Viper Energy Inc (VNOM) 2020 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Viper Energy Partners Second Quarter 2020 Earnings Conference Call.

(Operator Instructions)

Please be advised that today's conference is being recorded.

(Operator Instructions)

I would now like to hand the conference over to Mr. Adam Lawlis, VP, Investor Relations. Please go ahead.

Thank you, Sharon. Good morning, and welcome to Viper Energy Partners Second Quarter 2020 Conference Call. During our call today, we will reference an updated investor presentation, which can be found on our website. Representing Viper today are Travis Stice, CEO; and Kaes Van’t Hof, President.

During this conference call, the participants (sic) [company] may make certain forward-looking statements relating to the company's financial condition, results of operation, 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 Second Quarter 2020 Conference Call. During the second quarter, Viper had limited completion activity on our acreage as operators reacted quickly to oil price volatility by cutting capital expenditures, ceasing completions, and in some cases, curtailing existing production. However, Viper's production during the quarter was supported by 14 of Diamondback's 15 completions, having more than an 80% average royalty interest net to Viper. Further, and as it relates to our second half production outlook, nearly all our curtailed production has come back online as commodity prices have improved in recent months. Importantly, Diamondback has recently bought back 3 completion crews to work after taking an almost 3-month break from all completion activity in the second quarter of 2020. Looking toward the second half of 2020, Diamondback expects to focus on its completion activity on areas where Viper has significant mineral ownership, primarily in the Midland Basin. This increased completion activity by Diamondback will be supported by Diamondback ending the second quarter with approximately 165 DUCs, roughly 65% of which Viper expects to own a meaningful royalty interest. This current DUC backlog along with increasing visibility into third-party operators anticipated activity levels will support Viper's production profile for the coming quarters.

The advantage business model of Viper as a royalty company is highlighted during these times of depressed commodity prices in that our high cash margins, no capital requirements and limited operational costs drive continuous free cash flow generation through the cycle. To that end, at $40 oil and production held flat relative to our second half 2020 guidance levels, Viper is expected to generate more than $180 million in free cash flow in 2021 or a greater than 11% free cash flow yield. This is expected to be a roughly 2 percentage point increase from our second half 2020 annualized free cash flow yield as some of our hedges roll off. As it relates to the free cash flow from the second quarter of 2020, we've made the decision to retain 75% of that cash flow to fortify the balance sheet. The Board reviews the distribution policy each quarter, but with the continued depressed oil prices and uncertainty in the energy industry, the prudent decision is to retain the majority of cash flow to reduce leverage and protect the business. Viper remains in strong financial shape with $436 million of liquidity and will continue to look for avenues to accelerate the deleveraging process and get back to returning a more meaningful amount of cash flow through our distributions.

In conclusion, I want to underscore the fact that mineral ownership remains the safest asset in the oil industry because it is a perpetual real property interest that is high margin and requires 0 capital requirements. Within the mineral subsector, Viper is further distinguished due to our relationship with Diamondback as our primary operator. Times like these emphasize that the relationship as Diamondback focuses its operations on areas where Viper owns the minerals due to the lower consolidated breakeven economics. This relationship is evident by the midpoint of our second half 2020 average production guidance, implying greater than 6% growth relative to Q2 2020 average daily oil production, even with the challenging macro backdrop.

Operator, please open the line for questions.

(Operator Instructions)

Our first question comes from Will Thompson with Barclays.

For Travis or Kaes, it seems pretty clear that Diamondback doesn't plan to pursue growth unless they see a much higher forward curve. Given the concentration of activity in Midland, where Viper has high NRI as we saw in 2Q, would it be fair to assume Viper could see oil growth in 2021 that could provide upside to the free cash flow sensitivity provided in the slide deck? Just curious on your thoughts on maybe the directory for Viper next year.

Yes. Well, I think certainly, it's a possibility, particularly from the exit Q4 number. But I think that a year-over-year basis with Q1 being as high as it was, I think it would be tough to grow on a year-over-year basis. We have to see some more activity on the non-op side, but you're exactly right. I mean, even though Diamondback is not pursuing a large growth strategy in 2021, the concentration and the focus on Viper minerals, which I think has been accelerated due to the low commodity prices will benefit Viper and hold Viper up through what is a pretty uncertain time. So I think growth can continue from Q4. Right now, what we can see is growth into Q3 and certainly, growth into Q4 from Q3, all held up by Diamondback. And then I think 2021 has some optimism, but we've got to finalize the completion schedule at this point.

Okay. That's helpful color. And in terms of the payout ratio, you guys obviously stressed that, that's reviewed on a quarterly basis. I can appreciate there is some restrictions in terms of debt covenants on the payout ratio. I understand that it's kind of 3x leverage. But correct me if I'm wrong, there is some flexibility in terms of, I don't know, buckets of carve out that allow you to exceed it. I'm just -- just help us understand how you're thinking about the payout ratio going forward as we see kind of a better strip outlook and just in terms of the loan growth?

Yes. We have a few buckets in the indenture that allow us to distribute even if we're above 3x leverage. We're not above 3x leverage today, but I think as the Board went through the conversation on the Q2 distribution, given that the total free cash flow is about $0.12 a unit, and we're distributing 25% of that, really there is not a huge delta between paying out 100% and 25% for this quarter. But certainly, going forward, we're going to have some detailed conversations about what we can do. And if we have confidence in the forward outlook that we're not going to get close to 4x, and we're closer to below 3x than above it, I think there is a chance to increase that distribution looking into the second half of this year and into 2021.

Next question comes from Chris Baker with Crédit Suisse.

Just in terms of -- on the topic of Diamondback's ownership of Viper, which came up on the call earlier today, sounds like the Board is comfortable with where things are currently. But just curious, what the thinking is longer term as it relates to Viper.

Yes. Certainly, Chris, if you look at our prior behaviors at the Diamondback level, every opportunity we've had, we've increased ownership in Viper. And I think we're very comfortable with -- at the Diamondback level, where we're -- what our ownership position is in Viper.

Listen, it's certainly a support to the debt at Diamondback, and that's kind of the point we were hammering. I think there is no intention today to sell any -- sell down any ownership in Viper. And on top of that, I think just look at our actions where we've increased the share count of what we've owned since IPO.

That's helpful. And then just a follow-up. You mentioned looking to accelerate the deleveraging process. I'm just curious how you're thinking about levers that you could potentially pull beyond maintaining that lower payout ratio?

Yes. Chris, I mean, obviously, the payout ratio is the most visible, but there is a lot going on in the backdrop of doing work on our asset position, making sure we're getting paid for what we deserve to get paid on, working down the accounts receivable balance, but also probably, more importantly, working to bring some cash in by selling some undeveloped acreage positions. We've had a couple unsolicited bids on completely undeveloped properties where private equity is making a bet on next 2 or 3-year development and that doesn't provide a lot of value to Viper today. So those are kind of smaller packages here and there that we're looking to sell, if it's not reducing our cash flow.

Next question comes from Derrick Whitfield with Stifel.

With regard to your 2020 guidance, we're backing into an implied Q4 that is materially above the Street and on the higher side of your second half range. Does that square with your views based on the expected timing of Diamondback operated completions?

I think that's fair, Derrick. I think we tried to come out strong with the forward guidance and also maintain guidance unlike a lot of our peers who aren't even providing it. Certainly, with the high interest wells coming on, really starting about now and through the end of the year, we feel really good about the growth profile at Viper into the back half of the year.

Great. And then perhaps, for yourself or Travis, certainly based on your earlier Diamondback call, I know the environment for public or private M&A is challenging for working interest acquisitions. Perhaps, if you guys could speak to the broader view on M&A for the mineral sector, which is a bit more fragmented and perhaps, less mature?

Yes. We're really enough, Derrick. It's probably harder on the mineral side. I think there is still a lot of private money that likes this asset class, and therefore, the numbers that we're seeing on the opportunities set are still too high. There is just such a bid-ask spread that I think other people are paying for a recovery in oil prices, and that's kind of why we decided to sell some assets that aren't developed. We're getting prices that we thought were reasonable and well above our acquisition cost of that particular asset, and that kind of spurred the conversation of, hey, maybe we should sell a little bit here and there.

Next question comes from Brian Singer with Goldman Sachs.

First question is on the balance sheet and the dividend payout percentage. Can you just talk about how you see that evolving? And where you see, on a longer-term basis, that payout percentage? And the same thing for the balance sheet. Do you have a goal now of having a similar leverage at the Diamondback and VNOM level? Or is there comfort with VNOM having higher leverage ratio relative to Diamondback?

Well, I think it all depends on where the forward outlook goes on commodity price, but overall, given that VNOM is pure free cash flow and doesn't have to spend dollar on CapEx that we should feel a little more comfortable with the higher leverage ratio at the VNOM level. I still think we think about leverage on a consolidated and a deconsolidated basis, so we have to be careful there. But just like Diamondback, there is no set target on VNOM side. We do want to get that payout. I think the first step is to get the payout up from 25% to 50%, and then have real conversations with the Board on what the future holds. I think, overall, relying on capital markets for all of your acquisition activity is probably not the most prudent thing to do, but we've had a history of being able to acquire and raise capital. And I think that's probably changing a little bit, but overall, we still want this to be a vehicle that pays out the majority of its free cash flow to our shareholders, the largest being Diamondback.

Great. And then a follow-up on the divestiture opportunity and then potential acquisitions. Would these both be focused or would both divestitures and any potential acquisitions be focused on operators outside of Diamondback? Or is some of what you're talking about, either from a divestiture perspective or acquisition perspective, on Diamondback-operated properties?

Yes. I mean, we're not focused on any acquisitions right now but certainly, divestitures are acreage positions not operated by Diamondback that we have no line of sight to development. If there is line of sight or cash flow that's producing on that asset, then it's not up for sale. But the unique nature of the minerals business is that a lot of people like to bet on future development and with no development today, those assets kind of follow the front of what we could sell.

Next question comes from Jeff Grampp with Northland Capital.

Next question comes from Gail Nicholson with Stephens.

On Page 5, free cash flow sensitivity analysis, you guys are assuming a 95% WTI realization. Can you just talk about what factors could adjust that expectation on a go-forward basis?

Yes. Gail, I mean, it really depends on the Brent-WTI spread. If Brent-WTI widens out a little bit more than it is right now, it's pretty narrow, then you probably realize a little bit higher percentage of WTI. And I think, for us, that 95% is a good conservative number for the back half of the year. And really, we're trying to hammer the point across here that while we're a little bit hamstrung by hedging losses in the back half of the year, the free cash flow really kicks up in the first half of 2021, and you get a pretty solid free cash flow yield based on today's strip.

Next question comes from Leo Mariani with KeyBanc.

Just wanted to get maybe a little better quantification, if possible, on second half activity. Just wanted to get a sense, you guys mentioned a little bit more insight into kind of non-op activity. Are you guys baking anything in on the non-op side into the second half '20 production guide? And then roughly, how many second half '20 net well tie-ins are you expecting?

Yes. We -- I mean, I think on the non-op side, we're still going to be pretty conservative. We had 1.3 net wells in the second quarter, and we're expecting that number to go down in the third quarter. But the Diamondback side more than doubles on the net wells completed on the Diamondback side in Q3, so that supports the Q3 growth. And then as you look into Q4, you're still completing a good amount of Diamondback wells, and we're baking in a little bit of non-op -- not growth, but a few more -- a little over 1 net well is coming on the non-op side in Q4. So really driven primarily almost 65%, 70% on activity on the Diamondback side because we have a lot of confidence in that. So if the non-op tends to surprise to the upside, then that's gravy for Viper shareholders.

Okay. That's helpful. And I guess, I certainly understand that you guys don't have kind of a hard and fast leverage target, and fully agree that VNOM supports more leverage than certainly any traditional E&P company does. But clearly, you guys have made the decision to go on the defense here on distributions and only payout roughly 25%. The cash flow, is there some kind of leverage level out there, whether it's kind of a fair bit below that 3x coming in if it's 2.5x or less, where you feel like there is a lot more flexibility on the Viper level, either to payout a much more meaningful level of cash flow and/or to kind of resume any M&A activity out there, certainly noticeable that there were no deals in the second quarter. I know you guys said the bid-ask spread is wide right now, but I just wanted to get a sense around kind of balance sheet governors as well to future M&A.

Yes. I mean I think the balance sheet is most important, holding us back from M&A. I mean, if we saw the best deal in the history of minerals, we'd have to think hard about it, but unfortunately, those deals just aren't out there. And then on the leverage side, it really depends on the forward outlook, and we go through the next 18 months with the Board in detail every quarter. And if we see the strip materially improving, and we're not getting hit on hedge losses, you can see that our path to delevering is naturally going to happen, then we're going to bump that distribution back up.

Next question comes from Phil Stuart with Scotiabank.

I wonder if we could just circle back on the divestiture comments. Just curious if you all are -- if the interest is more skewed to the Delaware over the Midland, just given that it's less developed. If you guys have any comments on that?

That's probably fair, Phil. The couple of deals we've gotten done are in the Delaware. It is not to say that there is not Midland opportunities, but I think, overall, our Midland position is an area that have a lot of active development or a lot of visibility. Whereas, the Delaware is a little less developed and not as clear on the path to forward development.

Okay. And then I guess just one follow-up. I know you guys said that you're not focused on selling cash flowing assets. But given the Eagle Ford position is outside of the Permian, would that be under consideration as an asset to sale -- to sell, if the bid was there?

I think any asset is for sale if the bid's there, but there is really not -- I don't think there is going to be a bid there that we would want to move that asset. Certainly, we felt like we bought into that at a good price, and it is in one of the few areas where there is actually activity in the Eagle Ford. But overall, I think the job of a capital allocator is to be able to buy and sell, and we're going to take responsible bids. And if someone hits the bid, we'll sell it, but right now, I don't think that's going to be a position that's up for sale.

Next question comes from Welles Fitzpatrick with SunTrust.

It seems like the work in progress wells are perhaps unsurprisingly skewed towards Diamondback. Could you maybe give your thoughts on where you guys see exiting the year sort of percent Diamondback activity or percent Diamondback production?

Yes. It's really probably 2/3 Diamondback production exiting the year. I think we're somewhere a little below that today, probably close to 55% today, and then we're probably going to move up another 5% or 10% to Diamondback production. And I think from an activity perspective, what we're modeling wells is essentially 75% Diamondback activity in Q3 and somewhere around 55%, 60% in Q4. So you're basically averaging 65%, 70% Diamondback activity in the back half of the year.

Okay. Okay. That makes sense. And then if I remember correctly, it's pretty minimal, but can you talk to any federal exposure you might have on third-party acreage, particularly in the Delaware?

We -- I mean, Diamondback has none, but Viper, the mineral owner would be the federal government. So they don't -- we don't have any exposure unless we had a small override, but I don't think we have any of those.

At this time, I'll turn the call over to Mr. Travis Stice.

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

This concludes today's conference call. You may now disconnect.