Viper Energy, Inc. Q2 FY2022 Earnings Call

Good day and welcome to the Viper Energy Partners 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker Mr. Adam Lawlis, Vice President, Investor Relations. Please, go ahead.

Thank you, Sherry. Good morning and welcome to Viper Energy Partners second quarter 2022 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' second quarter 2022 conference call. The second quarter was an outstanding quarter for Viper. Oil production grew 9% quarter-over-quarter, which, combined with the benefit of increasing commodity prices and no inflationary cost pressures, resulted in a 20% increase in cash available for distribution. Importantly, the significant increase in production was driven primarily by a record 4.8 net wells being turned to production by Diamondback during the quarter. As a result of Diamondback's consistent focus on developing Viper's high-concentration royalty acreage, primarily in the Northern Midland Basin, as well as continued strong activity levels by third-party operators, Viper is increasing our guidance for oil production for the full year 2022 by 4% at the midpoint. This is the second time we've increased our production guidance for the year, with the midpoint now 1,000 barrels a day higher than our initial production guidance. Despite Diamondback and many other larger Permian operators committing to a maintenance capital plan over the past year, Viper has had oil volumes grow 20% over the same period. Additionally, Viper today announced the next step in the evolution of our capital return program. Beginning in the third quarter, the Board has approved an annual base distribution of $1 per unit, which provides a competitive yield of 3.3% at today's unit price and would represent an annual distribution roughly equal to 50% of our estimated cash available for distribution assuming $50 WTI. The Board also approved an increase to our return of capital commitment to at least 75% of cash available for distribution. To meet this commitment, our base distribution is expected to be supplemented by additional return of capital in the form of variable distributions and opportunistic unit repurchases. This enhanced return of capital framework, along with the increase in the unit repurchase authorization, displays the confidence we have in our forward outlook. The optionality provided by the variable return of capital beyond our base distribution will allow greater flexibility in taking advantage of extreme market volatility and the current dislocation from the long-term intrinsic value of our asset base. Going forward, we remain committed to generating the highest value proposition for our unitholders, whether that be allocating capital to a growing base distribution, variable distribution or opportunistic unit repurchases. In conclusion, the second 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. Viper remains differentially positioned to grow production without having to spend a single dollar of development or acquisition capital. And as a result, we also expect to generate unmatched per unit growth and returns. Operator, please open the line for questions.

Thank you. Our first question will come from Neal Dingmann with Truist. Please go ahead.

Good morning. Thanks for the brief comments. My first question is on the record wells turned to production last quarter, definitely notable. And I'm just wondering, are you expecting to continue at this pace? And wondering are there external opportunities to boost third-party interest which obviously would help the net well results going forward?

Hey Neal, this is Austen. So the second quarter, I mean if you look at the Diamondback loss turned to production, 4.8 for the quarter, that was a company record for us. Even going back to the days when Diamondback was running 20 to 25 rigs, this was still a really strong quarter with 85-plus percent exposure to Diamondback completions with about a 9% NRI. We probably won't maintain quite this pace. But when you look at it on an annualized basis, you're still looking at 11 or so net wells for the year. I think we can grow from that on an annual basis going forward. On the third-party side, it was a little bit of a lighter quarter, but we definitely have some higher interest up in the back half of the year. So I think that's going to support the production profile for the remainder of the year. And Diamondback is going to continue to focus their activity on our higher royalty acreage in the Northern Midland Basin. So it should be a strong combination of wells being turned to production here for the foreseeable future.

Great details. Thanks, Austen. And then second question Kaes probably for you just looking at capital return specifically, as Travis mentioned in his remarks or in the press release the new 75% minimum capital commitment. I'm just wondering, how do you balance this? And I know you all continue to want to pay down a bit of debt. So just wondering on that go forward, how do you balance this? And is there a certain point where you get debt down to where that payout would be well over 75%?

Yeah. Good question, Neal. I would say generally, the move to 75% took a lot of thought and consideration, on the Viper side particularly moving to a base distribution which can be seen as basically a base dividend like at the Diamondback side, but it's a little bit higher on a yield basis. And then maintaining that flexibility to repurchase units or pay a variable with the other 75% of free cash flow. This puts a governor on us for the other 25%. We definitely want to continue to try to consolidate new deals here and there, which gives us cash to do those deals. If we don't find any deals in a particular quarter, we'll pay down debt, like we did pretty aggressively in Q2. So I think it puts the governor on the return to unitholders, but they know that that's coming quarter in and quarter out. And the other 25% we have a little bit of flexibility to consolidate here and there if deals pop up or continue to pay down both the revolver and our senior notes.

Great job. Heck, the yields still out there. Thanks, guys.

Thanks, Neal.

Thank you. One moment for our next question. That will come from the line of Chris Baker with Credit Suisse. Please go ahead.

Hey, guys. Congrats on another beaten race quarter. Just to kind of follow up on Neal's question. I guess, where the stock is today, is there any reason to think that the quarterly dividends in the second half will be above that $0.25 per share base level? And then just is it fair to assume the residual cash again just given where the stock is, they would go to an accelerated buyback?

Yes. That's kind of the flexibility that we wanted to get from the Board with this new plan Chris. I think, generally we wanted to have a pretty high base dividend. As Austen mentioned, that would be about 50% of free cash flow at $50 oil. So it's a sizable base dividend. But generally, with the dislocations we've seen in the equity markets just like we talked about on the Diamondback call, I can't – we can't go buy a mineral in a Tier 1 area for anything close to where we're trading today in the public market. So I think it just continues to highlight the disconnect between oil and the public markets versus oil in the ground. As a result, we're going to be leaning into the buyback here. If we continue to see weakness, we'll just continue to lean into it. And that's why the Board wanted to be so aggressive with the size of the increase.

Great. Thanks. And just as a follow-up, I realize it's still early days but perhaps for Austen on 2023, can you just remind us the exposure Viper has to Robertson Ranch? And how many net wells that could potentially contribute to next year's program? I know you guys have been working on building out that water and gas processing adds there. Thanks.

Yes. We're really just starting to get active in the area. I kind of put sale on Robertson Ranch as one block together. There should be three or four rigs consistently running over the next few years in that block. So I think that's the kind of the benefit of the story this year is we're outperforming expectations. The years continue to look better. Non-op activity has continued to go up, and we're still not even in the core blocks that we're going to start developing here pretty soon.

Thank you. One moment for our next question, that will come from the line of Jeanine Wai with Barclays. Please go ahead.

Hi, good morning, good afternoon. Thanks for taking my questions.

Hey, Jeanine.

Good morning. Maybe our first question is just on the potential drop-down of NRIs from Fang's recently acquired Ward County acreage. Is this more pushed out in time as you prioritize debt reduction because you got the revolver in 2027, so maybe that's more likely to be a 2023 plus type event?

Yes. We really don't have a set timeline or plan to drop that down. Certainly, there needs to be a little more development on the block before we consider it. But I think it's generally a deal that Viper could handle with cash if the time comes. But generally starting to drill on that position, certainly need cash flow before that conversation can happen.

Okay, great. Thank you. And then a follow-up question maybe dovetailing on Neal's question. You've got a lot of third-party operators and your work in progress well. Have you seen any kind of change in that type of activity just broadly either in the industry or on your NRI with what we're seeing in oil prices and kind of the continuing tightening in the service price environment?

No Jeanine. I mean from a gross level, we've seen pretty steady activity I think on the third-party side pretty much for the past nine months or maybe a year even when you look at the rig count or the leading-edge indicators with the permitting activities. So that's increased staying pretty steady and we haven't really seen any slowdown or increases for that matter given the macro backdrop. With that said, with the activity that's going on now and will be resulting in the Midwest turn of production in the back half of the year, I think you'll just see the NRI bump up a little bit on the third-party side. So maybe the net well is probably a little closer to where they were in Q1 as opposed to Q2 for the third party. But really, it's just all of your big public guys that are really active right now in the Martin and Midland Counties driving the majority of our activity on the third-party side.

I think what's also changed a little bit is as all of us have gone to bigger pads, the lumpiness of both operated and non-operated production has picked up a little bit. But generally, that means if you do have minerals in a non-operated unit, you're very confident that that unit is going to get developed all at once rather than over the course of five or six years like we used to look at things in the past.

Great color. Thank you, gentlemen.

And one moment for our next question. That will come from the line of Leo Mariani with MKM Partners. Please go ahead.

Hi, guys. I wanted to dive a little bit more into the kind of the share buyback versus the variable distribution optionality here. I totally understand that at the parent level for FANG, but I guess just maybe from my perspective, a lot of people look at VNOM as more of a yield vehicle and really count on it for these really fat juicy variable dividends, which obviously all paid here in the second quarter. So can you just provide maybe a little bit more color if the shares are depressed could there be just a much higher level of buyback versus variable distribution, or is it still going to continue to be the variable distribution as the main avenue of returning capital to shareholders?

Leo, that's a good question. Generally, we would prefer to allocate more resources to the buyback at Viper, as that aligns with the business's original intent. From the perspective of Diamondback, I value the distribution to the parent company, but we also need to appreciate the worth of our investment and the potential of this business. In my opinion, minerals should be valued at a significant premium compared to E&Ps, as they represent the highest level of security in the oil field. If an operator loses or needs to extend a lease, they must compensate us, and this business is not affected by inflation concerns. It's frustrating to see a business that has increased oil production by 20% year-over-year, repurchased 3% or 4% of its stock, yet the yield remains very high. That’s why we are eager to invest in buybacks when there’s dislocation in the market. Ultimately, the main focus for this business is being a distribution vehicle, which is why we've set such a high base distribution. Once the equity markets appreciate the value of oil assets in the Permian Basin again, we will cease buybacks and instead provide a substantial distribution.

Okay, great. And I guess just as another question here for you folks. Obviously, you guys haven't done much really on the M&A side. I understand you're basically saying that the asset values in the private market are too high. Maybe you could give us a little bit more color around that market? I know that you all are not participating at the VNOM level, but are you seeing other deals trade hands out there in the mineral space, or are you just kind of seeing a general slowdown across the whole sector where maybe a lot of deals are being shown at these high prices but buyers just aren't as interested?

Yes, we've actually seen quite a bit of stuff transact over the first half of the year and kind of continued here into the summer. I think there's really two points to note, though: most of that's been stuff that has a lot of DUCs and permits on it, and key people are willing to pay a premium there for that visibility to production and cash flow. With our relationship with Diamondback, we can kind of get that same level of confidence by buying further out in the drill bit and just get it for a lot cheaper without having to compete with all the other players in that same small bucket. Really for us, it just all boils down to that. It's a pretty high hurdle right now for M&A. I mean we can look at our Diamondback operated production being 60% or two-thirds of our total production, and heavily high confidence that it's going to grow over the next three to five year period. To buy a mineral in the Permian that you have that same level of confidence in is just a pretty high hurdle. So, we're continuing to filter around, and I think maybe things have softened a little bit from a couple of months ago, but we're just staying really disciplined on that front for now.

Yes. And it kind of goes back to that comment I made about full units being developed. The prices being paid for DUCs and permits are pretty shocking to us on our side. So I think generally, if we use cash to do deals and buy stuff that's further out on the drill schedule, that should support the longevity of this business rather than chasing the next deal to boost near-term cash flow.

Okay. Great color. Thanks.

Thank you. I'm showing no further questions in the queue at this time. I would now like to turn the call back over to CEO, Travis Stice for any closing remarks.

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

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