Earnings Call Transcript - VNOM Q2 2025

Operator, Operator

Good day, and thank you for standing by. Welcome to the Viper Energy Second Quarter 2025 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Chip Seale, Investor Relations Director. Chip, please go ahead.

Chip Seale, Investor Relations Director

Thank you, Felicia. Good morning, and welcome to Viper Energy's Second Quarter 2025 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 Kaes Van't Hof, CEO; and Austen Gilfillian, 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 will now turn the call over to Kaes.

Matthew Kaes Van't Hof, CEO

Thank you, Chip. Welcome, everyone, and thank you for listening to Viper Energy's Second Quarter 2025 Conference Call. Despite oil price volatility in the second quarter, Viper delivered strong oil production growth, both on an absolute and per share basis. After closing the drop-down transaction from Diamondback on May 1, we remain excited and highly confident about the meaningful organic growth that Diamondback can drive on our concentrated royalty assets over both the short and the long term. This symbiotic relationship uniquely positions Viper as one of the few companies in North American energy that is expected to deliver organic growth over the coming quarters and years. As previously announced during the second quarter, we also announced a definitive agreement for Viper to acquire Sitio Royalties in an all-equity transaction. Sitio will be hosting their shareholder meeting to vote on a proposal to approve the merger on August 18, and if approved, we expect to close the merger shortly following the meeting. As a reminder, this transaction adds substantial scale and inventory depth for Viper that will support production profile over the next decade while also offering meaningful and immediate financial accretion. Following the expected close of the Sitio acquisition later this month, we remain highly confident in our organic growth trajectory that it will continue into 2026 at current prices, led by over 15% expected year-over-year growth in our Diamondback-operated net oil production. We expect full year 2026 average production to increase by a mid-single-digit percentage from our expected pro forma Q4 2025 production levels, which is the first quarter of Viper plus Sitio consolidated. Importantly, based on this production outlook, we would expect our oil production per share for full year 2026 to be approximately 15% higher than full year 2025, highlighting the unique combination of organic growth and accretive acquisitions. Moving to return of capital. We are going to return $0.56 a share to stockholders this quarter, primarily in the form of our base plus variable dividend, which represents 75% of our cash available for distribution. As announced with the Sitio acquisition, our pro forma net debt target is $1.5 billion, which represents approximately 1 turn of leverage at $50 WTI based on expected pro forma production levels. We're committed to maintaining a fortress balance sheet, but we see $1.5 billion as the right amount of permanent leverage for Viper as a royalty business, given we have limited operating costs and no CapEx. Therefore, in the coming quarters and years, should net debt be at or below $1.5 billion, stockholders should expect us to return all excess cash up to 100% of available cash for distribution generated in a quarter. In conclusion, we continue to believe that Viper presents a differentiated investment opportunity within the broader energy space. Our relationship with Diamondback remains strong and a distinct competitive advantage for Viper. We believe Viper's unique ability to deliver sustained per share growth with zero capital and only limited operating costs will result in a differential ability to return increasing amounts of capital to our shareholders over the long term, and the proposed Sitio acquisition only enhances our position as we look to compete with mid- and large-cap E&Ps for investor dollars, attention, and access to capital. Operator, please open the line for questions.

Operator, Operator

The first question comes from Chris Baker of Evercore.

Christopher Moore Baker, Analyst

Kaes, great to see the commitment to returning 100% of cash flow once you get to that $1.5 billion target. Maybe just help frame up the flexibility in terms of the path toward that target, whether it be organically or with perhaps noncore asset sales?

Matthew Kaes Van't Hof, CEO

Yes, that's a great question, Chris. There are a few ways to approach this. Essentially, if we allocate our returns 75-25 between equity and the balance sheet, the business can generate a significant amount of free cash, allowing us to reach that $1.5 billion mark fairly quickly after the Sitio deal closes. We mentioned that some of the non-Permian assets might not be central to our strategy, and there has been considerable interest that we haven't acted on due to the pending deal closure. It makes sense for us to consider selling an asset or two outside of the basin to expedite this process. We feel very positive about our current balance sheet, and we’re mindful of the stock’s trading value, which we believe is significantly undervalued compared to our anticipated growth over the next few years. Therefore, we plan to balance a few noncore asset sales with free cash generation, along with a strong focus on buybacks when we are able to do so after the closing.

Christopher Moore Baker, Analyst

Yes, that's great. And then I guess just hitting on that last point, how are you thinking about the mix of buyback versus variable on top of the base dividend? Is it fair to think that we could see most of that variable cut in favor of buyback, just given where the stock is today?

Matthew Kaes Van't Hof, CEO

Yes. I mean, I think we're going to have to look at how many days we're allowed to buy back before a buyback window closes and when the Sitio deal actually does close, which we expect in the coming weeks. But yes, I mean, I think generally, we prefer that Viper be a distribution vehicle. But when there are these dislocations, I think it's great to have a pure free cash flow vehicle to be able to allocate more cash to other forms of return of capital without worrying about CapEx commitments.

Operator, Operator

The next question comes from the line of Betty Jiang of Barclays.

Wei Jiang, Analyst

I would like to inquire about the activities of third-party operators. It’s quite impressive that despite the broader industry slowdown, there is an increase in activities related to third-party assets and a growing backlog. Can you provide any insights on this situation? Do you believe this level of activity can be sustained?

Austen Gilfillian, President

Yes. Good question, Betty. I think it's a couple of things. One, going back to last quarter, when we were in the midst of some of the heightened volatility, we highlighted for standalone Viper what our exposure is to third-party operators. And really, the bulk of the existing production and activity is just a handful of really large caps, namely being Exxon, Oxy, EOG, and Conoco. So I think those operators are folks that you would expect to stay pretty consistent with their development plan kind of through periods of volatility. So that's benefited us. Secondly, too, you're starting to see some of these concentrated assets that we've acquired and some of the recent acquisitions getting some activity on them. So it's really been more of a drive in net activity while gross activity has been relatively flat. And then the third thing that I would flag, and you can kind of see it showing up in one of the pie charts on Slide 12 is we're starting to see some of the benefits in those numbers from the Double Eagle development on the Reagan County asset that they have that development agreement in place with Diamondback to drive some growth on what was a very concentrated asset in the drop-down.

Wei Jiang, Analyst

Great color. So a follow-up to that is, if I look at your 2026 production growth outlook of the mid-single-digit growth, I believe that's really underpinned by Diamondback-operated activities. Based on what you currently see with the third-party activity, do you think there could be upside to that growth trajectory in '26?

Austen Gilfillian, President

Yes, Betty, so that mid-single digits is really 3,000 or 4,000 barrels a day of growth, if you think about it on an absolute basis, which is entirely driven by the growth that we see coming from the Diamondback-operated side. So as we look at it today, if you maintain like historical permit conversions and timing and such, I think current activity on the third-party side would be a little bit of growth relative to the baseline of being flat, but a lot of things can change, and there's certainly a lot of volatility in the market. So we're still kind of guiding to third-party volumes staying flat, but we are really encouraged by the activity levels that we've seen over the past couple of months.

Operator, Operator

The next question comes from the line of Neil Mehta of Goldman Sachs.

Neil Singhvi Mehta, Analyst

Just want your perspective on some of the noncore or I should say, non-Permian stuff in the Sitio portfolio, your perspective on how are you evaluating how much of that ultimately stays versus gets monetized? And this has historically been a Permian pure-play asset. How important is that for you as you think about the long term of the business?

Matthew Kaes Van't Hof, CEO

Yes, Neil, I mean, I think we still see our combined business as a long-term Permian-only business, but I think we've done a lot of deals over the past years, and in some instances, we've sold assets immediately post-close to pay down debt or just to clean up the asset base. I think in this situation, given that it's minerals and it's really heavily PDP weighted, we're probably going to be pretty patient on some of the larger positions, particularly knowing that the buyer universe is strong, but the buyer universe is going to underwrite strip, and with the strip weak, we don't have to sell assets here and might be patient waiting to sell some of the larger positions over the next few years.

Neil Singhvi Mehta, Analyst

And then on the flip side, Kaes, you've been very clear about using this asset to consolidate. You have an advantaged cost of capital even if it's undervalued and you are the logical acquirer of a lot of royalty acreage. Is the opportunity set available and interesting? And how do you weigh that against the intensity of integration around the Sitio asset that you'll need for the next couple of months?

Matthew Kaes Van't Hof, CEO

Yes. I think the integration is going to go pretty quickly. I think Sitio had a very clean business and some of the key employees are hopefully going to join us at some point at Viper. And so I think the integration won't necessarily be the problem. But I do think as you think about uses of capital, we want to be patient at the Viper level given that we've done two large deals in 6 months. And we expect those deals to be accretive, and we expect the market to reward those deals for being accretive, and that hasn't happened yet. And so I think we need to hit numbers and be aggressive on our buyback and let things settle out for a little bit before doing anything large or strategic right away. There certainly are packages we're very interested in. Most of those are held in private hands. So they're pretty patient. And so I think we need to show some clean quarters or two pro forma for the Sitio and show that we're hitting our synergies and hitting our production targets and reducing our share count, all while paying a very large dividend.

Operator, Operator

The next question comes from the line of Paul Diamond of Citi.

Paul Michael Diamond, Analyst

I wanted to quickly ask about the 1.5 net debt target. Once that target is reached, even without selling any assets, will that change your hedge strategy? Do you feel it's necessary to keep current levels, or could we see a slight reduction? How do you view the situation after reaching that target?

Austen Gilfillian, President

Yes, Paul, we've always kind of thought about our hedging strategy as locking in a certain amount of downside protected cash flow that even if things really go south, you have some level of protection and leverage isn't going to blow out on you. So I think we'll continue to hedge probably in this consistent form of the deferred premium puts. So really, just as debt goes down or net debt goes down, you just need to hedge fewer barrels to lock in the required amount of downside protected cash flow to solve for a cap on leverage.

Paul Michael Diamond, Analyst

Got it. That makes sense. Now, regarding the second half of the year after the Sitio close, how should we consider the allocation of the 75% of distributable cash between variable distributions and buybacks? There seems to be a significant dislocation in the equity market at the moment. Are you considering focusing more on buybacks, or how do you envision this between now and the end of the year?

Matthew Kaes Van't Hof, CEO

Yes. I mean, I think it's all going to be flexible, but there is a lot of cash and capacity to buy back shares here once we close the deal. I think we're just going to have to see how things unfold over the back half of the year, but that's the beauty of a pure free cash flow business that's actually growing is that there's capacity to do both, but I think today, I think you're hearing a strong message from us that we would lean into buybacks over a variable today.

Operator, Operator

The next question comes from the line of Derrick Whitfield of Texas Capital.

Derrick Lee Whitfield, Analyst

For my first question, I wanted to focus on the Sitio acquisition. While it's hard to fully attribute stock performance to any specific development, VNOM has underperformed several of its peers since the announcement. Are there any aspects of the acquisition that you feel are underappreciated by investors?

Matthew Kaes Van't Hof, CEO

Yes. I mean, listen, I think the size and scale of the combined business is misunderstood, right? It's hard to model mineral businesses because you have a small interest in a significant number of wells. But I think if you combine the visibility we have with the Diamondback drill bit and the financial accretion associated with the trade, you start to see numbers go up. And listen, our job is to make the business look cheap by executing on either growth or a reduction in share count. And over time, the market is a weighing machine versus a voting machine, and these higher per share metrics tend to prove to be the right way to run a business long term. So I think while we often get stuck in the malaise of the short term, the long-term path is very bright.

Derrick Lee Whitfield, Analyst

Great. And then, Kaes, in past calls, Sitio management has highlighted the substantial investment it has made in back-office efforts to identify unearned payment of royalties. Kind of in thinking about the levers that you guys have to pull for accretion, how much of that exists within VNOM?

Matthew Kaes Van't Hof, CEO

They've done some pretty interesting things on the automation side that we're really excited to bring into our business. I think they've had to do it out of necessity given the number of wells they have an interest in, and that's why we have a lot of confidence that we'll be able to integrate that very quickly. I mean, I think in general, a lot of the administrative functions throughout our business in E&P and in minerals, the AI revolution and machine learning are going to be two very important pieces to review 35,000 wells a month to make sure you're getting paid right, and I think it will accrue to our shareholders' benefit long term as well.

Operator, Operator

The next question comes from the line of Aaron Bilkoski of TD Cowen.

Aaron Bilkoski, Analyst

So your presentation outlines an expected 5.9% NRI in Diamondback-operated wells through 2029. I guess my question is, do you expect that NRI to be fairly consistent across those years? Or do you anticipate a higher NRI in 2026 and see that taper off in the later years?

Austen Gilfillian, President

Yes, Aaron, I think really the important metric is the net well count, and as we think about that, on the Diamondback operated side, it's really a function of two things. It's one, your exposure to total Diamondback gross activity levels, and then secondly, your NRI within those wells. So we kind of laid this detail out with the drop-down given we have such increased alignment with the Diamondback development plan over an extended period of time given the overlap of that drop-down acreage. So you'll see on Slide 11, thinking about around 25 net wells per year over this time period. I would say that certainly will be a touch front-weighted. So if you think about '26 and '27, that will be biased to touch higher than that, and that's really going to drive a couple of thousand barrels a day of growth that we're talking about on an absolute basis, but really over a 5-year period, it's going to be pretty consistent exposure to whatever Diamondback's development plan is going to be, and that really underscores the confidence we have in the long-term production growth outlook.

Operator, Operator

The next question comes from the line of Leo Mariani of ROTH.

Leo Paul Mariani, Analyst

Yes. I wanted to touch base on the debt target here. Do you guys anticipate hitting that? It sounds like in the relatively near future. Do you think that's going to happen here in the first half of '26? And then could you also just talk about the strategy of sort of dividends versus buybacks? Obviously, it sounds like you want to step up the buyback here given the weakness in the shares on a relative basis. But do you also see room for dividend increases in the back half of the year given the accretion from the mergers?

Austen Gilfillian, President

Yes, Leo, I mean, I think it's reasonable to expect that the Board will look at the base dividend and possibly increase that sometime in the next quarter or two on top of that, just free cash flow growth overall from production growth and the accretion of the deal starts to roll through as well, and I think importantly, this $1.5 billion net debt target and just saying, 'Hey, we're not going to hold on to a bunch of cash on top of that number.' If we're at that net debt number, we're giving the cash back to shareholders, and I think that once that starts flowing through numbers, people are going to realize how much cash they're going to get back from Viper over the next couple of years is going to be significant.

Leo Paul Mariani, Analyst

Okay, and then on the M&A side, obviously, it sounds like you got a lot to still digest here. You haven't closed Sitio yet. You kind of made a comment here that perhaps you take it a little bit slower as you want to get maybe the stock price up a bit to kind of fully reflect the benefits of the acquisition. So I understand maybe you don't have as much desire in the very near term, but could you talk about the availability of deals out there? Are you seeing packages that are transacting? Obviously, oil prices have settled down a little bit after a pretty tumultuous second quarter.

Matthew Kaes Van't Hof, CEO

Yes, it's been pretty quiet for us, but it's probably because we've been doing this large deal. I think most importantly, as I said earlier in the call, we did two transformative deals in 6 months. We expect our investors to make money on those deals, and that's why we're kind of signaling that we'd like to be patient on M&A, and make sure our investors are made whole on the accretion that we all expect to come.

Operator, Operator

This concludes the question-and-answer session. I would now like to turn it back over to management for closing remarks.

Matthew Kaes Van't Hof, CEO

Well, thanks, everybody, for participating in today's call, our second call without air conditioning, and I appreciate you making it shorter than the Diamondback call, have a good day.

Operator, Operator

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.