Earnings Call Transcript - VNOM Q3 2023

Operator, Operator

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

Adam Lawlis, Vice President of Investor Relations

Thank you, Anton. Good morning, and welcome to Viper Energy Partners’ Third 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.

Travis Stice, CEO

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners’ Third Quarter 2023 Conference Call. There were several important updates made yesterday with our earnings announcement, so I will start with our upcoming conversion into a Delaware corporation first. The Board of Directors approved the conversion on November 2, and we expect that it will become effective on November 13. When completed, this conversion will deliver increased corporate governance rights to our limited partners and is intended to position Viper such that the value of our mineral and royalty assets can be fully recognized. Further on that point, we expect the conversion to result in an increase in Viper’s trading liquidity and potential investor universe. Given Viper’s current status as a partnership, we estimate that approximately 2% of our public float is held by index funds. This compares to a select group of our peers averaging around 30% ownership. Fundamentally, we believe this conversion is the right thing to do for our unitholders and that it will provide numerous benefits; but the foundation of the decision is to fully highlight the advantageous nature of mineral ownership and the unique value proposition that Viper presents within the space. As a separate recent event, Viper announced last week the closing of our GRP acquisition. This acquisition was a truly unique opportunity and checked all the boxes we look for in an acquisition: a medi-accretion to all relevant financial metrics, substantial undeveloped inventory to support long-term returns, and significant scale that results in a pro forma business that is both bigger and better. What differentiates this acquisition, however, is both the quantity and quality of the undeveloped inventory, particularly in the Northern Midland Basin. Following the closing of this acquisition, Viper now owns roughly 32,000 net royalty acres in the Permian Basin, and our production will be over 25,000 barrels of oil per day. Looking ahead, we have an unparalleled growth runway of high-quality undeveloped acreage, and as the largest player in the public minerals market, we expect to play a meaningful role in consolidating the highly fragmented space as high-value proposition opportunities like GRP present themselves. Turning to the results of the business, the third quarter was another strong quarter for Viper as production grew roughly 5% for the second consecutive quarter. While growth will not always be ratable from quarter to quarter, given we own varying interests in what is mostly large-scale development in the Permian Basin, we expect the trend of meaningful growth on an annual basis to continue, as evidenced by our preliminary full-year 2024 production guidance that we provided. Additionally, during the third quarter, Viper announced almost $100 million in lease bonuses, which will allow for the future development of deeper zones on certain acreage in the Midland Basin. As mentioned in our rationale for converting into a corporation, there are many structural advantages to mineral ownership beyond just the cost-free royalties, and this significant lease bonus is just one specific example. As owners and lessors of the subsurface property, modern lease terms can dictate development requirements of operators. And when those terms are not met, leases can expire, and the full development rights revert back to us as mineral owners. As deeper zones are tested throughout the basin, we believe this is an advantage that will only be further highlighted in the years to come. As a final point, Viper remains committed to a sustainable and growing return of capital through cash distributions over the long-term. We have the balance sheet strength, durable cash flow profile, and undeveloped inventory base to support many years of significant return of capital through the cycle. Activity on our asset base continues to be strong, and we believe we are positioned to execute on opportunistic M&A to further complement what is already a unique value proposition, both in terms of return on and return of capital. Operator, please open the line for questions.

Operator, Operator

Thank you. Our first question comes from Neal Dingmann from Truist Securities. Please go ahead.

Neal Dingmann, Analyst

Morning, guys. Nice quarter. My first question is just on all these bonuses. That's the impressive one you all recently received. I'm just wondering, could you speak to if all that bonus was tied likely to the deeper zones and wondering, do you all believe you have many of your other assets that have potential for similar type bonuses, maybe in those types of areas?

Kaes Van’t Hof, President

Yes, Neil, good question. I’ll answer part of it and then give it to Austen to talk about the rest of the asset base. I think, high level, we kind of added a slide in the deck to show that even in an area like Spanish Trail, highly developed on the traditional Wolfberry play that we all know, but now moving back in and developing Barnett, Woodford, and some of the Wolfcamp D across the position, the mineral owner gets the benefit there, right? They get a lease bonus, and they get a royalty on all of the new zones. I think we’re going to be slow to test it. I think it was a convenient time to get that lease done between Diamondback and Viper as it provided a lot of cash to Viper to help close the GRP deal. But generally, we’re trying to highlight that we own a lot of minerals in the Midland Basin, and there’s a lot left to do in terms of other zones, deeper zones, shallower zones, and all of that benefits the mineral owner, whether you can model it today or not. Austen, do you want to talk about the asset base?

Austen Gilfillian, General Manager

Yes. No, the monitoring and enforcing these types of returns is a really important part of what we do now, especially given where we are in the industry and in these modern leases and the terms that they can have. So this specific lease with Spanish Trail represented about 10% of our total net acres. When we look at the lease specifics included across the acreage that we own, we estimate about 50% of our acreage has similar lease language where if the deeper rights haven’t been developed, that acreage would fall out and become available. I don’t think that’s a story for tomorrow, but certainly, as things play out over time and the zones become more developed and expand across the basin, it’s something that you’ll see more about going forward.

Neal Dingmann, Analyst

Yes, I like that upside. Thanks, Austen. And then just a quick second question on capital allocation. I’m just wondering, given the current leverage post the deal and obviously, the great production guide for next year, any thoughts if capital allocation would change? Or will that payout type continue?

Kaes Van’t Hof, President

No. It’s a good question too. I think our payout philosophy is the same: 75% of free cash flow goes to equity, and 25% goes to the balance sheet. We know we put a good amount of cash in this GRP deal, but we have the balance sheet capacity to handle it. We also have a small balance on our revolver after closing the deal. So that will be easy debt paydown. With the strip prices, we’re still going to likely be below one times leverage at the end of 2024, even if we do pay out 75% to equity. I think Viper has gone back and forth on how we’re returning capital to shareholders. We’d probably prefer to distribute more cash via the fixed plus variable distribution rather than buybacks, but there might be opportunities to buy back stock in unique situations over the coming year. But our preference on that 75% that gets returned to shareholders or unitholders is through the base plus variable dividend.

Neal Dingmann, Analyst

Appreciate the details. Thanks, guys.

Kaes Van’t Hof, President

Thanks, Neal.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Derrick Whitfield from Stifel. Please go ahead.

Derrick Whitfield, Analyst

Hi, good morning. Thanks again for your time. With respect to the recent GRP acquisition, this was one of the first we’ve seen you pursue where there wasn’t a Diamondback angle or immediate Diamondback angle. Thinking about your prepared remarks and consolidation opportunities you’re seeing, could you speak to what you’re seeing in deal flow and the bid-ask spreads for minerals, which could lead to incremental opportunities?

Kaes Van’t Hof, President

Yes. I’ll talk about the GRP deal, and Austen can talk about the market right now. I mean this deal was kind of the one we’ve been waiting for. This team built this asset base over 8 or 10 years. I think it can be best summed up as very unique in that it’d be impossible to build that position today. So we needed to buy that position. The reason why we liked it is it’s a lot of the Midland Basin as the core asset. It’s a lot of undeveloped units in the Midland Basin, and it’s all in acreage that we would cover. So while there isn’t a huge Diamondback operated component to it, we put our operator hat on and said, would we like to own exposure to the core of the basin under competent operators like Pioneer, Endeavor, and now Exxon? In our mind, that is second to none and can't be built through the ground game. We used our size and scale to put a good amount of cash in the deal and get it across the finish line.

Austen Gilfillian, General Manager

Yes, Derrick, there have been quite a few deals that have come to market and have transacted this year. We’ve really been pretty selective in the last couple of years, focusing on Diamondback operated, like you mentioned. Secondarily, as Kaes highlighted, if it doesn’t have the high Diamondback operated percentage, it must be really high-quality acres with clear undeveloped inventory where we can have confidence in what the long-term development is going to look like. Going forward, it’s going to be a similar viewpoint for us, and we see an opportunity for quite a few more deals to come to market. But for us, it’s always a pretty high hurdle given the quality of acres that we have today. The development that we see going forward must compete for that; just being accretive day one is not enough for us. We have to have confidence in that development outlook over year 2, year 3, year 4, etc. That’s always the hardest hurdle to clear.

Kaes Van’t Hof, President

And one last comment on the Diamondback operated piece. It certainly has been beneficial to have the Diamondback-Viper relationship for a significant amount of our production. As the business has gotten bigger, and we chased the same decline rates that the E&Ps do, it’s been harder to find sizable packages under Diamondback that will move the needle for the next 5, 6, 7 years. So generally, we have a great position operated by Diamondback, but the next leg of the stool is going to be undeveloped units, particularly in the Midland Basin, like what we found with GRP, that drive growth into the next decade.

Derrick Whitfield, Analyst

Perhaps actually picking up with where you ended there, Kaes, because I think the opportunity that you guys have with the deep rights under Spanish Trail could be quite remarkable. But I would love to know what opportunity you see with the Woodford and Barnett intervals at present and how soon you could see meaningful activity that would clearly benefit Viper given the elevated NRIs you have in that area?

Kaes Van’t Hof, President

Yes. There’s certainly a lot of industry activity in the Barnett and Woodford. Traditionally, our mentality has been to be a fast follower. There will be some tests, particularly operated by Diamondback in the next 12 to 24 months. I don’t think it will move to full-scale development until around 2025, 2026. But all indications are pointing to those zones being very productive across much of the basin. It works at a price, right? It’s going to be a little more expensive to the operator. Wearing my Viper hat, we don’t really care as long as there’s a lot of resources. All indications are pointing towards significant resources in those deeper zones.

Derrick Whitfield, Analyst

Thanks, Kaes. Thanks for your time.

Kaes Van’t Hof, President

Thanks, Derrick.

Operator, Operator

Thank you. One moment for our next question. Our next question comes from Paul Diamond from Citi. Please go ahead.

Paul Diamond, Analyst

Hi, thank you. Good morning, and thanks for taking my call. Just a quick one on the Delaware corporation conversion. You talked about currently 2% of the public float being held by index funds versus about 30% by peers. Just wanted to dive a bit deeper on that to see how you guys envision any trend towards that higher rate after the conversion?

Kaes Van’t Hof, President

Yes, great question. We’ve done some work on it. The conversion is supposed to close next Monday, and then we’ll be a corporation. There are some details there for shareholders so they know what’s going on. From what we can tell, several indices that we could be eligible for even before the end of the year. Those are significant indices, including Vanguard-related indices and eventually some of the S&P-related indices. As the market knows, that typically leads to a lot of buying for a company that has a lower public float. We’re going to start working with them right away after getting this closed to get into as many indices as possible, following the path that Diamondback took years ago as that business grew and gained more exposure to large index funds.

Austen Gilfillian, General Manager

Yes, Paul, the main benchmarks are like your S&P and Russell. S&P and Russell do quarterly rebalances, with both scheduled for mid-December. The conversion will be completed by then. We’ll communicate with them to see if that’s something we can achieve this year. Russell does annual rebalances in June. You also have criteria-based or subjective measures like the S&P 600, where we’ll need to communicate with them. All signs point towards us being eligible right away, and hopefully getting included shortly after. We certainly meet the criteria now by being a corporation instead of a partnership.

Kaes Van’t Hof, President

Yes. The strategy there is also exposure. There are many other investors that are limited in their exposure to minerals. We’ve already had some success translating some shareholders and potential shareholders on the road to understand the story. I envision, as does Travis, a world where this mineral space and this business compete with mid and small caps on the E&P side. This business shows as a safer way to play the Permian Basin or oil exposure with no capital requirements and just upside.

Paul Diamond, Analyst

Understood. I appreciate the clarity there. Just one more quick follow-up on the lease bonus payments. How do you guys envision that going forward? Is it likely to trend towards chunkier payments or just consistent growth over time?

Kaes Van’t Hof, President

Well, Spanish Trail is unique, right? This was a generational asset that doesn’t come around very often. So this was definitely the big one. I think it’s logical that many of the deep rights throughout the basin will get leased up over the coming 12 to 24 months. But for us, those will all be smaller than this large payment, which was a significant amount of acreage.

Paul Diamond, Analyst

Understood. Thanks for the clarity.

Kaes Van’t Hof, President

Thanks, Paul.

Operator, Operator

One moment for our next question. Our next question comes from Leo Mariani from ROTH MKM. Please go ahead.

Leo Mariani, Analyst

Hi guys. I wanted to ask whether you see any kind of material change in the tax rates for Venom following this corporate conversion. I saw you had a soft guidance, but just kind of the numbers you rolled out for 2024 outside of production, where you talked about an effective tax rate. I know you’ve got multiple classes of units historically, and with that going to more than one class of shares, just trying to get a sense: are we going to see any material difference in cash taxes in 2024 versus 2023?

Kaes Van’t Hof, President

No, nothing should change at all for the public unitholders that will become public stockholders. So the tax position didn’t change, and I think this will just provide them more flow and more liquidity.

Austen Gilfillian, General Manager

That’s why the conversion made so much sense. We became a tactical partnership back in 2018. The agreement shielding us from corporate taxes ran out at the end of last year. In 2023, we are effectively a partnership paying full corporate income taxes without any upside. It just made a lot of sense to convert today, given in large part our current tax situation.

Leo Mariani, Analyst

Okay, that’s helpful. I also wanted to ask about a couple of other numbers here. You guys are expecting production to come down a little bit in the first quarter. Is that all timing-related? I just wanted to get some color on that. I also noticed your cash G&A per barrel guidance came down nicely. Is that due to spending less than expected, or perhaps were production results better than expected, allowing you to spread the cost over more barrels?

Austen Gilfillian, General Manager

On the production side, first, reported production will actually go up from Q4 to Q1. In Q4, you’re going to have two-thirds of contributions from the GRP assets, with a midpoint of 24.5%. Going into the first quarter, actual reported production will increase, given you have a full quarter of those assets' contributions. But we’re trying to be intellectually honest here to look at it on a pro forma basis. That’s kind of what we’re pointing to with a slight sequential decline. In context, this follows back-to-back quarters of 5% growth, mainly a result of the timing of some of these really large Diamondback pads where we have a high interest. We included Slide 9 in the deck showing visibility to the Diamondback schedule. We expect 2024 to have around 60% of Diamondback’s completions next year with about a 6.5% interest in those wells, being split roughly 40-60 between the first and second halves of the year. So still significant growth is coming, especially on the Diamondback-operated side; it will be mostly significant in the second half of the year, given some of the larger pads. On the cost items, those are very minimal. We’ve been spending $6 million, $7 million, maybe $8 million a year in cash G&A. Production growth is continuing, and we are not adding any personnel, so the costs per unit should trend down further over time.

Leo Mariani, Analyst

Okay, thank you.

Operator, Operator

Thank you. At this time, the Q&A session has now ended. I will now turn the call over to Travis Stice for closing remarks.

Travis Stice, CEO

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

Operator, Operator

This concludes today’s conference call. Thank you for participating. You may now disconnect.