Viper Energy, Inc. Q1 FY2023 Earnings Call

Good day, and thank you for standing by. Welcome to the Viper Energy Partners' First Quarter 2023 Earnings Conference Call. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Mr. Adam Lawlis, Vice President of Investor Relations. Sir, please go ahead.

Thank you, Chris. Good morning, and welcome to Viper Energy Partners' First Quarter 2023 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; Kaes Van't Hof, President; and Austen Gilfillian, General Manager. 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 2023 Conference Call. The first quarter was a strong start for the year as Viper's oil production set a company record for a fourth consecutive quarter. The advantaged nature of this royalty business model was highlighted during the quarter as we maintained our strong free cash flow conversion despite the volatility in commodity prices. Further on that point, Viper's low operating costs and zero capital requirements allow us to convert over 80% of our operating cash flow into free cash flow during the quarter. This measure compares favorably to many operators at around a 40% free cash flow conversion and insulates Viper's free cash flow profile in return of capital during times of commodity price volatility. Additionally, Viper announced it completed the drop-down transaction of certain royalty interests from Diamondback on operated properties located in Ward County. This transaction was a $75 million acquisition of an overriding royalty interest representing 660 net royalty acres that will provide high NRI exposure to Diamondback's expected development plan in the Southern Delaware Basin. Production on the acquired asset was roughly 300 barrels of oil per day during the first quarter and is expected to increase through the remainder of the year to average over 500 barrels of oil per day for the full year 2023. Looking ahead, we have initiated average production guidance for Q2 and Q3 2023 that implies over 8% growth relative to the first quarter. Importantly, on an organic basis, so excluding the impact of the drop-down acquisition, production is growing at over 5% in this period, primarily as a result of large Diamondback operated additions with high Viper NRIs being turned to production. On the capital return front, Viper took advantage of the volatility experienced during the quarter due to our flexible return of capital program by opportunistically repurchasing over 1 million units. Since the inception of our unit repurchase program, we have now repurchased over 11 million units for an aggregate of roughly $250 million, reflecting an average price of under $23 per unit. In addition to the unit repurchases, our return of capital program during the quarter is going to also deliver a distribution that represents a roughly 5% annualized yield at today's price. In conclusion, the first quarter was an outstanding quarter for Viper and the forward outlook continues to improve as our high-quality asset base continues to attract outsized activity levels. Viper remains differentially positioned to grow production without having to spend a single dollar in capital and with only limited operating costs. As a result, we look forward to continuing to efficiently return substantial amounts of capital back to our unitholders. Operator, please open the line for questions.

Our first question will come from Neal Dingmann of Truist Securities.

My first question is on future activity specifically. Can you remind maybe just in really broad terms how much of your acreage has what I would call maybe more relatively virgin units where we could see continued large pad boosting the already record volumes versus a lot of the other acreage out there, I know, is more on what I would call developed assets where we're seeing more child-type wells.

Yes. Good question, Neal. I would say that nearly all of the Diamondback operated position we acquired from Swallowtail is still largely undeveloped. We haven't even started our first pad yet in the Robertson Ranch area, where we own about half of the minerals at Viper. I believe there is a fundamental misunderstanding regarding Viper's growth potential; this growth isn't going to be a short-term phenomenon over the next couple of quarters. I think this business can see significant growth over the next few years, even as the exploration and production sector grows at a slower pace or enters maintenance mode. That's the advantage of this mineral business. There's considerable potential for growth because when we allocate capital for drilling at Diamondback, we factor in the 58% ownership stake in Viper in those economic calculations.

Great point. Okay. And then second question, just on capital allocation of the shareholder return. Just wondering, while I know you asked earlier, I know at FANG the allocation decision is largely driven by how you view your share price versus the assumed value based on mid-cycle prices. And I'm just wondering if you think about that the same way with Viper, and obviously, with oil down today now approaching, is there any change to your thinking?

Yes. I want to discuss mineral valuations as it's important for our capital allocation strategy at Viper, which now focuses on balancing unit buybacks and variable dividends. We've established a higher base dividend at Viper for a reason. However, I believe the public markets are undervaluing mineral interests compared to upstream assets. Consequently, we've invested more in the mineral business. If the market continues to misprice these mineral values, we will increase our ownership, similar to our actions in Q1. Additionally, our net asset value at Viper is significantly underappreciated, especially at a mid-cycle price of $60 a barrel, which aligns with Diamondback. We've also seen incredible activity in the private market, where we're facing fierce competition, often losing deals at significant discounts. While this is just an observation and not the basis for our strategy, if private deals continue to trade at substantial premiums to our current valuation, we will consider buying back more units.

Yes, I agree. Glad to see you all lean into the unit repurchase.

Our next question will come from Paul Diamond of Citi.

Just a quick question regarding the current situation. You mentioned that some private deals are trading at prices 50%, 60%, or 70% above what you consider a fair value, yet you still managed to close a few deals last quarter. Do you see this trend becoming more nuanced and specific, or do you anticipate the market will open up more and return to a more rational state?

Yes. I was also referring to where Viper is trading on a mineral acre basis. But I think your point is valid. I think we're getting a pretty competitive environment in a lot of the, I would say, mid-market deals, $20 million to $80 million deals or $20 million to $100 million. I think Viper has a unique advantage with our size and scale to compete in the $500-plus million mineral deals. Now I think those are fewer and further between. But I do think eventually, like a deal like Swallowtail, we have a unique advantage to get that deal done. That's kind of our playground because right now, in the middle market deals, the numbers being paid are astronomical.

Our next question will come from Derrick Whitfield of Stifel.

Congrats again on a solid quarter and drop-down transaction. With regard to the drop down, and I think it about some of your comments on the mispricing of mineral assets, I mean this drop down was extremely impactful from the perspective of line-of-sight activity at elevated NRIs as this was sourced from a ward acquisition at Diamondback over a year ago. I wanted to ask if there are other potential carve-outs from the FireBird or Lario acquisitions that could make sense in the future.

Yes, Derrick, there are none today that came with the Lario or FireBird packages. Now that when we do get a new playground to buy minerals, that does allow some opportunities to try to buy minerals in those new areas, but no drop-down opportunities. To comment on the drop down specifically, this deal, we have the benefit of figuring out the right timing of when to drop something down between the two companies. This deal wouldn't have made sense to do a year ago, but now that development is happening and there's that forward visibility, it made a lot of sense to be able to get that done ahead of the first large pads coming on in March. Austen, do you want to add anything to that?

No, that's right. I mean we got it done right around the ramp-up in production and then still quite a bit of visibility to some high-interest pads over the next couple of years. So it made a lot of sense for Viper, and I think Diamondback, to do a deal here this past quarter.

Terrific. And with my follow-up, I wanted to focus on a bigger picture question for Permian activity, which I think places your benefit relative to your peers. And that question is, if we were to assume strip pricing, do you think we've seen peak activity in the Permian for at least the immediate term, given that privates generally have less quality inventory depth and are likely more exposed to weaker gas pricing? Again, the benefit part would just be what percent operated you guys carry today and the visibility you have with that?

Yes, I think that's a fair statement. I believe we have likely reached peak activity in the Permian. We have mentioned significant service cost reductions on the Diamondback side, and part of this can be attributed to the availability of equipment in other basins. We indicated that this year, public companies may remain flat while Diamondback and Viper benefit from the activity, majors are increasing their operations, and since we do not hold many minerals under major companies, we see that privates are generally slowing down to either preserve their inventory or sell themselves. This situation gives us an advantage with the Diamondback segment, especially since we are directing a substantial amount of upstream capital to areas where we own mineral interests, particularly in Central Martin County.

Our next question will come from Leo Mariani of ROTH MKM.

I was hoping you could provide a little bit more color around this kind of additional $41 million of acquisitions that you guys did kind of apart from the $75 million drop down, was that just kind of a bunch of little stuff? In the aggregate, obviously, you commented that it's kind of hard to get deals these days given the overpricing in the markets. So maybe just some color around the recent $41 million of activity.

Yes, Leo, that was primarily due to our ground game acquisitions. We are continuously engaging with smaller mineral owners. There has been considerable competition for larger marketed deals, as Kaes mentioned, especially in the middle market. However, we have been focusing on smaller transactions, effectively acquiring smaller interests bit by bit. We have secured a few additional deals recently, concentrating on regions that we find promising, whether Diamondback is the operator or another active operator is involved. The acquisitions primarily include Pioneer, Exxon, and Martin County. We are confident in the quality of the rock and optimistic about the future outlook, even though these deals represent a distinct subset compared to those facing heightened competition.

All right. That's helpful. And then obviously, in your prepared comments, you talked about how you guys are comfortable sort of deemphasizing the variable dividend for the foreseeable future, it sounds like and doing kind of more buyback just based on where you see the disconnect on the value here. I guess just curious if you guys kind of look at this, do you guys kind of take into consideration kind of relative yield of your securities, say, versus alternatives in the market? I know a lot of people look at either the 10-year treasury yield or even the 2-year these days with the inversion. Do you guys kind of pay any sort of attention to kind of where you're trading relative to that on a yield basis when you make these decisions?

I wouldn't say it impacts us in terms of yield, but from a cost of capital standpoint, we closely monitor interest rates and our debt's cost along with our cost of equity. Ultimately, the value of equity is determined by the present value of future cash flows from the business. We believe this is significantly undervalued for an asset that represents the highest security level in the oil field. If an operator loses a lease for any reason, they must negotiate a new lease with the mineral owner. Additionally, if new economic zones emerge, like some of the deeper zones in the Midland Basin currently being discussed, operators will need to approach a company like Viper to pay a bonus and re-lease those mineral interests. So, while it factors into our calculations, it doesn't dictate our final decision. That decision is primarily based on the net present value calculated at a reasonable discount rate.

Our next question will come from Tim Rezvan of KeyBanc Capital Markets.

My first question is a follow-up regarding your acquisitions. You've not been involved in many of the larger acquisitions that have taken place. In the recent $41 million deal, you appeared to acquire some third-party minerals. How actively do you pursue third-party minerals? It seems like you are primarily focused on Diamondback. Is your approach that you'll consider third-party opportunities if the price is right? How should we understand your future willingness to explore third-party options?

Yes. Good question. We've kind of shied away from a significant amount of third-party acquisitions. I think we're certainly still looking at them today. They're just harder to get across the finish line because we don't have, what I would say, differential knowledge as to the development pace of those positions. And so you've seen a few deals trade where they're concentrated positions that you could probably underwrite some sort of pace of development. But we still just kind of got blown out in terms of value. So I think it's good discipline to not have your name on every trade, but we still think we have the differential knowledge on the operated side.

Okay. I would like to return to the cash return framework. In the Diamondback call this morning, Kaes mentioned that when the stock is down, the variable dividend doesn't hold much importance. This aligns with your capital allocation approach in the first quarter. There seem to be various perspectives in the market regarding the role of a minerals company and the yield it offers to investors. You've also pointed out the discount to NAV, which is likely evident in any public equity throughout the energy sector. How do you view the competitiveness of Viper equity now that its distribution is half that of its public peers? What is the overall role of Viper for investors seeking yields?

I believe the purpose of Viper is to generate value. At the current prices, the most effective way to do that is through increased share buybacks. The public markets may not fully understand the dynamics of the private markets or the relative value of minerals in comparison to upstream operations. Over the past few years, there has been a shift in the upstream model towards a focus on yield and distribution, with some companies reallocating capital from distributions to buybacks. Ultimately, if we had to choose a strategy, we would prefer to distribute more cash at Viper and buy back more shares at Diamondback. However, during significant market dislocations, like those seen in recent months, we will prioritize buybacks. In the end, we believe that creating real value is more important than simply crafting a narrative.

I appreciate that. I just have a different perspective based on our discussions with shareholders who may prefer that yield. However, I value your insights on the matter.

Yes, we are open to those discussions. Ultimately, we are the largest shareholder at 58%. By not distributing funds and repurchasing shares in the market, we are taking money away from ourselves. However, we believe that this approach provides the best long-term value for both us, Diamondback, and the remaining public shareholders.

And I'm seeing no further questions in the queue. I would now like to turn the conference back over to the CEO, Travis Stice, for closing remarks.

Thanks again for everyone participating in today's call. If you've got any questions, don't hesitate to reach out using the numbers we provided. Thank you again. Have a great day.

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a wonderful day.