Viper Energy, Inc. Q1 FY2022 Earnings Call

Good day. Thank you for standing by, and welcome to the Viper Energy Partners First Quarter 2022 Earnings Conference Call. Please be advised that today’s conference call is being recorded. I would now like to hand the conference over to your speaker today, Adam Lawlis, Vice President of Investor Relations.

Thank you, Cherry. Good morning, and welcome to Viper Energy Partners’ First Quarter ‘22 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’ First Quarter 2022 Conference Call. During the first quarter, Viper continued to build on its track record of delivering strong financial and operating results highlighted by the 43% quarter-over-quarter increase in our distribution to $0.67 per common unit. This distribution represents approximately 70% of the total cash available for distribution and implies a 9.5% annualized yield based on yesterday’s unit closing price. Additionally, we repurchased 1.6 million common units during the quarter at an average price of $24.84 per unit for a total cost of $39 million. Combined with the distribution, this represents a return of approximately 95% of free cash flow to our unitholders. Looking ahead, we continue to focus on maximizing long-term returns to our unitholders and believe we are differentially positioned to do so with our best-in-class cost structure that enables investors to participate in the recent strength seen in commodity prices via the highest margins in the public oil and gas industry. Importantly, with zero capital requirements and only limited operating costs, Viper will not face the inflationary cost pressures being seen across the industry and broader economy. As a result of the strong production seen during the first quarter, as well as continued strong levels of activity across our acreage position, we have increased our guidance for oil production for the full year by roughly 1.5% at the midpoint. Our 23.5 net wells currently with visibility to development is a company record and underscores our confidence in this forward outlook. This record amount of activity, which is enhanced by Diamondback’s continued focus on developing our concentrated royalty acreage, demonstrates both the quality of our acreage as well as our ability to grow production without having to spend a single dollar of development or acquisition capital. Based on the midpoint of this full year 2022 production guidance, Viper is expected to generate over $3.75 per unit in distributable cash flow, assuming $95 WTI. With a 70% payout and an opportunistic unit repurchase program, Viper offers a competitive cash return yield that provides maximum exposure to commodity prices with limited operational risk. In conclusion, the first quarter was an outstanding quarter that was record-setting on almost every metric. The record results of our business highlight our quality asset base, best-in-class cost structure, and overall differentiated business model. Given the strength of our balance sheet, we have evolved our hedging strategy so that we can maximize upside exposure to commodity prices while also protecting against the extreme downside. We look forward to continuing to generate robust amounts of free cash flow and maximizing returns for our unitholders. Operator, please open the line for questions.

Your first question comes from the line of Neal Dingmann from Truist Securities.

Nice results. Kaes, perhaps you or Travis can address how you view the recent buybacks alongside the record payout on the distribution. I'm curious if you consider the mineral business differently in this regard compared to your approach to diversification.

Yes, that's a great question, Neal. I believe Viper is one of the pioneering cash distribution vehicles in North America's oil and gas sector. When the business went public in 2014, exploration and production companies were still using all of their cash flow, often exceeding it to fund growth, and Viper benefited from that while still distributing cash to investors. We still have debt, so we won’t distribute all of our cash each quarter. The current deal market is challenging, so there's additional cash above the 70% of free cash flow that will be used to pay down debt and bring our revolver closer to zero. After that, we can discuss increasing shareholder returns. The buyback authorization has had a positive impact on our story. Given the volatility in this space, we've had chances to buy back shares, making it a solid defensive strategy. A recent example is what we accomplished in Q1 by buying back some Blackstone units from the Swallowtail deal. Generally, 70% is the baseline for cash distribution. As long as our balance sheet improves and our unit price increases, we will be proactive in distributing more than that quarterly.

Okay. Lastly, regarding the confidence in increasing production, is it mainly based on the visibility you're observing? I assume you have no expectations of any remaining dropdowns from Diamondback, so is it primarily about potential increases from third parties for the rest of the year?

Yes, Neal. For the most part, it’s just having that increased visibility to the non-op side. We don’t like to be too aggressive in making assumptions with timing that we can’t control. So typically, we put out that rolling 6-month guidance because that’s a rough timeline for when the well gets spud to when it gets through to production. So as we fast forward through the year and activity remains strong, we just have further visibility to the back half of the year, and that gave us the confidence to increase that outlook.

Your next question comes from the line of Chris Baker from Credit Suisse.

Congrats on the quarter, solid cash flow and cash return update. If I could ask sort of a similar question, maybe perhaps a different angle here. So last year, it looks like the buyback plus the variable dividend return roughly 80% of cash available. I’m just wondering if that’s a fair baseline to try to think about the pace of the buyback for the rest of the year?

Yes. I still think that the buyback, Chris, is going to be opportunistic. So I don’t want to say that we’re going to hit a certain amount of units a month or a trading day or a quarter. Kind of like we said on a call earlier today, this market has provided us a lot of opportunities to buy back shares opportunistically. And I think we’re going to have that opportunity at Viper. But we do want to adhere to a top. But I think right now, where Viper’s trading, we’re going to have chances to buy back shares. I think it would be fair to say 80% or 85% of total cash gets returned through the dividend plus the buyback. But if we get another opportunity to buy a big chunk of stock, like we did with the Blackstone trade in Q1, we’ll entertain that opportunity if it presents itself.

Great. Yes. That makes a lot of sense. As a follow-up, I appreciate the additional information in the presentation regarding the bank operated inventory. I'm curious how many third-party locations you would add on top of that. Additionally, if I could ask one more question, how many net completions do you think are necessary to achieve a mid-single-digit oil compound annual growth rate? It sounds like it might be over 20 years, so I'm interested in how you would frame that regarding the inventory.

Well, I think the inventory question, you can take the Diamondback inventory and assume most operators in the basin are using similar spacing and economic zones to Diamondback. So you could roll that up on the non-op side. We certainly have a lot more confidence in the pace of development on the Diamondback side and we can get those net wells drilled faster, so your pace is a little slower in the non-op piece. But the inventory wise, it’s still there. And then on growth, I think we’re projecting some growth this year. Obviously, the forward visibility is as high as it’s ever been and growth is balancing that. I don’t know, Austen, how many net wells a year keeps you growing?

Yes. This year, we're expecting approximately 11 to 12 net wells from the Diamondback side and about 5% to 6% from the non-operated side. Looking at how we finished last year, factoring in the Swallowtail acquisition, I would estimate around 17 net wells would lead to around 5% organic growth. Our base decline has also decreased slightly as activity has slowed in the past couple of quarters. Moving into 2023, I would estimate needing around 16 net wells per year to keep production stable, and with our current activity levels and future outlook, we can likely achieve some growth from that.

Great. Yes. It sounds like definitely differentiated inventory depth. Appreciate the update, guys.

Yes. I think I’ll add on that is that the Swallowtail deal gets developed, that confidence in the Diamondback growth is only enhanced. I think when we announced the deal, we said we’ll get to 5,000 barrels a day net by 2025, and that looks on track. So that’s going to help the growth profile of the rest of the business.

Your next question comes from the line of Derrick Whitfield from Stifel.

With my first question, I wanted to touch on the Ward County acquisition that Diamondback announced yesterday. In light of its elevated NRI and the premium paid for it, is the incremental NRI with that asset something that you’d envision dropping down at some point to Viper?

Yes. I think that’s logical to have that discussion. We’re doing our work now. I don’t think there’s a rush necessarily, given that Diamondback is just starting developing that position. So you won’t see much production until the end of the year or next year. But there’s probably a time where Viper and Diamondback can get together to get a deal done here. It’s just not priority #1 today in Q2.

That makes sense. And then kind of looking out over the balance of the year and even further out into 2023, how should we think about your cash tax exposure for distributions in light of the current higher prices that we’re seeing?

Yes. When Viper transitioned to a taxable partnership from an MLP, we made an arrangement with Diamondback to protect investors from potential cash tax liabilities resulting from the conversion. This included a significant special income allocation that provided that protection. Given the current commodity prices, that protection will likely be exhausted this year. Therefore, aside from depletion protection, Viper is expected to become a significant cash taxpayer in 2023 and beyond. Austen, do you want to add anything?

Yes. And Derrick, listen, what’s important for this year is we put out that guidance of 10% to 15% on effective cash tax rate, but that’s only for the income that’s retained at the Viper LP level. So as Kaes outlined, we still have that special allocation of income going back to Diamondback. So if you look at it this quarter, 85% of the pretax income went into Diamondback and they paid the taxes at that level. Then the 15% remains at the Viper LP level, which is then subject to that tax rate that we put out guidance for. Going ahead to next year, Diamondback will just get their pro-rata ownership 54% to 55% of the pretax income. So there’ll be more absolute dollars at the LP level, and we’ll probably pay a slightly higher rate on that as well.

Your next question comes from the line of Jeanine Wai from Barclays.

Our first question, maybe just hitting back on the minerals market. You mentioned there may not be as many deals out there as there was before, so that skews the cash distribution higher, which is terrific. But can you just provide a little bit more color on what’s going on out there in the market, in particular for differently sized deals?

Yes, it's challenging. There's been a lot of consolidation in the mineral sector. As commodity prices rise, especially at the beginning, well owners are receiving substantial payments each month. As a buyer, we remain disciplined and will not overpay for those assets, particularly not at exorbitant multiples. I believe we will still be very competitive for larger packages like the Swallowtail deal. However, we haven't had much success with significant transactions so far in 2022. Austen, do you have anything else to add?

Yes, that's accurate. We're still seeing transactions despite the higher commodity prices, but most of the deals are structured with visibility, whether it's through ducts or permits. Given that production is expected to increase with the higher prices, at least based on today's market conditions, we're still underwriting lower price decks that we haven't previously engaged with, and we're competitive in those areas. Moreover, our focus isn't solely on short-term gains; we're looking at longer-term strategies. We're collaborating with Diamondback to understand the development plan for the next two, three, or even four years, and attempting to add inventory where we can support a lower price deck. While we need to be patient and innovative, I believe there are opportunities for some smaller deals to emerge.

Okay, great. And then for a follow-up question, I apologize for hitting back on cash returns again, but maybe following up on Neal and Chris’s question. In terms of the expanded buyback program, can you just talk a little bit more about how you decide between the buyback and the payout ratio? I know at FANG, you talked a lot about mid-cycle pricing. It’s not necessarily about intrinsic value, relative value. You’re looking at the track record of buybacks in the industry is not so great, and you guys want to buck that trend. So can you just talk a little bit more about how you’re thinking about that for VNOM?

Yes, Viper's 70% is there, which reflects in the fixed part, but with a variable distribution. We maintain an internal view of NAV at Viper and consider what we can purchase in minerals on the market through Viper stock compared to the private market. The private market is very active, leading to a lower implied dollar commitment per acre for better acreage with higher visibility. This gives us confidence that we can acquire reserves through our stock price instead of through ground deals.

Your next question comes from the line of Kyle May from Capital One Securities.

Just a quick question looking at unit costs. It looks like in the first quarter, unit costs were lower versus your guidance. So just kind of curious how we should be thinking about those trending through the year.

I think we’re in good shape. There’s a little bit of noise in G&A throughout the year. So I think we feel like we’re going to hit those numbers there. Now if we’re able to continue to pay down interest expense or bid on our revolver aggressively, then we could be towards the lower end of our interest expense guidance throughout the year.

Yes. The good thing, Kyle, is most of those cost items are pretty sticky. We’re not getting faced with inflation there. So hopefully, if the performance continues to outperform, they trend lower on a dollar per BOE basis. But generally, if you model them on an absolute basis, I think that will be pretty fair.

Okay, great. That’s helpful. And also on the hedging front, it looks like you removed the oil collars that were in place for 2Q. Just wanted to get your latest thinking around hedging at Viper.

Yes. It’s kind of evolving into a similar story as we experienced at Diamondback, where we are purchasing puts to protect against significant downside risks. We definitely don’t want to revert to a situation where we have to reconsider our distribution policy. By buying options at $50 and $55 and above, we are safeguarding against extreme downside scenarios in a challenging market where leverage is not effective, while still providing substantial distributions. We aim to enhance our upside exposure by purchasing puts instead of using broader collars.

Your next question comes from the line of Leo Mariani from KeyBanc.

I wanted to follow up on one of the prepared comments here. Obviously, you all bought a nice chunk of stock from Blackstone in the first quarter. Just so I heard you right, it sounds like you guys would be very open to doing more deals like that if the opportunity presents itself?

Yes. But price sensitive, Leo, we’re not looking to just follow through our buyback program just to do it. We’ve got a big advantage of pullbacks in the market. And I think we’ve got opportunities here over the last couple of months to do so.

Got it. Okay. And lastly, I wanted to clarify on cash taxes. It seems like you expect the rate to increase next year, and you mentioned that your cash tax shield is around 55%. I just wanted to understand that part better, and I suppose that relates to the ownership interest of VNOM and FANG?

Yes. Basically, high level, the shielded income from the parent company to the public unitholders is going away next year. This is the last year of it. And so a small amount of cash taxes this year, but stepping up pretty meaningfully next year.

All right. I’m showing no further questions at this time. I would now like to turn the conference back to Travis Stice.

Thank you again to everyone for participating in today’s call. If you’ve got any questions, please reach out using the contact information provided.

This concludes today’s conference call. Thank you all for your participation. You may now disconnect.