Kimbell Royalty Partners, LP Q3 FY2022 Earnings Call

Greetings, and welcome to the Kimbell Royalty Partners Third Quarter Earnings Conference Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rick Black, Investor Relations. Thank you, Rick. 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 third quarter ended September 30, 2022. 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 kimbellrp.com. Information recorded on this call speaks only as of today, November 3, 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'll 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 earnings release for our disclosure on forward-looking statements. These factors and 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 release. Kimbell assumes no obligation to publicly update or revise any forward-looking statements. I would now like to turn the call over to Bob 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'll start by commenting on the quarter and the current operating environment before turning the call over to Davis to review our financials in more detail before we open the call to your questions. We maintained strong momentum in the third quarter, coming off record results in the second quarter. In terms of production, we achieved another record as run rate daily production for Q3 2022 was 14,985 BOE per day. While last quarter's record production was driven by a surge in natural gas production in Haynesville, this quarter's record performance was driven by accelerated oil-weighted activity, primarily in the Permian and Eagle Ford, which drove an 8% sequential increase in oil production. This is a good example of the power of geographic diversity. As of September 30, 2022, we had 79 rigs actively drilling on our acreage, up 7% from last quarter and representing over 10.6% market share of all rigs drilling in the Continental United States. This is the highest level of rigs actively drilling on our acreage that we've experienced since 2019. Reflecting these strong quarterly results, we are pleased to announce today that our third-quarter distribution is $0.49 per common unit. Moving into the final quarter of 2022, we see continued momentum supported by a record number of DUCs and permits at the end of Q3 2022. We believe that this operational success is a result of seeds planted over the last 5 years with more than $900 million in acquisitions across the leading basins in the U.S. since 2018. Our consistent and proven strategy of having a strict set of time-tested acquisition criteria, which includes significant upside drilling inventory, continues to propel our business model and enhance growth. We are now realizing the benefits of this acquisition strategy, as reflected in our inventory conversions, record production, and operational performance. I'm pleased to announce that we now believe Kimbell only needs 4.0 net wells completed each year to keep production flat, an 11% reduction from the prior estimate of 4.5 net wells per year. This reduction further highlights Kimbell's best-in-class production stability. Given that we currently have 5.44 net DUCs and permits, which is another quarterly record, we're well-positioned to drive continued organic production growth. Today, the macro events dominating the financial headlines in many industry sectors, which were leaders over the last several years, are experiencing significant headwinds in this current environment. However, I believe the energy sector is in the best shape that I've seen in my career, which has spanned over 40 years, as it is well prepared to weather any storm that may be coming in future quarters. In general, balance sheets are running at low levels of leverage, free cash flow is strong, management teams are disciplined, and valuations remain compelling, even in a higher interest rate environment. Many are expecting a slowdown in drilling in the medium term due to increased costs, especially labor. As I said before, this is one of the strongest competitive advantages of being a pure royalty company, namely, we have 0 inflationary risks in terms of drilling and production costs, yet we receive the upside from higher commodity prices. We remain structurally bullish on both oil and natural gas over the long term due to years of woefully low investment, especially among energy companies outside of the U.S., and strong global demand trends that we expect to accelerate in 2023. As we finish 2022, we are very grateful to our employees, Board of Directors, and advisers for helping us achieve a record year at Kimbell. We remain extremely excited about our role as a leading consolidator in the oil and gas royalty sector and the prospects for Kimbell to generate long-term unitholder value for years to come. I'll now turn the call over to Davis to review our financials in more detail before we open the call to questions.

Thanks, Bob, and good morning, everyone. We are very pleased to report record performance during the quarter, and we are again reaffirming our full-year 2022 guidance that was previously disclosed in our fourth quarter 2021 press release. I'll start by reviewing our financial results from the third quarter, beginning with oil, natural gas, and NGL revenues of $73.9 million, a decrease of 6% from Q2 2022, primarily due to a decline in realized commodity prices. Kimbell's third quarter 2022 average realized price per barrel of oil was $92.65, per MCF of natural gas was $6.92, per barrel of NGLs was $35.50, and per BOE combined was $53.58. Our record third-quarter average daily production was 14,985 barrels of oil equivalent per day on a 6:1 basis, an increase of 0.2% from Q2 2022. This daily production was composed of approximately 62% from natural gas on a 6:1 basis and approximately 38% from liquids or 25% from oil, and 13% from NGLs. On the expense side, general and administrative expenses for Kimbell were $7.5 million in the quarter, $4.5 million of which was cash G&A expense or $3.26 per BOE. Third quarter net income was approximately $43.8 million. Total third quarter consolidated adjusted EBITDA was $47.5 million, and cash available for distribution was $0.66 per common unit. Today, we announced a cash distribution of $0.49 per common unit for the third quarter. This represents a cash distribution payment to common unitholders of 75% of cash available for distribution, and the remaining 25% will be used to pay down a portion of the outstanding borrowings under Kimbell's secured revolving credit facility. Since May 2020, excluding this upcoming Q3 payment, Kimbell has paid down approximately $75.2 million of its outstanding borrowings under its secured revolving credit facility by allocating just a portion of its cash available for distributions for debt paydown. Commenting further on our balance sheet and liquidity. As of September 30, Kimbell had approximately $203.9 million in debt outstanding under its secured revolving credit facility. It also had net debt to third quarter 2022, trailing 12-month consolidated adjusted EBITDA of approximately 1.0x, and remained in compliance with all financial covenants under its secured revolving credit facility. Kimbell had approximately $96.1 million in undrawn capacity under its secured revolving credit facility. We are extremely proud of the strength of our business model, which continues to perform very well in the highly cyclical energy industry. We are also very pleased with our strong performance, which is largely the result of seeds planted many years ago when we completed several acquisitions when commodity prices were much lower. We remain highly focused on our goal of generating long-term unitholder value for years to come. With that, operator, we are now ready for questions.

Our first question is from John Ana with Stifel.

Congrats on a strong quarter. For my first question, you mentioned in the past of wanting to get the leverage ratio below 1x before considering buying back some stock or increasing dividends. Now that you're around that 1x level, could you share your updated thoughts on increasing the payout ratio or stock buybacks?

Yes. Thanks for that question. That's one of the topics that we discuss most frequently as a management team and at the board level. As we look at the environment, I think investors continue to want us to delever the business. Looking at it, I think it would be nice if we could get to maybe 0.5 turn of leverage long-term at kind of the mid-cycle levels so that when prices inevitably do go back down, let's say, they fall 50% from mid-cycle to trough or back at 1x. So I think thinking about deleveraging is an important thing. At the same time, though, we want to look at the overall context and the overall environment. If we feel very good about the fundamentals of the business, but our stock continues to trade at levels that we think are dramatically undervalued, particularly undervalued relative to third-party M&A that we could do, then we would, of course, consider buying back stock, notwithstanding our focus on continuing to reduce leverage. So I think what you'll see for us going forward is hopefully a very thoughtful, active approach to optimizing the way in which our investors are rewarded with their cash flow. And that will be a combination of possible share repurchases, debt paydown, or third-party M&A depending on the environment in context.

And then for my follow-up, I wanted to focus on the commentary regarding the reduction in wells required to keep production flat. Could you help me better understand what the drivers were for the assessment you performed that led you to revise this estimate down to 4 net wells per year?

Absolutely. That's a great question, and it's a crucial aspect of our business that many people may not fully grasp. We evaluate this on an annual or even biannual basis, examining the number of wells. We have a strong belief in the sustainability of an upstream model and have been committed to this approach from the beginning. We focus heavily on the underlying PDP decline rate, which we have considered vital since our early days as one of the first mineral buyers in the late '90s. When we analyze this data, it's essential for us to assess our replacement production levels. The drop from 4.4 net wells needed to maintain flat production to 4 wells can be attributed to the fact that much of the production growth in our assets over recent years has come from unconventional properties, which typically experience a higher PDP decline rate. As these wells mature and new wells come online, the underlying PDP decline rate has slightly decreased, meaning we need fewer wells to maintain flat production. Since we began tracking and quantifying our net DUCs and permits, we've never felt better about the ratio of net DUCs and permits in our acreage compared to the number of wells needed to sustain production. Currently, we have 5.44 net DUCs and permits, which is a new record that we're thrilled about. We only require 4 wells to keep production flat. This gives us a 35% surplus in our immediate development catalyst category for offsetting drilling. We generally adopt a conservative approach to guidance. We prefer to see our production grow by low single digits or potentially high single digits in a favorable environment, and this situation suggests that our fundamentals support the latter. In simple terms, we have never been more confident about our immediate development net DUCs and permits in relation to what's required to maintain production levels. This position is favorable for our business.

Our next question is from Torrey Schultz with RBC Capital.

You highlighted the $900 million of acquisitions since 2018, and I think it's clear you've had success executing on M&A. How do you see the setup for transactions into next year? Maybe also in the context of having 2 of your peers considering a merger, how that may change the competitive landscape for you all, if at all? Or, just generally, does it change how you view size and scale to remain competitive?

Yes. Thanks, TJ. Good question. Nothing's changed on how we view the M&A landscape. As you know, we're just very selective. We often disappoint sell-side brokers, investment bankers, and frankly, just other mineral companies that are looking for an exit because we just have a set of criteria under which we underwrite deals. We've been doing it for coming on 30 years now and really have never deviated. The space is so large since you brought up competitive dynamics. I mean, we're talking about pushing a $1 trillion sector with 20 million Americans, and the math is pretty simple. We have in our investor presentation and a bunch of groups, including Bloomberg, I think have adopted our methodology for trying to quantify the size of the minerals and royalty sector. But over 20 million Americans get royalty checks, most of those on average are $100 a month. So it's a rapidly consolidating space. The public mineral companies represent a very small fraction of that, like a low single-digit percentage of the overall market. So consolidation is happening. It needs to happen. Moreover, I think often the mineral space gets overlooked because the United States is the only place where private mineral ownership exists. So if you look at 7 billion people on the planet, 6.6 billion of them outside the United States don't even realize that this asset class exists and that you can invest in it. So underappreciated in the very early innings of growth, and there will not, in our opinion, be a single company or even half a dozen companies that are able to acquire everything that exists out there. So for us, we focus on what we do. We don't worry about what our competition does. And we've seen years we've done 0 deals. We've seen years where we've done 3 or 4, I think on average, we've executed on 1 per year. So looking forward to next year, we plan on doing more of the same. I think you'll see us be, as always, more focused on deploying capital on behalf of our unitholders in the most effective way. We want to generate the highest return on invested capital, regardless of basin. That gives us a huge advantage to not be solely focused on the hottest basin at every time. So we can look where it's most efficient for us to deploy. And I think we'll just continue to do that. Anything you'd add, Bob?

No, I agree with all those.

How do you view your geographical diversity and the various opportunities available? Are there specific basins that you are focusing on more today compared to others?

Great question. The answer is no. We always assess what's available in the market and have no specific preference for gas or oil. We've always operated this way and are also agnostic to the basin. Uniquely, since our IPO, we have managed to acquire assets successfully in every basin across the United States. This flexibility allows us to deploy capital more efficiently because we are not restricted from investing in specific locations. We review all potential opportunities and believe we are aware of most significant transactions, evaluating each one. However, only a small fraction aligns with our investment criteria, and when we identify a suitable opportunity, we act on it.

There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

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

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.