Viper Energy, Inc. Q4 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Viper Energy Partners Fourth Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Operator instructions. Please be advised that today's call is being recorded. Operator instructions. I would now like to hand the call over to Adam Lawlis, Vice President, Investor Relations. Please go ahead.

Thank you, Michelle. Good morning, and welcome to Viper Energy Partners' fourth quarter 2020 conference call. During our call today, we will reference an updated Investor Presentation, which can be found on Viper's website. Representing Viper today are Travis Stice, CEO; and Kaes Van't Hof, President. During this conference call, the participants may make certain forward-looking statements relating to the company's financial condition, results of operations, plans, objectives, future performance, and businesses. We caution you that actual results could differ materially from those that are indicated in these forward-looking statements, due to a variety of factors. Information concerning these factors can be found in the company's filings with the SEC. In addition, we will make reference to certain non-GAAP measures. The reconciliations with the appropriate GAAP measures can be found in our earnings release issued yesterday afternoon. I'll now turn the call over to Travis Stice.

Thank you, Adam. Welcome everyone and thank you for listening to Viper Energy Partners' fourth quarter 2020 conference call. Viper's financial and operational performance rebounded strongly in the second half of last year, after surviving the unprecedented volatility experienced through most of 2020. Commodity prices have increased and associated activity on Viper's acreage has increased alongside the commodity. Even in a year where we experienced historically low commodity prices, Viper was able to generate almost $200 million in operating cash flow, which was almost entirely converted to free cash flow due to our business having zero capital requirements. This recovery again highlights both the advantaged nature of the relative business model as well as the benefit of Viper's symbiotic relationship with our parent company Diamondback. Looking at the fourth quarter specifically, Viper's 10% quarter-over-quarter increase in oil production was driven primarily by Viper having an interest in 21 of Diamondback's 35 completions with well performance exceeding internal expectations. Viper also benefited from third-party operated well performance and timing of wells being turned to production outperforming our prior conservative expectations, which had been lowered due to the uncertainty presented by the volatile oil prices experienced early last year. Viper was once again able to generate significant free cash flow both organically as well as inorganically through non-core asset sales, which accelerated in the fourth quarter. The truly unique nature of Viper's business model is highlighted by the fact that during the fourth quarter alone, we were able to declare a $0.14 distribution, repurchase over 2 million units, and repay over $40 million in debt. Over the past nine months, we have now reduced total debt by $110 million or roughly 16% over this period. Further, the units we have repurchased today represent 1.6% of total units previously outstanding. Looking ahead to 2021, we have initiated production guidance for 2021 that incorporates our strong backlog of work-in-progress plus line-of-sight wells, as well as the anticipated impact to our production from the recent winter storms in the Permian Basin. Viper is expected to have meaningful exposure to Diamondback's high graded primarily Midland Basin focus to development in 2021. Additionally, visibility into third-party operators anticipated activity levels continues to increase, as commodity prices have improved and operators have returned to work. However, in an effort to be conservative, we'll continue to incorporate slower than normal timing assumptions in the guidance we have provided. Despite this conservatism, along with the production impact from the recent winter storms, Viper is still expected to generate roughly $250 million in free cash flow this year, assuming $55 WTI in production at the mid-point of our full-year 2020 guide. This equates to greater than 8% free cash flow yield as a percentage of our enterprise value, or roughly 10% based on our current market cap. Viper remains in strong financial shape with $515 million of liquidity and will look to continue to decrease leverage, while also increasing return of capital to our unitholders over the coming quarters. In conclusion, 2020 was truly historic for all the wrong reasons. Despite these difficult conditions, Viper showcased its differentiated business model and best-in-class cost structure to emerge from this down cycle with a positive forward outlook. Operator, please open the line for questions.

Operator instructions. Our first question comes from Neal Dingmann with Truist Securities. Your line is open.

Good morning guys. I'm trying to figure out here with your guidance, maybe give me a little bit of help here. You mentioned that all the wells that are in processing 529 you put in there and then you talked about the 538 wells that are in-site. Just wondered, could you talk about what's included in the guide? Is that just these wells or maybe the expectations for total wells around that?

Yes, Neal, good question. I think we're assuming somewhere in the range of 9 to 10 net Diamondback wells throughout the year. While we had a lot of high-interest Diamondback wells come on in Q3 and Q4, we're taking a bit of a pause there based on the schedule today. So that number will come down a little bit here in Q1, but pick back up in Q2 of 2021. And then we're assuming somewhere around one net well a quarter on the non-op side. I think that is probably a little more back-half weighted than the Diamondback plan. But we're pretty excited about the amount of net wells we're seeing on the non-op side start to get permanently drilled and eventually completed here as commodities recover.

Okay, no, that makes sense. I think it was maybe back-weighted. And just one follow-up, should we think about that 58% oil weighting and I think the NRI run was around 6%? Is that going to be somewhere in that ballpark going forward?

I think the oil weighting at 60% is a fair assessment and the plant-operated NRI is 6%.

Yes, that's probably about right — 6% to 7%. We've talked about it as percent exposure to the standalone Diamondback development plan, so probably roughly 70% exposure to that plan. That'll decrease as future guidance is incorporated. But yes, I think 6% to 7% average NRI throughout the year will be fair.

Operator instructions. Our next question comes from Derrick Whitfield with Stifel. Your line is open.

Hi. I wanted to circle back to your comments on visibility at a high level, referencing your forward visibility slides on Pages 7 and 9. Could you comment on how we should think about Diamondback's contribution to Viper post the QEP and Guidon transactions? Would it be safe to assume the combined value of work-in-progress and line-of-sight wells would remain around that 10 to 11 net wells or in line with Q3 and Q4 levels?

Yes, I think that's right, Derrick. We'll get into this later in the call, but we do have a lot of opportunities to increase mineral ownership under QEP and Guidon. We didn't own many minerals under those entities prior to announcing the deals. Our team is working to get more exposure under the pads where we have visibility, including areas where permits may not yet be filed, to get a position on attractive opportunities. I don't think the addition of QEP or Guidon changes the number of net wells under Diamondback for the year, but as the year progresses there will be opportunities to increase that number with selective purchases of minerals under the pro forma Diamondback development plan.

Okay. That was, in fact, my follow-up. With the pending successful closure of both of these transactions, could you put some parameters around the greater A&D opportunity that presents to Viper?

Yes, it's pretty significant, Derrick. We've been working the pro forma development plan to make sure we're buying selectively. We also need to manage our balance sheet appropriately. The capital allocation decision for us is going to be whether we continue buying back shares, use cash to buy minerals, trade minerals, or continue to sell non-op minerals like we did in the fourth quarter. That market continues to heal. If you think about Viper, we no longer need to be the biggest mineral company out there; we need to be the best. To be the best means we have to have more visibility into the other side of our business, which we're trying to do here by buying more minerals under Diamondback.

Operator instructions. Our next question comes from Gail Nicholson with Stephens. Your line is open.

Good morning. When looking at that $250 million of free cash flow generated at $55 oil, how do you bucket that from the standpoint of cash distribution payment to shareholders versus debt reduction versus continuing buybacks and/or future M&A events?

Yes, Gail. We're pretty happy with 50% of distributable cash flow going to investors in the form of the distribution right now. The board had a very active discussion on the buyback, and we're pleased the buyback has worked to date. The buyback versus buying more minerals under Diamondback is really the fulcrum here, because probably a quarter of our free cash flow still goes toward debt reduction. We want our revolver to be at or as close to zero as possible by the end of this year, and we're well on our way to doing that. We have visibility into a revolver at zero and our bonds are trading well, so I'm not concerned there. With more free cash flow, the distribution percentage will likely increase over time.

Great. And then looking at the over $40 million in asset sales that were done this quarter, were those smaller packages or was there a larger package? Can you just talk about what that divestiture activity looked like for you guys?

Yes. It was really four deals — two small, and two of decent size. The two of decent size were one in the $12 million to $15 million range and one close to $20 million. Those were all third-party non-operated assets not operated by Diamondback, with limited visibility, not many permits, no existing meaningful production. We were happy to get those deals done. They accelerated the deleveraging process and also allowed us to buy back a lot of stock in December and January when the stock was weaker than it is today. We ended the year under three times leverage, which I think is a testament to the team getting these deals done before year-end and not touching that three-times threshold that we don't want to go above.

Operator instructions. Our next question comes from Pearce Hammond with Simmons Energy. Your line is open.

Yes, good morning, and thanks for taking my questions. First, congrats on the success of fortifying the balance sheet. What leverage ratio are you targeting for the balance sheet? And when you reach that target, would you expect to increase the payout ratio? Or is the payout ratio a function of how much stock you expect to buy back?

Yes, good question, Pearce. It's more about gross debt reduction; as I said earlier, getting the revolver down to zero is a priority. With the forward strip where it is, the forward free cash flow outlook looks strong enough that we will be comfortably under 2.0x net leverage by the end of the year. Longer term we prefer to be in the 1.0 to 1.5 times range while also paying down gross debt. So the first step is under 2x, and I think that will happen pretty quickly with the strip where it is. But, like Diamondback, I don't think that precludes us from continuing to increase returns to unitholders in the form of the distribution.

Thank you, Kaes. And then as a follow-up, as the balance sheet is strengthened, would the desire to hedge decline as well?

I think we've learned that some small amount of hedging at Viper to protect the downside or to protect a minimum distribution and a maximum leverage is probably going to be in the cards. I don't think we'll hedge all of our production, but certainly protecting the downside and guaranteeing some returns to investors and simplifying the business is probably prudent over a longer period.

Okay, thank you, Kaes. And as a comment, I'd love the prepared remarks where Travis said '2020 truly historic for all the wrong reasons' — well put.

Yes, thank you.

We're onto 2021.

There are no further questions. I'd like to turn the call back over to Travis Stice, CEO, for any closing remarks.

So before Travis speaks, there wasn't a question about the storm impact in Q1. I just want to give investors some guidelines around the year because Guidon was taking down a little bit of Viper. We're assuming four to five days of downtime on Diamondback-operated properties, and we're assuming five to seven days of downtime on non-op properties just to be conservative, then getting the production back online. I point people to look at Q1 as very similar to what we produced in Q2 of 2020, but then expect some pretty significant growth after that in Q2 through Q4, which roughly equals a similar oil production guide to where the Street was prior to the storm impact. So, while the storm impact will be meaningful in Q1, we do expect a pretty quick rebound in Q2, and we saw some positive things early in Q1 prior to the storm. Travis, I'll let you close.

I appreciate those comments, Kaes. Thank you again to everyone participating in today's call. If you have any questions, please contact us using the contact information provided.

Ladies and gentlemen, this does conclude the program and you may all disconnect. Everyone have a great day.