Earnings Call Transcript - KRP Q3 2020

Operator, Operator

Greetings and welcome to the Kimbell Royalty Partners Third 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 for today's call, Rick Black, Investor Relations. Thank you. You may begin.

Rick Black, Investor Relations

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 of 2020. 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 5th, 2020. So, please be advised that any time-sensitive information may no longer be accurate as of the date of any replay. 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 disclosure 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. And with that, I would now like to turn the call over to Bob Ravnaas, Kimbell Royalty Partners' Chairman and CEO. Bob?

Bob Ravnaas, Chairman and CEO

Thank you, Rick, and good morning everyone. We appreciate you joining us for this call. I'm joined here on the call with 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'd like to begin by providing an overview of our performance in the third quarter before handing the call over to Davis to walk you through the financials in more detail. We had a very good quarter with both a strong improvement in commodity pricing and increased production, once again proving the resilience of our business model. Production curtailments, which were put in place by many operators during the height of the pandemic earlier this year, were largely reversed in the Permian and Eagle Ford during the quarter. However, curtailments were still largely in place on our Bakken assets during the third quarter. We are hopeful that these will reverse in Q4 of 2020 due to improved differentials in commodity prices. There was a slight uptick in the number of rigs drilling on our acreage from 29 to 30. The biggest increase occurred in the Haynesville, with a rig count increase from five rigs drilling at the end of the second quarter to eight rigs drilling at the end of Q3 2020. We are very excited to see the expected improvement in natural gas prices, both in Q4 2020 and the full year 2021, based on the futures curve. With approximately 59% of our daily production from natural gas, this price improvement could have a very meaningful positive impact on our future cash flows and quarterly distribution payments. To put this in perspective, natural gas prices have averaged $2.02 per Mcf so far this year. The average expected natural gas price for the full year 2021 is $3.03 per Mcf, a 50% improvement over 2020 year-to-date prices. In addition to our gas-weighted daily production, we also have a significant amount of future drilling inventory located across the major natural gas basins in the U.S., with a concentration in the core areas of the Haynesville and Marcellus. We expect to benefit from this significant natural gas drilling inventory for years to come. In the third quarter, we also achieved a record low cash G&A per Boe, demonstrating the continued efficiency of our business model and our focus on cost control during these uncertain times. In addition, our strong hedge book and solid balance sheet provide future flexibility to make accretive acquisitions that fit our criteria for accretive growth. We are paying close attention to the hotly contested political discourse regarding fracking in the overall energy industry. With less than 2% of our royalty acreage on federal lands, a potential frac ban on federal acreage would not have any material impact on our production or future drilling prospects. If anything, such a frac ban on federal acreage could have the unintended consequence of disrupting supplies of oil and natural gas in the U.S., potentially causing a spike in commodity prices. As we look towards the future, we remain confident that regardless of which political party controls Washington, our nation will continue to be a global leader in the oil and natural gas industry for decades to come. Focusing more closely on our specific business model, we have a highly differentiated strategy compared to most companies in the U.S. energy sector. Kimbell is a pure royalty model with a diverse asset base, a commodities mix that is heavily concentrated in natural gas, and with substantial pricing hedges and a very low PDP decline rate, which is among the best in the industry. All of these aspects of our strategy are by design. We created this company with a long-term vision for sustainability and growth. We believe KRP will continue to be a consolidator of minerals and royalties across all of the major U.S. basins, and we are not tied to a particular operator in one specific basin, which we believe creates unnecessary idiosyncratic risk. These factors continue to contribute to our mission of maintaining a sustainable, diverse portfolio of royalty assets that is broad and stable. Our mineral interests span over 13 million gross acres in 28 states and include more than 96,000 gross wells, with over 40,000 wells in the Permian Basin. Since our IPO, Kimbell has demonstrated organic production growth and a five-year forecasted PDP decline of only 13%, which is one of the lowest among our minerals peers. Our leadership team has successfully managed through a number of economic cycles over the past several decades, and I believe Kimbell is very well-positioned to not only weather this storm, but also be opportunistic as the right situations present themselves in the future. These strong characteristics of our business, coupled with a proven consolidation strategy that acquires high-quality and accretive assets, have demonstrated significant growth, scale, and cash flow for our company. Our goal is to continue the advancement of our long-term strategy as a preeminent consolidator of diversified and low PDP decline minerals that generate substantial free cash flow for distribution to our unitholders. And since roughly 59% of our daily production is from natural gas and a substantial portion of our production is contractually hedged for the next couple of years, we believe that our business model is well-positioned for any tough challenges ahead and to participate in the eventual economic recovery. We also believe that Kimbell offers a compelling investment opportunity with growth opportunities and a robust distribution yield, which we expect our distributions to be substantially tax-free through 2023 and instead to be considered a return of capital to the extent of a unitholder's basis in its common units. While significant uncertainties remain in the U.S. energy sector, primarily related to the pace of new drilling and completions for the remainder of 2020 and into 2021, we remain very optimistic about the future of the U.S. energy industry and our business specifically. And with that, I'll now turn the call over to Davis.

Davis Ravnaas, President and CFO

Thanks Bob and good morning everyone. As we discussed on our call last quarter, curtailments largely reversed themselves in the third quarter, specifically on our Permian and Eagle Ford properties. However, curtailments were still largely in place on our Bakken assets in the third quarter. We are hopeful that these will also reverse in the fourth quarter given improved commodity prices. We are pleased with the continued strong performance of our large and diverse asset portfolio, as well as the fact that production mix is weighted more heavily to natural gas production. As Bob laid out a few moments ago, natural gas price futures are projected to be up approximately 50% in the next 12 months as compared to the average prices over the last 12 months, which could generate a significant improvement in cash flow for the company. We are encouraged by the way production and pricing are currently positioned for the rest of 2020 and continuing into 2021. We continue to maintain a robust hedge book with a significant amount of future production hedged through Q3 2022 using swaps. In addition, we continue to maintain a very strong inventory of permits and drilled and uncompleted wells across our acreage as a result of strong drilling momentum on our acreage just prior to the pandemic. We expect these locations will provide even more stability to our production profile as eventual conversions to producing wells occur when frac crews resume operations. The company's third quarter average daily run rate production was 14,160 Boe per day, comprised of approximately 59% from natural gas on a 6:1 basis and 41% from liquids, 28% from oil and 13% from NGLs. As of September 30th, Kimbell had 794 gross and 2.62 net drilled but uncompleted wells, as well as 573 gross and 1.84 net permits on its acreage. Also, as of the end of September, the company had 30 rigs actively drilling on our acreage, which represented a 12% market share of all drilling rig activity in the Lower 48 at that time. For the third quarter of 2020, the company's oil, natural gas, and natural gas liquids revenue was $24.3 million, which reflected Q3 average realized prices of $38.30 per barrel of oil, $1.76 per Mcf of natural gas, and $13.42 per barrel of NGLs for a total combined Boe realization of $18.67. In Q3, we realized hedging gains of approximately $675,000. On the expense side, general and administrative expenses were $6.1 million in Q3, $3.7 million of which was cash G&A expense or $2.81 per Boe. This marks a new record low cash G&A per Boe for Kimbell, reflecting our intense focus on controlling costs during these uncertain times. Q3 consolidated adjusted EBITDA was $17.1 million, an increase of approximately 41% as compared to Q2 of 2020. The net loss for the third quarter was $25.7 million and the net loss attributable to common units was $17.8 million or $0.50 per common unit. The net loss for Q3 reflected a $22.2 million non-cash ceiling test impairment expense recorded during the quarter related to the substantial weakness in commodity prices. This non-cash ceiling test impairment is not expected to impact the cash available for distribution generated by Kimbell or its liquidity or its ability to make acquisitions in the future. The Q3 2020 distribution of $0.19 per common unit, which was declared on October 23rd, 2020, reflects a 75% payout of the Q3 cash available for distribution. We will use the retained amount to strengthen the balance sheet and pay down a portion of the outstanding borrowings under Kimbell's credit facility. We continue to manage the company in a conservative and prudent manner, especially given this year's unprecedented events and uncertainties in the energy sector and the broader economy. You will find a reconciliation of both consolidated adjusted EBITDA and cash available for distribution at the end of our news release. Looking now at the balance sheet and liquidity. At September 30th, 2020, Kimbell had approximately $169.7 million in debt outstanding under its revolving credit facility and $55 million in undrawn capacity or approximately $130 million if aggregate commitments were equal to Kimbell's current borrowing base, which is $300 million. Increases in commitments pursuant to the accordion feature of the revolving credit facility are subject to the satisfaction of certain conditions, including obtaining additional commitments from new or existing lenders. Total debt to Q3 trailing 12-month consolidated EBITDA was approximately 2.2 times. Earlier this year, we announced that we would begin disclosing our DUCs and permits by basin on our major properties, and we have continued this additional disclosure in our third quarter earnings release. As of September 30th, 2020, we reported 2.62 net DUCs, 794 gross DUCs, and 1.84 net permits, 573 gross permits on Kimbell's acreage at the end of the period. This data does not include our minor properties, which we estimate could add an additional 20% to the DUC and permit inventory based on our experience. We appreciate your interest in our business. I want to thank the Kimbell investors for believing in our strategy, and we will strive to continue to generate long-term value in the years to come. With that, operator, we're ready for questions.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Chris Baker with Credit Suisse. Please proceed with your question.

Chris Baker, Analyst

Hey good morning. I hope you guys could talk a little bit more about what you're seeing in the Haynesville. It certainly looks like some robust volume growth sequentially and with the rig count back up to eight. Any sense of where that points you in terms of potential growth next year? And anything that you guys are hearing from your major operators over there?

Davis Ravnaas, President and CFO

Thank you for the question, Chris. I believe this aspect of our business hasn't received the attention it deserves from many investors. It's our largest production area. I can confirm that we had seven significant new wells in Haynesville, six of which were operated by Aethon. In Bossier and Bienville County, we completed one well in Red River. We’re not ready to provide guidance for next year just yet, as we prefer to do that alongside our K, considering the ongoing market uncertainties. However, the rapid increase in the rig count combined with the significant improvement in natural gas prices gives us confidence in this asset within our portfolio. I want to emphasize that we believe no other company, either public or private, holds a better position in the Haynesville shale than we do. This advantageous position largely resulted from the Haymaker acquisition we completed a couple of years ago, which involved legacy Chesapeake assets that were initially pivotal in developing this play 15 years ago. Bob or Matt, do you have anything else to add?

Matthew Daly, COO

Yes, this is Matt. I want to mention that the wells currently being drilled as of September 30 are highlighted in our investor presentation for the Haynesville. The positive aspect is that many of these wells have a higher interest, closer to 1%, compared to the typical wells we drill, which usually have around 50 basis points net revenue interest. So when these wells come online, hopefully in the third or fourth quarter of next year, we can expect to benefit from that higher net revenue interest.

Chris Baker, Analyst

That's great. And then just as a follow-up on the cash cost side, certainly continue to see some good progress there. Can you talk about the sustainability of the recent improvement in G&A? And maybe what we can look at in terms of a clean run rate fourth quarter and beyond?

Davis Ravnaas, President and CFO

Yes. Really good question. It's hard to answer because a lot of the cost that we cut were related to marketing and investor relations and traveling for conferences, which we didn't do any of, given the virus, as just about everything got canceled. But there is some amount of that that I would classify as a permanent or sustainable reduction in G&A. We worked with a couple of our vendors to reduce costs. We terminated a couple of smaller relationships. Matt, any detail you want to give that might be more specific than that or anything you want to add?

Matthew Daly, COO

In Q2, our cash general and administrative expenses were $4.3 million, which included $300,000 related to the transitional service agreement from the Springbok acquisition, leading to a $4 million run rate. In Q3, these expenses decreased to $3.7 million, reflecting a reduction of around $300,000 primarily due to lower professional fees associated with less overall activity. Although the $3.7 million represents a record low cash unit cost of $2.81 per barrel of oil equivalent, I anticipate that as our activity increases next year, we might see a rise in expenses due to additional professional fees. Therefore, while I consider the current level a bit low, a slightly higher figure may be more sustainable. We will provide more detailed guidance when we disclose our Q4 earnings in February.

Chris Baker, Analyst

Great. Thanks guys.

Bob Ravnaas, Chairman and CEO

Thanks Chris.

Operator, Operator

Our next question is from Harry Halbach with Raymond James. Please proceed with your question.

Harry Halbach, Analyst

Good morning guys. I was wondering if you could give me somewhat an estimate of shut-ins in the quarter, like as a percent. You obviously said it came down from the 6% or 7% last quarter, but I'm just trying to get a sense of what's like a fair just normal production decline you all saw?

Davis Ravnaas, President and CFO

Good question. Matt or Bob, just wonder if you want to tackle that first? What do you think?

Matthew Daly, COO

Yes. In the last quarter, we noted that the 6% of the overall 7% decline was due to curtailments. All of those have been reversed in Q3 and are back online in the Eagle Ford and the Permian. The only area that hasn’t come back is the Bakken, where we estimate that current production is curtailed to between 90 and 100 barrels of oil equivalent per day. This production is currently offline, and we are optimistic that it will resume in Q4. If you divide 90 or 100 barrels per day by our current daily production of 14,160, you'll see the percentage of curtailed production is very small, but it can still have an impact. Once again, we are hopeful for its return in Q4.

Harry Halbach, Analyst

Great. Thank you. And then in regards to M&A, are you all seeing any meaningful split in interest for gas versus oil properties given the right divergence in the two commodities?

Davis Ravnaas, President and CFO

Yes, we have been active in mergers and acquisitions recently and will continue to look at potential acquisitions. However, we are cautious about using cash in the current environment as we prioritize improving our balance sheet and want to avoid raising equity at unattractive discounts. We are considering issuing units directly to sellers and have had success with that approach in the past. While we are still placing bids, the challenge is that our stock is currently undervalued, with a dividend yield of 12% and a free cash flow yield of 16% to 17%, making it difficult for M&A to be accretive. Sellers may need to adjust their expectations given the significant decline in stock prices of public companies like ours and our peers. Nonetheless, the opportunity to acquire private equity-backed portfolios remains, as these firms must eventually monetize their assets. In regards to the gas and oil mix, we have noticed increased competition in gas recently, although we were previously aggressive in that area with our Haymaker acquisition. We will evaluate gas assets but will not overpay for them, and some oil assets are becoming more appealing. Overall, while we see more competition in the gas sector than we did 6 to 12 months ago, it does not hinder our M&A strategy. We haven't lost any deals we really wanted on the basis of quality; any bids we made were fair and aimed at benefitting our shareholders. There have been many opportunities where we placed bids, but we haven't missed out on any critical deals due to price.

Harry Halbach, Analyst

Great. Appreciate you guys taking my question.

Operator, Operator

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

Rick Black, Investor Relations

Yes. Thank you for joining this morning and we look forward to speaking with you again when we report year-end and fourth quarter results. This completes today's call. Thanks everyone.

Operator, Operator

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.