Earnings Call Transcript - KRP Q3 2021

Operator, Operator

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. 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 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 kimbellrp.com. Information recorded on this call speaks only as of today, November 4, 2021. 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 disclosure on forward-looking statements. These factors and other risks and uncertainties are detailed 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 these metrics can be found at the end of today's press 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?

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 will begin today's discussion by providing comments about our third quarter before turning the call over to Davis to walk you through our financials in more detail. For the third quarter, Kimbell had record oil, natural gas and natural gas liquids revenue, record consolidated adjusted EBITDA, record net income and record cash available for distribution per common unit. The company was positively impacted by surging commodity prices, especially natural gas, that contributed to our record quarter. The operational momentum we identified in our last call continued, as evidenced by the 20% increase in our rig count at the end of the quarter compared to the end of the second quarter, led by natural gas-driven basins such as the Haynesville and Mid-Con. Our operational momentum today resulted from seeds planted in July 2018 with the completion of the Haymaker acquisition, which provided a world-class mineral position in the core areas of the natural gas-heavy Haynesville shale. That transformational acquisition over three years ago is proving very fortuitous in this market environment. For the third quarter, our run rate average daily production was 14,083 BOE per day on a 6:1 basis and was composed of approximately 62% from natural gas and 38% from liquids, of which 25% was from oil and 13% from NGLs. The prior-period production recognized in the third quarter of 2021 was primarily due to new wells outperforming previous estimates, reflecting our continued conservative approach for new wells. The combined momentum of improved pricing and production as well as controlling costs drove the positive operating leverage and expanded consolidated adjusted EBITDA to a record $33 million, an increase of 18% compared to the second quarter. We also had record cash available for distribution for the third quarter of $0.50 per common unit and declared a distribution of $0.37 per common unit or 75% of cash available for distribution, which was a 19% increase sequentially from Q2. 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 third quarter, private operators comprised 43% and public operators 57% of our active rig count. Overall, we believe this energy up cycle will last longer than previous cycles. Also, we believe that the modest increase in investment that is expected in 2022 will only serve to largely replace the significant depletion in drilled but uncompleted wells in the U.S. rather than providing much in the way of oil and natural gas production growth in the Lower 48 next year. The oil and natural gas royalty sector is particularly well positioned to benefit from this cycle since we participate in the upside from commodity price inflation, but do not experience the cost inflation that is currently being experienced by both the energy services and upstream sectors. We remain very bullish about the future of our space. In particular, we are optimistic regarding our differentiated business strategy that has consistently demonstrated a strong track record of production stability in our legacy assets as well as acquiring strategic portfolios, such as our Haymaker acquisition in 2018, in a disciplined fashion across active basins. We believe our low PDP decline rate and diversified royalty portfolio is a core competitive advantage for our company in the mineral and royalty space. In addition, we plan to remain focused on our role as a major consolidator in the highly fragmented U.S. oil and gas royalty sector, assembling a high-quality, low PDP decline and diversified royalty portfolio, generating recurring cash flow with growth potential and no capital requirements. This year has been challenging for acquisitions in the minerals and royalty industry. In fact, there has only been one significant publicly announced minerals transaction year-to-date in our space on the public side. We've been in this business a long time and have seen many different market cycles. This current situation is not necessarily uncommon. The minerals industry does go through cycles, where the bid-ask spread is so significant that people just aren't able to get deals done. However, history has demonstrated that the pendulum will swing the other way and often very quickly. And when it does, we'll be ready. Our long-term vision for Kimbell since inception has been a focus on sustainability and disciplined growth, and we will continue to be highly opportunistic in this mission. With modest growth forecasted for well production in the Lower 48, we believe that our production stability and flat PDP decline rates will be a winning theme for energy investing rather than the hyper-growth models of the past. As we disclosed previously, the results of our inventory evaluation of our portfolio, in coordination with Ryder Scott, a global engineering firm, illustrated that it will take a relatively low number of new net wells to maintain flat production due to our superior PDP decline curve. The results from this evaluation demonstrated that only approximately 4.5 net wells per year are needed to keep our production flat. And at this level, we have approximately 19 years of drilling inventory. This strengthens our belief and confidence that Kimbell was built for these conditions. We look forward to finishing the year strong and continue to be very excited about the future of Kimbell and its prospects for delivering unitholder value for years to come. And with that, I'll now turn the call over to Davis.

Davis Ravnaas, President and CFO

Thanks, Bob, and good morning, everyone. We are very pleased to report record quarterly results for the company in terms of both improving sequential operating metrics as well as record financial results. Third quarter total revenues were $31.8 million. Net income was approximately $7.5 million, and net income attributable to common units was approximately $1.8 million or $0.04 per common unit. Based on positive trends and improving cash flows in the quarter, we announced a significantly higher cash distribution of $0.37, up approximately 19% sequentially from Q2. As we have done in previous quarters, the company will utilize 25% of its Q3 cash available for distribution to pay down a portion of the credit facility. Since May 2020, the company has paid down $36.9 million of outstanding borrowings under its secured revolving credit facility by allocating a portion of its cash available for distribution to debt paydown, and we expect this capital allocation strategy to continue. For the third quarter of 2021, the company's oil, natural gas and natural gas liquids revenues were $47.6 million, up 23% sequentially from Q2. This primarily reflected higher third quarter average realized prices of $68.31 per barrel of oil, $3.86 per Mcf of natural gas and $28.77 per barrel of NGLs for a combined per BOE pricing of $35.16. Third quarter 2021 average daily production was 14,810 BOE per day, which consisted of 727 BOE per day related to prior-period production recognized during the quarter and 14,083 BOE per day of run rate production. The prior-period production recognized this quarter was primarily due to new wells outperforming estimates. We had 60 active rigs at the end of the third quarter, led by the Permian and Haynesville basins, which was up 20% from Kimbell's 50 rigs at the end of Q2. Our continental U.S. rig count represents 11.7% of total market share for rigs drilling in the Lower 48, up from 10.9% at the end of Q2. Based on the level of activity we are seeing on our acreage and improved pricing, we are reaffirming our 2021 guidance that we outlined earlier in the year. As of September 30, Kimbell had 770 gross and 1.69 net drilled but uncompleted wells as well as 674 gross and 3.02 net permits on its 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 $6.8 million in the quarter, $4 million of which was cash G&A, or $3.09 per BOE, which was flat from Q2. Third quarter consolidated adjusted EBITDA was $33 million, an increase of 18% compared to the prior quarter, and a new record for the company. Record net income for the third quarter was approximately $7.5 million, and the net income attributable to common units was approximately $1.8 million or $0.04 per common unit. The $0.37 per common unit distribution this quarter reflects a 75% payout of cash available for distribution. We will use the retained amount to pay down a portion of the outstanding borrowings under Kimbell's credit facility. Our capital allocation strategy continues to be focused on prudent management of the company's liquidity and balance sheet as a risk mitigation against future uncertainties. 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. As of September 30, 2021, we had approximately $180 million of net debt and 1.7x debt-to-Q3 trailing 12-month consolidated adjusted EBITDA. At the end of the third quarter, we have approximately $72.3 million in undrawn capacity under our secured revolving credit facility. Further to our balance sheet and capital structure work earlier this year, we successfully completed the redemption of 55% of the outstanding Series A cumulative convertible preferred units during Q3, and the redemption was funded through a borrowing from our secured revolving credit facility. We expect to redeem all remaining Series A cumulative preferred units outstanding in Q1 2022, further streamlining our capital structure and reducing our overall cost of capital. Before we open the call to questions, I would like to reiterate our guidance regarding the expected favorable tax treatment of future earnings and distributions to common unitholders that we provided last quarter. We do not expect Kimbell to pay a material amount of federal income taxes this year, 2021, through 2027. And also important, we expect that substantially all cash distributions paid to common unitholders from 2021 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 unitholders. Kimbell's current asset base as well as global energy sector tailwinds across the broader U.S. energy sector continues to give us confidence in our ability to generate strong operational results and cash distributions for unitholders 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 DUCs rather than lead to much in the way of new production 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 the significant downside risk of further input 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. With that, operator, we are now ready for questions.

Operator, Operator

Our first question comes from Chris Baker with Crédit Suisse.

Christopher Baker, Analyst

I just wanted to circle back on some of the acquisition comments Bob made earlier, just mostly curious if you've seen the bid-ask spread narrow at all over the past few months. And any additional color around what you're seeing on the M&A front would be great.

Davis Ravnaas, President and CFO

We have noticed that activity has increased significantly lately. I’m not sure if this is due to year-end tax considerations or a desire to finalize deals, but sellers seem to be adjusting to current public company valuations. Our company is currently trading at about 7.5 times distributable cash flow, while five or six years ago, quality royalty packages were valued at around 10 times. Unfortunately, that’s not the case in the current market. However, the situation is improving, and we are encouraged by that. We are actively engaging in discussions and negotiations with various sellers. Nonetheless, we need to remain very cautious and keep our bid prices low to ensure that any deals we pursue are clearly beneficial. The threshold for completing deals is quite high, which is why we've only seen two deals by public companies this year. This is surprising to many. Overall, I believe we're heading in the right direction and hope things continue to progress positively.

Christopher Baker, Analyst

Great. And just as a follow-up, I realize it's still early days, but it looks like a nice uptick in the activity backlog. Any color around how you guys are thinking about 2022 growth, just given what looks like a backlog well in excess of what you need to hold production flat?

Davis Ravnaas, President and CFO

Yes, I feel optimistic about that. I appreciate your observation. It is surprising that despite achieving a record number of records this quarter, our stock has decreased. This situation is unfortunate for our shareholders, but I believe it presents a great buying opportunity for many investors. As we look at the activity for 2022, considering the current gas prices, we believe we are in a favorable position in the Haynesville. We have many high-interest units there, and we anticipate strong drilling and completion activity. We hold a significant amount of acreage, especially in the Red River Parish, which was recently acquired by Southwestern. It would be hard to believe we won't see substantial positive results, especially in terms of gas production in that region. Does anyone else want to add to this?

Bob Ravnaas, Chairman and CEO

No, I'll just say that, I mean, that's also tempered with the fact that most operators are trying to be relatively flattish next year. But yes, Davis is totally right. The gassy areas in the Haynesville and Mid-Con are definitely seeing the most rig count growth for us right now.

Davis Ravnaas, President and CFO

Yes, Chris, this is a lengthy response. We aim to be realistic and do not promise unrealistic growth, as that's not our approach. We strive to provide conservative forecasts. While increased prices may lead us to be slightly more optimistic about expected activity, any guidance we share for 2022 will remain conservative. We have consistently met our guidance in the past.

Christopher Baker, Analyst

Great. No, I appreciate it. And if I could just sneak one more in. Any comments around how you're thinking about the payout ratio once the remaining preferred is redeemed? Just any color around the puts and takes and potential to see maybe a buyback if you see continued weakness in the share price here would be great. And I'll leave it there.

Davis Ravnaas, President and CFO

Yes, that's a good question, and feel free to keep asking since there are only 15 people on the call. We plan to eliminate the preferred shares, likely in the first week of January instead of the first quarter as initially stated. We have appreciated our partnership with Apollo, but we intend to redeem the remainder of that preferred stock in January, which is about 60 days away. It's nearly complete. After that, we will continue to pay down our debt for a while, but if we find ourselves trading at very low valuations, we may consider shifting cash flow towards stock buybacks instead of debt repayment. We remain active in seeking M&A opportunities, though our current bids are low and will only be accepted if sellers are willing to offer discounts. It wouldn't surprise me if we engage in some M&A using our stock and also consider buying back shares next year. Our goal is to strengthen our leverage to a solid level as there have been concerns about the overhang from the preferred shares, which I find puzzling. I want to emphasize that, barring any significant issues, we aim to resolve that in the next 60 days and then move forward positively from there. Matt or Bob, do you have anything to add?

Bob Ravnaas, Chairman and CEO

No, totally nailed it.

Davis Ravnaas, President and CFO

I want to add that I have never felt better about the state of our business. It's great to see activity on our acreage and an increase in gas prices. We've faced criticism in the past for our 61% natural gas focus. When we acquired Haymaker in 2018, it was not favored at all. The minerals we obtained were largely related to Chesapeake and were under Abry's position, which he established during the peak of the Haynesville. They did not sell those minerals to the Haymaker team, and we later purchased them from that team. I believe we have an unparalleled position in the Haynesville, and we feel positive about the price realizations, as shown in the data. Overall, I've never been more optimistic about the business. The tax shield is intact, and we are currently trading at a 10% tax-free dividend yield. I can't think of anywhere else you would find that. Our company's leverage is reasonable and improves each quarter. The free cash flow yield is even greater, and it all comes as nontaxable returns to capital, making us view this as an excellent investment. We are managing this conservatively, and if we do pursue any purchases, it will be at a price that seems incredibly attractive. Is there anything else? Bob, do you want to contribute anything?

Bob Ravnaas, Chairman and CEO

No.

Operator, Operator

There are no further questions in the queue. I’d like to hand the call back to management for closing remarks.

Bob Ravnaas, Chairman and CEO

Thank you very much. Look forward to a very good fourth quarter call in 3 months.

Operator, Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.