Kimbell Royalty Partners LP (KRP) 2017 Q4 法說會逐字稿

Good morning, and welcome to the Kimbell Royalty Partners fourth quarter earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Anne Pearson of Dennard Lascar Investor Relations.

Thank you, Ms. Pearson. You may begin.

Thank you, Rocco, and good morning, everyone. Thanks for joining us for Kimbell Royalty Partners conference call to review financial and operational results for the fourth quarter and the full year 2017.

This call is also being webcast and can be accessed through the audio link on the Events and Presentations page of the IR section of kimbellrp.com.

Information recorded on this call speaks only as of today, March 8, 2018. So please be aware that any time-sensitive information maybe no longer be accurate at the date of the replay. I'd also like to remind you that statements made in today's discussions that are not historical facts, including statements of expectations or future events or future financial performance are forward-looking statements, made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We'll be making forward-looking statements as part of today's call, that are, by their nature, uncertain and outside the company's control and actual results may differ materially. Please refer to our earnings release for our disclosure on forward-looking statements. These factors and other risks and uncertainties are described in detail in the company's filings with the SEC.

Management may also refer to non-GAAP measures, including adjusted EBITDA and cash available for distribution. Reconciliations to the nearest GAAP measures can be found at the end of our earnings release. Kimbell assumes no obligation to publicly update or revise any forward-looking statements.

Now I'd like to turn the call over to Bob Ravnaas, Kimbell's Chairman and Chief Executive Officer. Bob?

Thank you, Anne, and good morning, everyone.

Thanks for joining us. I'm here with the several other members of our senior management team, including Davis Ravnaas, our President and Chief Financial Officer; Matt Daly, our Chief Operating Officer; Jeff McInnis, our Chief Accounting Officer; and Blayne Rhynsburger, our Controller.

I would like to begin with a look back at our record operational performance for the fourth quarter and full year 2017, also at our most recent distribution increase and the acquisitions we made in the fourth quarter, and finish with a recap of our strategy and our view of the market and the opportunities ahead of us this year.

Then I'll ask Davis to cover of our financial performance in more detail. After that, we'll take your questions.

First, to look back in 2017, we are very pleased with our overall performance for first year as a publicly traded partnership as well as for our fourth quarter.

For the fourth quarter, we generated a record revenue, EBITDA and cash available for distribution to our unitholders. And we generated record production of oil, gas and NGLs. We made approximately $30 million of acquisitions in 2017, which added approximately 3.4 million Boe to our reserves as of year-end. Based on the opportunities we see in the market this year, we expect continued robust activity in 2018 in making royalty acquisitions that add to current production, offer additional development upside and are immediately accretive to unitholder value.

We grew reserves by 35% on a total proved PV10 basis, which add solid growth in unitholder value that will be realized for many years to come. I want to thank and congratulate the entire Kimbell team for helping make our first year as a public company so successful and for their hard work in positioning the partnership for what we believe will be an even better 2018.

Looking at the fourth quarter results: We are very pleased with the performance of our royalty portfolio. Production increased by about 6% versus the third quarter to 3,508 Boe per day. On a revenue basis 58% was from oil, 26% was from natural gas, 11% was from NGLs and 5% was from lease bonuses and other sales.

Along with the acquisitions we announced during our third quarter conference call that closed in the fourth quarter, an additional acquisition totaling $1.3 million was also completed in the fourth quarter, further driving production growth. The core assets we acquired in this package are oil-focused and located across 6 states.

In keeping with our strategy to drive sustained long-term accretive growth to our unitholders, all these assets we acquired in the fourth quarter feature long-life reserves with shallow production decline rates in fields with significant hydrocarbons still in place and additional development potential.

We currently have 21 rigs operating on our properties, with 12 rigs in the Permian basin, 2 rigs in the Eagle Ford shale, 4 rigs in Wyoming, 2 rigs in the Bakken and 1 rig in the Mid-Continent. This is up from 19 rigs as of year-end 2017.

A significant increase in the price of crude oil and liquids from the third quarter to the fourth quarter drove materially better financial results relative to the last quarter, which Davis will come back to in more detail.

This combination of a higher commodity prices and higher production allowed us to increase our quarterly distribution to common unitholders by 16% from the prior quarter to $0.36 per unit, which was paid on February 14, to unitholders of record on February 7. That represents an annualized distribution of $1.44 per unit.

We are variable distribution partnership, that is we distribute 100% of cash available each quarter. So depending on the pace of acquisitions and the fluctuation in commodity prices, we can't promise increases like this every quarter, of course. Since our IPO in early February of '17, our distributions have totaled $1.20 per unit.

On the pricing side, we have just initiated a new hedging program to help us reduce the impact, particularly the downside impact of change in commodity prices on our distributions. We have hedged approximately 10% of our oil and natural gas production in 2018 and '19, using fixed price swaps.

On the production side, I'd also like to underscore an important characteristic of our strategy and our portfolio that sets us apart from some of the other royalty-based MLPs in our peer group. The decline curve from our portfolio is very low, only about 10% per year. So commodity price improvements, conversion of PUDs to producing wells and the pace of our acquisitions are the biggest drivers of potential distributionption growth. Unlike some of our peers of both royalty in operating interest in some hot with very high-decline rate basins like the Permian, we have very strong visibility and greater stability in our average daily production. We don't have to defend our distribution by making acquisitions at any price, simply to replace natural declines, that range from 25% to 50% a year, in the case of some of our bigger peers.

This give us our luxury of choosing what we believe will be the most accretive deals over time. We don't have the constant pressure of high production at inflated prices in hot plays, just to maintain our production and prop up our distribution.

Permian royalty assets are extremely difficult to acquire at this time and fortunately, we already have a lot of them. We've built this position in the Permian years ago when the assets were out of favor.

For hot plays, they are cyclical, they move around as technology opens up more known resources to profitable production. As we evaluate transactions for their long-term value, we are agnostic to oil or gas. And in the same way, we approach the Permian when we assembled our acreage years ago, we will stay away from plays where there is a bidding war for mineral rights and leases and seek acreage held by production that still has strong production for future development and exploration.

Our strategy is to be well positioned at the right price and right future rate of return, to benefit from the next hot plays as part of the diversified, low-decline rate portfolio that will perform well for our investors quarter-to-quarter, year-after-year.

Most oil and gas companies are valued using strength performance metrics like EV to EBITDA, but our focus is on growing production to increase scale, completing accretive acquisitions and, over time, building maximum net asset value. We do this by assembling a high quality diversified royalty portfolio that generates positive cash flow and offers low-risk, high-return growth potential with no additional capital outlays. In fact, we are virtually immune to the cost inflations that working interest E&P companies are currently experiencing. Our current portfolio includes mineral and royalty interests across 20 states, in more than 300 counties and a nearly every active basin on lower 48.

When we buy royalties, we almost always buy the right shale zones, whether they're developed or not. And nearly everything we buy is held by production with little exploration risk.

The portfolio with long-life production and shallow average decline rate not only enables us to generate current income, but also adds significant upside potential for organic growth through additional field development or application of new technology. This upside is cost free to Kimbell, since we are a royalty owner and not a working interest owner. That's a very important distinction in our investment thesis.

We believe that diversity and our rigorous evaluation discipline is a real strength of our investment strategy and will serve our investors both in the near term and long term.

Our deal flow right now continues to be as active as it has ever been, in part, because of our public company status makes us more visible to potential sellers. We estimate that the total value of the U.S. royalty market is between $300 billion to $500 billion and the 3 largest royalty MLPs represent only about 1% of that value. So the consolidation opportunities are immense and we will be a major participant in that consolidation. We have the team and infrastructure to -- in place to continue to grow, thus we should realize continued operating leverage.

We are frequently asked by investors when to expect the next drop-down from our sponsors. Our answer is the next one is likely to be this year, although the timing is still yet to be determined. We expect to continue to grow in 2018 both through additional accretive acquisitions and a potential drop-down of assets from our sponsors.

Now I'd like to turn it over to Davis for a look at our financials.

Thanks, Bob, and good morning, everyone. Fourth quarter net income was approximately $1.1 million, which is up 792% from the third quarter. Revenues increased by 20% to $10 million and operating income was $1.4 million, up 297% from the third quarter. These increases were due to an improvement in commodity pricing of almost 9%, led by oil and NGLs pricing, plus an increase in production resulting from the acquisitions that closed in Q4. We also benefited from modest organic growth in production from our existing properties, as Bob mentioned.

G&A increased by about 7% from Q3, primarily due to increased professional fees, which included many onetime items, such as legal fees associated with the unit lockup expiration and implementing our hedging program.

Adjusted EBITDA was a $6.3 million, which is up 20% from the prior quarter.

Cash available for distribution was $6.1 million, also a sequential increase of 20%. We define cash available for distribution as adjusted EBITDA less cash received plus cash needed for debt service and other contractual obligations and fixed charges and reserves for future operating expenses or capital needs.

You will find a reconciliation of both adjusted EBITDA and distributable cash flow at the end of our news release.

Our average realized price per Boe was $29.33 per barrel, up almost 9% from Q3. Crude prices increased by almost 18% to $51.78 per barrel and NGLs prices increased by more than 16% to $22.95 per barrel. This was partially -- partly offset by a 5% decrease in natural gas prices to $2.65 per Mcf.

As Bob mentioned, and will be described more fully in our 10-K to be filed shortly, we've initiated a hedging program for 2018 and 2019 in the form of fixed price swaps for a portion of our production. At the end of the year, we have swaps for both calendar '18 and '19, covering 43,070 barrels of oil and 352,590 MMBtu of gas. These are priced at a fixed rate per barrel of oil of $56 for 2018 and $53.07 for 2019, and for gas a fixed rate per MMBtu of natural gas of $2.71 for '18 and $2.76 for '19. The current swaps in place, as a percentage of our Q4 2017 production, is approximately 10% of our oil and natural gas production.

We did not incur a full cost ceiling test impairment in Q4, under the exemption we received from the SEC for calendar year 2017, but we do expect to recognize an impairment in the first quarter of '18. Again, let me stress, this impairment would be a noncash charge and would not impact, in any way, cash available for distribution or liquidity, asset borrowing base or our ability to grow through acquisitions or drop-downs.

As of year-end, we had cash on hand of $5.6 million, and about $31 million outstanding on our revolving credit facility, which financed the acquisitions we made through 2017. This gives us current liquidity of $69 million, if we exercise the accordion feature that doubles our revolver to $100 million.

We plan to continue to use the revolver to provide short-term financing for acquisitions. As our needs for additional capital for acquisitions grow, we will look to equity markets periodically to ensure that we maintain a strong and conservative capital structure. Our debt to enterprise ratio at year-end was a conservative 1.4x.

Operator, we are now ready for questions.

(Operator Instructions) Today's first question comes from Matt Schmid of Stephens.

On the hedging, it seems that you've started to layer those in. How are you thinking about that going forward? And as you make additional acquisitions, and just thinking about generally a target level of hedges, is there any update there?

Yes. Really glad you asked that and we were going to put that in writing, but we thought it would be easier to kind of explain over the Q&A. So glad you asked that. We had a discussion at the board level about how we want to think about hedging philosophically, and I think it's a little bit different for us as a royalty company versus an operator for some obvious reasons. So we decided that we were going to try to fix our -- the percentage of volume that we hedge to the loan-to-value ratio of the company. So we simply take -- year-end, we took debt outstanding -- net debt outstanding, divided that by market cap. It was about 10%. And so we decided, why don't we hedge 10% of our volumes. And really the reason for that is, because we don't have any operating costs or CapEx requirements, what's the only risk here, what are we trying to protect against and would it just be the modest amount of levers that we have on the business. So again, it's only 10% of our production, it's not a big deal. But we think that it's an important conceptual point for us to kind of implement for our company.

Okay, great. That's helpful color. And just thinking about acquisitions in 2018, how do you all think about balancing the third-party environment out there versus potentially doing some drop-downs later this year?

Yes. We hope to achieve a drop-down this year. We think that's likely, as we've said, but third-party -- the third-party acquisition environment continues to be very robust. I think that with oil trading now above $60, we're seeing a lot more willing sellers and I think that stability as much as the increase in crude prices, has helped the A&D market. So to answer your question, it's hard to say, what that mix will be? I am cautiously optimistic, it will be a healthy balance of both. And I think that to the extent we do a drop-down, if that's achieved, I think the likely way in which that would be financed would be to just issue units directly to our sponsors. That's at least what they've indicated to us at this time. So that wouldn't necessarily require for us to do an equity offering, if that make sense. But again, all options are on the table for this year.

And our next question comes from John Freeman of Raymond James.

So just a follow-up on the hedging strategy. I think you've always been very clear about -- you all looked at it in the past if sort of -- if leverage you got to kind of 1.5x or if oil kind of approached $60, is when you all look to do it. So just a little bit more color, Davis. So on that strategy, just to make sure I'm clear, if the oil price theoretically went to $70, $75, that wouldn't necessarily change your hedging strategy which is going to be tied more with the debt levels. Is that correct?

John, that's a good question. We talked about that to you. I mean -- so to answer your question, yes, I think it's going to be tied in debt levels. And as you know, from talking with us, we're very conservative on debt level. So I don't see hedging becoming a major part of what we do, just because debt will never be a major part of what we do. But yes, I mean, if oil went to -- hypothetically, if oil went to $80 next quarter, we would certainly take a hard look at putting some hedges in place. I think we would be foolish not to. But -- so I guess, what I'm saying is, that the debt rule is a rule of thumb. And I think you can use that as the kind of parameter of what to expect from us. But if some outliers then happen, like oil going to $80 bucks, we might depart from that rule, if that make sense.

Yes, that make sense. And then my follow-up question, I'm trying to kind of balance, obviously, where we've got the more kind of stable oil price environment, which is, as you all mentioned, usually that creates a better environment where you get kind of a shrinking bid-ask spread. Balancing that with the commentary Bob, you made about the Permian remains kind of red hot and the prices are pretty frothy. Again, we've talked about this maybe in the past, but just maybe, again, if it would be considered above potentially selling some Permian to potentially buy more attractive minerals -- at least more attractively priced minerals in some other basins?

Yes. Again, yes, John, thanks for bringing that up too. We are continuing to explore that and I'd say, I don't want to be too vague to not give you any value in my answer. We have escalated, I guess, is a good word I'll use -- our exploration of exactly that concept. So that -- I think that's all we want to say from now. But we've escalated it and maybe one more thought would be -- if there's various ways we can monetize that underdeveloped acreage, for example, in the Delaware basin that we have, one way is simply to sell it for cash. Another way to do it would be to find a party that would be willing to exchange some properties that we like that generated a tremendous amount of current cash flow, which would obviously be very accretive to our company. So we have a couple different ways that we can handle that. It's something that we are focused on and discussing weekly and more to come on that. Is that enough color for you, John?

That's very helpful. And if I could just be allowed to sneak one more in. On the G&A front, is there anything in the 4Q number, anything that we should be aware of that when we're trying to think about like the G&A outlook for '18? And that would be my last question.

Yes, there is -- and again thanks for bringing that up too. The fourth quarter G&A had some disappointingly high professional fees. It's expensive to be a public company in your first year, particularly when the unit lockup expiration occurs, that was a lot of work, just given the size of our sponsor group. We put in a hedging program, so that was expensive, and then over the course of the year, we did hire a few additional folks in our technical group and then within -- one in our accounting office so that kind of bumped G&A up a little bit too. Again, we're trying to make sure that we're prepared to run this company as a billion dollars plus enterprise and be able to keep up with that growth with the resources we have in-house. I will share now, because you brought it up, I think our target for G&A for full year '18 is going to be $8 million to $8.5 million. I think it's what we feel comfortable disclosing. So you guys can kind of revise your G&A estimates accordingly.

(Operator Instructions) Today's next question comes from T.J. Schultz of RBC Capital Markets.

How much production is at the parent that is suitable right now to be dropped? And what's the decline rate for that type of production that would come in this year?

We've never disclosed -- I don't think we feel comfortable disclosing how much production there is at the parent level. It's a lot. I'll put it that way. It's a significant amount. I would say the decline profile of those assets would be virtually indistinguishable from the existing public assets. Bob, would you agree with that?

I definitely agree, and also varied across various basins and I'd say high-quality basins. So, very similar to the properties that are currently in the MLP.

Yes, exactly. So I think the way you can think about it is, it's kind of a warehouse of -- and by the way, it's not just one parent, we have multiple parents. But it's a warehouse of assets that look very similar, in quality to -- if not exactly the same in quality to what we have currently.

Okay. And would that just be fully financed with units and the sponsor? Or have you balanced kind of that nice signal of support obviously versus any doing other equity, maybe as you think about improving flow in that sort of thing?

Great, great question. We spent a lot of time talking about that in our board meeting yesterday. We're going to -- that there's a fine line there as you've kind of hinted at. And I think that, that's something that we're going to focus on and we're just going to have to make a judgment decision. Some drop-downs will be equity financed, would be directly issuing units. Others will do a primary raise and get some capital and do it that way. So I guess, it's hard to say. I think that to your point, we're very focused on improving float and liquidity in the business and to that extent, I think that we are going to do everything that we can in the near to medium term to enhance that liquidity, and as part of the drop-down, if we can achieve that, all the better. So definitely something that we're -- we think about every day.

(Operator Instructions) This concludes our question-and-answer session. I'd like to turn the conference back over to Bob Ravnaas for any closing remarks.

Thank you, everyone, and thank you all for joining us this morning. That completes today's call.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.

Thank you.