Sitio Royalties Corp (STR) 2022 Q3 法說會逐字稿

Ladies and gentlemen, welcome to the Sitio Royalties Third Quarter 2022 earnings call. My name is Glenn, and I'll moderating today's call. (Operator Instructions)

I'll now hand you over to your host Ross Wong, Senior Director of Corporate Finance and Investor Relations, to begin. Ross, please go ahead.

Thanks, operator, and good morning everyone. Welcome to the Sitio Royalties Third quarter 2022 earnings call. If you don't already have a copy of our recent press release and updated investor presentation, please visit our website at www.citio.com where you will find them in our Investor Relations section.

With me today to discuss third quarter 2022 financial and operating results is Chris Conoscenti, our Chief Executive Officer; Carrie Osicka, our Chief Financial Officer; and other members of our executive leadership team.

Before we start, I would like to remind you that our discussion today may contain forward-looking statements and non-GAP measures. Please refer to our earnings press release, investor presentation and publicly filed documents for additional information regarding such forward-looking statements and non-GAAP measures.

And with that, I'll turn the call over to Chris.

Thanks, Ross. Good morning, everyone, and thank you for joining Sitio's Third Quarter 2022 Earnings Call. We had another great quarter as we continue to execute on our large-scale consolidation strategy. We also refinanced our bridge loan with a flexible capital solution and made progress like we have done every quarter, developing our team and improving our processes to enhance the scalability of our business model. Despite a double-digit percentage decrease in realized commodity prices for the third quarter versus the second quarter, we are increasing our dividend from $0.71 per share for the second quarter to $0.72 per share for the third quarter. This is a clear demonstration of the accretive nature of the transactions we have closed this year.

The highlight of the quarter was the announcement of our all-stock, at-market transaction with Brigham Minerals, which was the largest ever public merger in the mineral sector. This transaction brings additional high-quality assets into our company, dramatically increases the public float of our stock, reduces our leverage statistics and has a significant benefit of giving us the opportunity to bring additional talented employees to Sitio. Since announcing the transaction, we have spent a significant amount of time with the Brigham employees to identify where their skills intersected with our needs today and our plans for future breaks.

We are excited to announce that Dax McDavid, who is currently Brigham's SVP of Exploration, will be joining Sitio after the transaction closes in the newly created role of EVP of Corporate Development. Many of you know Dax already. He is a geologist by background and has built an impressive network of relationships throughout the upstream oil and gas, and mineral and royalty sectors. In his new goal, Dax will be responsible for leveraging these relationships and his technical expertise as we continue to consolidate high-quality minerals and royalties assets. He will also work closely with our technical, brand and corporate finance teams to develop new ways to differentiate Sitio from other minerals companies. In addition to that, we have identified 13 other Brigham professionals across every functional group in the company, including geology, engineering, land, GIS and accounting, who plan on staying with Sitio post close, which will bring our total head count to 49 employees.

On October 11, we filed a merger proxy with the SEC, and we are currently working through their review process and expect to respond to the SEC's first set of comments soon. There will not be a proxy meeting for Sitio shareholders since the transaction was already supported by Sitio's 3 largest shareholders who own approximately 84% of the equity. There will be a proxy meeting for Brigham shareholders, however. The exact timing of that meeting will be determined by the length of the SEC review process. Upon closing of the Brigham transaction, we plan to put a new revolving credit facility in place that is appropriately sized for the combined company.

While the new revolver side still needs to be determined by going through a syndication process of our bank group, I can provide some context to help frame situations. Currently, on a combined basis, Sitio and Brigham stand-alone revolvers have a borrowing base of $590 million, which has not been adjusted upward for recent acquisitions, including Foundation, Momentum and Avant. In aggregate, these acquisitions added more than 35,000 net royalty acres for an aggregate purchase price of more than $650 million and should add a meaningful amount of reserves to support an increased borrowing base. In late July, we closed on the acquisition of more than 12,200 NRAs from Momentum Minerals, which is turning out to be one of our best acquisitions to date and has already outperforming our underwritten production forecast. These assets, in combination with the minerals and royalties acquired from Foundation Minerals in June, have strong visibility for near-term activity and comprise approximately 32% of our line-of-sight wells as of September 30.

We funded both acquisitions primarily with proceeds from a $425 million bridge loan. We evaluated a wide range of alternatives to refinance the bridge loan and are pleased to have identified a solution that met all of our needs, including a competitive cost of capital, no impact on our existing ability to continue to pay our dividend even in lower commodity price scenarios and structural flexibility. On September 21, we issued $450 million of senior unsecured notes to a small group of private lenders and use the proceeds to fully retire the bridge loan. We negotiated the terms of these notes to ensure they were tailored for our business and structured as the best solution for our company at the time.

It is important for us to maintain a large amount of prepayable debt because of how much cash flow our business generates, and the notes allowed for us to 10% amortization of the initial principal per year at par, which we plan to take full advantage of. The notes also only have a 1-year noncall period and lower call pricing than traditional public bonds, which provides the flexibility to refinance as early as September of next year, if credit markets are in a better state.

Our third quarter financials included a full quarter of results from the acquired Falcon Minerals and Foundation Minerals assets and roughly 2/3 of a quarter of results from the Momentum Minerals acquisition, which closed in late July. This was the first full quarter with several of our newly acquired assets. We had many record high metrics, including average daily production of 18,000 BOEs per day, adjusted EBITDA of $106.3 million and discretionary cash flow of $93.4 million. On a pro forma basis, including a full quarter of production volumes from the Momentum acquisition, our third quarter production would have been 18,571 BOEs per day. While these headline numbers are notable and a reminder of how rapidly we have been executing on our large-scale consolidation strategy, I think it's most important to look at some of the key metrics that drive shareholder value and future growth.

First, we declared a third quarter dividend of $0.72 per share based on a 65% payout ratio of our discretionary cash flow. This represents a $0.01 increase relative to our second quarter dividend, even though average unhedged realized prices were down 14% from $76.65 to $65.71 or nearly $11 per BOE. We also had $2.7 million in realized hedging gains during the quarter, which was a direct result of the commodity hedging we put in place related to the 4 cash acquisitions we made earlier this year. In hedging, we don't try to predict future commodity prices, but instead, hedged multiple years of expected production on cash acquisitions when we are in above mid-cycle pricing environment to protect returns we are underwriting. This is the perfect example of this philosophy at work.

As a reminder, our oil hedges are at a weighted average price of $106.31 per barrel for the remainder of this year and are $93.71 per barrel for 2023. Second, we recorded third quarter lease bonus of $6.7 million, which is $5.4 million greater than lease bonus in the second quarter and more than our lease bonus for the entire first half of the year. We don't underwrite any lease bonus activity on acquisitions but have been very focused on increasing our leasing activities to get the most productivity out of our assets. So it's nice to see this showing up in our results.

On the cost front, at $2.80 per BOE, we recorded the lowest annualized cash G&A per BOE in our company's history and growth of $3 per BOE barrier for the first time. This highlights the scalability of our business model and demonstrates one of the reasons why we continue to pursue large-scale acquisitions. Each acquisition drives down our cash G&A per BOE since we don't need to increase cash G&A linearly, which directly improves our discretionary cash flow and dividends to our shareholders. We expect this metric to improve over time as the business grows. Using the bookends of annual cash G&A guidance and combined 3Q actual production for Sitio and Brigham, including a full quarter for Momentum, third quarter cash G&A per BOE would have been in the $1.80 to $1.88 range for the combined company.

Activity and line-of-sight activity on our assets remains robust with 4.1 net wells turned in line during the third quarter and nearly 27 line-of-sight wells as of September 30, which is near our historic company high. Pro forma for a full quarter of Momentum Minerals assets, our third quarter production was 18,600 BOE per day, which is above the midpoint of our second half 2022 guidance for standalone Sitio. We have strong visibility to a few high-interest pads in the Permian Basin that have been spud and are expected to come online in late 4Q 2022 or early 1Q 2023. And these pads represent more than 2 net wells and are a catalyst for continued near-term growth trajectory of our Permian assets. On a combined basis and including a full quarter of momentum, Sitio and Brigham's assets produced an average of 33,600 BOEs per day in the third quarter, which is above the midpoint of the average daily production guidance range released at merger announcement for the 12 months ended June 30, 2023.

Given these results, we are increasing the average daily production range for the combined company to 32,750 BOEs per day to 34,250 BOEs per day, which is a 250 BOE per day increase at the midpoint. We are looking forward to continuing to execute on our differentiated large-scale consolidation strategy at the combined company and are doing all we can to ensure that closing of Brigham transaction is completed in a timely manner.

That concludes my prepared remarks. I'd like to open up the call for questions.

(Operator Instructions)

We have our first question comes from Jeanine Wai from Barclays.

This is Jeanine Wai. You mentioned in your prepared remarks that you really want to hone in on what differentiates Sitio from other mineral companies. And just what do you think is the most impactful way to do that? Is it really through the quality of the portfolio or do you think it's more on share size and float or maybe through your investor conversations or your outreach? Is it on just having like a highly competitive cash return? I guess, what's your early look on that?

Sure. Thanks, Jeanine. So I'd say, first of all, the advantages of scale which are manifesting itself in our ability to execute on large scale transactions. And really, as we said before, it's not just size. For size stake, it's really size for efficiency and profitability stake. And what we mean by that is, we get more profitable, the larger we get. We continue as we get more scale to refine our internal systems and data management because really, since we don't own pipelines or trucks or rigs or wells, we just own data. And so for us, the larger we get, we're just trying to improve how we manage that data. And so as a real benefit of scale is adding efficiencies. The larger we get, enhance how we manage that data.

Okay. Great. We look forward to working with Dax in his new position. And my second question on A&D. Based on what you see in the market, can you talk about how you view upside to the 65% of discretionary cash flow in your framework at least in the near term here? And if there's any read through there on divestitures?

Yes. I'll take the second part first on divestitures. So up to this point in our company's life really before June of this year, we didn't have many logical opportunities for portfolio management. I think as we sit here today and then pro forma for Brigham, we will have the potential for some of that. So those are opportunities we are looking at today. But as far as the payout ratio goes, I think it's more going to be driven by what we do with our leverage and how we work that down over time. I think the way to think about our payout ratio over time is, as we grow the business, pay down the debt, and have excess cash flow. It's our shareholders' money, and we're going to return it to them. So I think the first priority right now is working down debt.

We have our next question comes from John Annis from Stifel.

Congrats on the strong quarter. For my first question, I wanted to focus on Slide 8 and the impressive backlog of line-of-sight wells. Post your recent transactions, could you comment on how many net wells are required to hold production flat on a pro forma basis?

Yes. So that's obviously evolved over time. It used to be a much smaller number as we were a smaller company. But as we sit here today with about 27 line-of-sight wells, that's a number that implies organic growth on our asset base today. So as you get to a smaller number of line-of-sight wells, the whole production flat, it's going to be in the teens. And so it's going to be -- as I said, it's been a growing company, that number is going to continue to grow. Certainly, as we add the Brigham assets, there's going to be a step change in what's required to keep the entire production base flat.

When you think about it in terms of PDP decline rates, it's another way to frame the conversation. If you look at Sitio standalone, our PDP decline rate is up 34%. And then if you look at the Brigham assets, it's a hair higher than that. So I think company-wide, it will tick up maybe 1% or so after the Brigham transaction, but that's just another way to think about it.

That makes sense. And then for my follow-up and maybe building off of that question, could you comment on how we should think about production volumes trending over the next couple of quarters in Q4 and Q1? And based on your Q3 results in line-of-sight inventory?

The biggest catalyst for near-term production is really going to be a large number of high interest spuds that we see right now. So for example, Pioneer's shared wells, you have some SM wells in the (inaudible), Tall City and their Otter lease, Ovintiv and their Thor lease. So there's a number of high interest wells where whether they coming in 4Q of this year or 1Q of next year is really going to drive what the cadence looks like for us. But as I said, the line of sight wells implies some organic growth on our assets, and it's just a timing issue of when these pads come on.

We have our next question comes from Noel Parks from Tuohy Brothers.

I just had a couple of things. As we're heading into the end of the year, I'm wondering if you're seeing any particular patterns among operators, I'm thinking about what I've heard that some of them are more inclined to be a little more aggressive on CapEx for the sake of heading on to rigs and crews. So any insights you have on that as far as your activity crossing over the year boundary? And then maybe any thoughts you have on costs as well?

Noel, so I think we're seeing the same thing you are in terms of what operators are expressing in terms of cost inflation. Now what we've seen so far is that it's not translating into a reduction in activity, it's just causing operators to raise their capital budgets. And I think the reason for us is, hopefully, the trends continue from what we've seen, which is sustained levels of high activity from operators. And we've seen it from both rigs on our asset, spud activity, permits, wells turned in line, have all been pretty healthy. And candidly, it's across all different kinds of operators. If you look at the large caps, small caps and the private, all very active. Privates are still out punching their weight in terms of their activity levels on our assets relative to the amount of acreage that they operate for us. So that trend continues.

Great. And to the degree that you're -- a lot of acquisitions already under your belt, but to the degree you're still keeping watch on what might be available out there. We've had some pretty significant volatility in commodity prices, a little bit of strengthening in the last maybe month or so. And is it really price deck that is the main thing that determines bid ask at this point? Or are people looking more broadly, I'm thinking about maybe timing, their own view or concerns about interest rates and their own ability to sustain capital to, well, not so much the same capital but to satisfy whatever thresholds they have for returns?

We found that the price deck is usually the least controversial of the inputs into any sort of bid-ask spread. Oftentimes, when we do postmortems on situations where we were not successful in buying an asset, we find that the difference arises from different assumptions around pace of development. And sometimes, it's around --- on the margins around remaining inventory, although if you think about in terms of remaining inventory, you think it's 10 wells per section or 15 wells per section, those last 5 wells are so far out in the future that the PV impact is pretty small. Really, the differentiator is pace of development. And so oftentimes, people have much more aggressive views on future pace of development than we do. And that's what leads to a wider good asset spread.

(Operator Instructions) We have no more further questions from the line. I will now hand the floor over back to Ross.

All right. Well, that concludes our call. Thank you for joining today.

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines.