are you doing?

Doing good.

On the Tiger deal. So do you pause M&A or potential M&A activity right now and Kimbell Royalty until you get out?

No. No, no, no. So very important. So nothing changes at Kimbell. Exact same, but very important to us, we wouldn't have done this if we didn't find a manager who has a management team that he's identified once we find an asset to run that business. So no, day jobs, the exact same, allocation of duties, the exact same. Not a distraction whatsoever. Really, just given the fact that we're looking at 15 to 20 deals at any given time. So our peers, by the way, that's how minerals businesses work. This is just another one of those potential acquisitions that we're looking at. We want to continue to run Kimbell machine the same as it's been since we founded the business 20 years ago. This is just a pretty exciting strategic direction that we're allocating resources that we've brought on for that purpose specifically.

Okay. Now that makes sense. Then on production guidance, appreciate that. Maybe if you could just expand on drivers that would push you to the low-end or high-end of that range at management, commodity and activity-driven. So would you say that the commodity prices, maybe your bias a bit to the higher-end, and then just confirming there's no view on future acquisitions built-in into that guidance. Thanks.

I'll now hand it over to Matt after making a few brief remarks. Our guidance does not include acquisitions. We aim to be conservative with our guidance for a couple of reasons. Firstly, we prefer to set expectations that we can meet or exceed, rather than setting a high target and not achieving it. As a royalty business, it's crucial to be conservative because we lack developmental control over the asset. For instance, even if we have leases in prime areas and oil prices are high, the operator might choose not to increase drilling activity, leaving us reliant on their decisions. In the current environment, operators seem to be focused on maintaining fiscal discipline. It will be intriguing to see how they respond in this environment of higher oil prices—whether they will stick to maintenance capital expenditures or choose to escalate them. Overall, we are committed to being conservative with our guidance, avoiding any overly ambitious projections. I wouldn't be surprised if we exceed our targets, and I’m pleased to see that most of our peers adopt a similar approach in setting conservative guidance. Now, Matt, I’ll pass it over to you for any additional insights.

No, no, I agree with all that. I mean, on the low end, this is obvious, you have a big correction in commodity prices or another flare-up in COVID; that could probably be in play. And on the high-end, we are still in the backwardated curve right now, at the spot price of $97, plays out throughout the year. Right now, we're looking at oil drop into $84 later in the year. Silver are very good, but if the prices stay where they are now throughout the year, the rig count will continue to grow, and you'd expect maybe on the high-end there. And also the Haynesville has been, with gas prices where they are, we have some very high net revenue interest wells in the Haynesville that could also be a big area for us on the upside. As David said, we're being conservative with this guidance; we feel good about it for the year.

Yes. All makes sense. Appreciate it. Thank you.

Thanks, TJ.

And there are no further questions at this time. And I would like to turn the floor back over to management for closing remarks.

We thank you all for joining us this morning and look forward to speaking with you again when we report first-quarter results. This completes today's call.

And ladies and gentlemen, thank you for your participation. This does conclude the teleconference. You may disconnect your lines and have a wonderful day.