Viper Energy Inc (VNOM) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Viper Energy Partners Third Quarter 2020 Earnings Conference Call. (Operator Instructions) Please be advised that this call is being recorded today. (Operator Instructions)

I would now like to hand the conference over to Adam Lawlis, Vice President, Investor Relations. Thank you. Please go ahead, sir.

Thank you, Bridget. Good morning, and welcome to Viper Energy Partners Third Quarter 2020 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; and Kaes Van't Hof, 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'll now turn the call over to Travis Stice.

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners Third Quarter 2020 Conference Call.

The third quarter was a strong quarter for Viper as we saw a resumption of completion activity on our mineral and royalty acreage as commodity prices improved from the historic lows witnessed during the second quarter of this year. Viper's 10% increase in oil production during the third quarter was driven primarily by 38 of Diamondback's 41 completions in the quarter, having roughly 10% average royalty interest net to Viper, as third-party activity remained minimal, again, showcasing the differential relationship between Diamondback and Viper.

The advantage nature of the royalty business model with no required CapEx and only minimal operating expenditures, further enhanced by Viper's best-in-class cost structure, has been highlighted during this severe industry downturn, as Viper has been able to reduce total debt by 10% in just the past 6 months.

As a direct result of this and because of our confidence in the expected free cash flow to be generated in our forward outlook, the Board has elected to increase our distribution payout for the third quarter to 50% of our total cash available for distribution, up from 25% previously. The $0.21 per unit of total cash available for distribution implies a 12% annualized distributable cash flow yield based on our current unit price.

On the operations front, we continue to maintain a strong inventory of both work-in-progress and line-of-sight wells. Given that visibility, we have initiated average production guidance for the fourth quarter of 2020 and the first quarter of 2021 of 15,250 to 16,250 barrels of oil per day.

While production is already within the high end of our previously guided range, and we remain confident we'll exit 2020 with a strong production rate, Diamondback operated activity on Viper's acreage is expected to be slightly lower in the fourth quarter this year and into the first quarter of next year, before returning to a more elevated level again starting in the second quarter of 2021. This is seen with only 3.5 net Diamondback operated wells in the work-in-progress bucket, which we define as well as expected to be turned to production within the next 6 to 8 months, but 7.4 net line-of-sight wells, which are expected to be turned into production in the roughly 6- to 8-month time period thereafter. Further, we continue to be conservative in our forecasting of third-party operated production despite leading its indicators pointing to a return to increased activity levels and timing of operations.

Despite this conservatism at $40 WTI and production held flat relative to our average fourth quarter 2020 and first quarter 2021 guidance, Viper is expected to generate approximately $200 million of free cash flow on an annualized basis in the first quarter of 2021. This equates to greater than 11% free cash flow yield as a percentage of enterprise value or roughly 18% based on our current market cap. Viper remains in strong financial shape with $461 million of liquidity, and we'll continue to look for avenues to accelerate the deleveraging process so that we can continue to increase our return of this free cash flow to our unitholders over the upcoming quarter.

Operator, please open the line for questions.

(Operator Instructions) Our first question comes from the line of Brian Downey with Citigroup.

You increased your implied payout ratio here to 50% in the third quarter. I noted in your deck that you expect to continue to maintain a portion of cash available to reduce debt. Any updated thoughts on how we should think about the pace of that payout ratio increasing over time, what guidepost you're watching and what the anticipated ceiling is given those debt reduction goals?

Yes, Brian, good question. I mean, I think we're going to be patient. We did take the step from 25% up to 50% this quarter, and I think we have a lot of confidence in keeping that kind of overall payout ratio going forward.

Now I think the key is going to be Q1 and Q2, and our hedges roll off from 2020, and we start to realize a lot of higher oil price on a majority of our production. And if we -- I think if we're at current prices to hire from here, I think it's logical that payout percentage rises a little bit.

I think still, we're probably focused on getting to kind of 2x leverage at the end of 2021, which I think is a pretty logical first step or next step for us from a leverage perspective. And -- but like we've said, the increased payout is not going to be mutually exclusive to that further debt reduction.

Great. That's helpful. And then it looks like from the deck in the cash flow statement that you sold a small number of third-party operated Delaware Basin acres for a few million dollars. Could you update us on the potential for further third-party operated asset sales? And I guess more theoretically, with the E&P consolidation we've seen within some of Viper's third-party operator cohort, has that changed how you're thinking about your third-party operated acreage footprint at all versus 3 or 6 months ago?

I wouldn't say that the E&P consolidation has impacted our thought process on asset sales. But certainly, the strength we're seeing in the private market versus the public market or where we're trading has continued to give us confidence that selling some assets at these prices isn't the worst idea.

I think overall, we're selling assets that are completely undeveloped under operators with not a ton of visibility and not a lot of active development. We do have some larger packages that we're talking to people about, but we're going to be patient. And like -- I think like we said last quarter, we're not a forced seller here, but we are recognizing where we trade versus where we can sell some of this stuff in the public markets with 0 cash flow -- sorry, excuse me, in the private markets with 0 cash flow.

Our next question comes from the line of Derrick Whitfield with Stifel.

Thinking about 2021 production, while clearly a lot can still change in the macro conditions, would it be fair to assume that your forward visibility, including work-in-progress and line-of-sight wells, with that visibility, you could hold Q3, call it, Q4 production relatively flat, assuming a ratable conversion of that inventory?

Yes, Derrick, I mean, I think that's fair. There's obviously going to be some movement. Large pads at the Diamondback level do impact Viper uniquely versus a (inaudible) at the parent co. I think the kicker is going to be non-op production and non-op volumes. And we're still very conservative on how we're modeling those non-op volumes. But certainly, our leading indicators, permits and rig count and line-of-sight wells has improved slightly on the non-op side, particularly in the last couple of months. So while I won't commit to staying flat as guidance today, I think it's a potential outcome for the full year.

And Kaes, just staying on that point specifically, when you guys look at the permits to assess your third-party queue, so to speak, does that support the notion that the rig count has largely bottomed from a third-party perspective? And then also, would it support the notion that your completion flow probably bottomed as well?

I think that's fair. And I think you've seen it in the data we put out, that the Diamondback net wells really held up the company in Q2 and then -- well, sorry, mainly in Q3, and we'll continue to do so in Q4.

Certainly -- I certainly hope the rig count has bottomed, but I also hope, from an industry perspective, we don't go back to grow, grow, grow and instead focus on maintaining production, and hopefully, Viper is the beneficiary of some of that non-op production getting turn of mind here over the next few quarters.

And our next question is from the line of Brian Singer with Goldman Sachs.

On the Diamondback call, I believe Diamondback said flattish-type production until oil prices move higher, and then more longer term, low single-digit or just single-digit production growth. And I just wondered, what's the longevity by which the Viper production profile can outperform Diamondback based on the focus of Diamondback on drilling higher interest wells on -- from a Viper portfolio -- from a Viper perspective? That was obviously a driver of the strong production here this quarter. But what's the longevity of that until, potentially, you start to see Diamondback growth equal Viper growth x the -- what happens on the nonoperators?

Yes, Brian, I mean, I think, certainly, the second half of this year, Viper's growth is going to outperform Diamondback's growth -- Viper's operated production by Diamondback is going to outperform Diamondback's growth. This does go in waves, and we had some really high interest wells come in on -- in Q3 that's going to help us going into Q4.

But over the longer term, I would hope that Viper's Diamondback operated production can slightly outperform Diamondback, if Diamondback is staying flat or grow a couple of bps higher than -- couple of hundred bps higher on a percentage basis than Diamondback's. But that's our job as a consolidated capital allocator to make sure the drill schedule is encompassing Viper minerals.

And what we see today is that there's going to be a lot of high interest pads coming on in 2021, continuing that trend of increased pro forma capital efficiency heading into 2021.

Got it. And then my follow-up, you talked about asset sales earlier and the understandable focus on deleveraging, part of which you've already shown here over the last 6 months. But can you just talk philosophically on the acquisition side about the interest level in further growth via M&A and how you expect that market to -- and your interest level to evolve?

I think M&A has been really important to Viper to achieve scale in the mineral space. I think we're going to echo the comments that Travis had on the Diamondback call that Viper doesn't need to be the biggest mineral owner in Texas or the biggest mineral owner in the Permian. We need to be the best. And that means that we're going to be reshaping our portfolio a little bit, buying minerals under Diamondback and selling non-op minerals.

And while I'm not going to -- like we said, we're not going to sell minerals at fire sale prices. We do recognize that there's a bit of a value disconnect between where we're trading and where these minerals are trading in the private market under operators with no visibility, no line of sight. It's good acreage, but there's no control over the drill bit. So I'd rather have control over minerals that we operate with a 16% forward yield and pristine visibility.

Our next question comes from the line of Chris Baker with Crédit Suisse.

I realized it's hard to talk about 2021 without formal guidance from FANG, but just looking at that Slide 7 in the deck, it looks like, historically, you guys have averaged, call it, 70% to 75% of Diamondback activity. What's a reasonable placeholder for Viper's exposure to FANG's program next year? And could that sort of be biased above the historical average as we've seen over the past few quarters?

I think it's going to move around. The Q3 number was as high as it's ever been. I think we had 93% exposure to Diamondback wells. But I think, Chris, over a longer period of time, 2/3 to 3/4 is a pretty safe baseline. Now I do think our Viper team is going to be looking to increase that number by buying under Diamondback when the balance sheet allows it. But 2/3 to 3/4 exposure to Diamondback's completions is probably a safe bet.

Okay. Great. And just as a follow-up, realizing the focus today is on the balance sheet. But once that sort of peak leverage is in the rearview mirror, is there a specific leverage target? You talked about 2x by the end of next year. But is there a specific leverage target that allows you to restart the acquisition program? Albeit and what it sounds like is a very thoughtful way.

Yes. I think being closer to 2 and getting 3x in the rearview mirror is more important to us today. I think if we have a lot of confidence, that, that's going to happen over a couple of quarters, and then we can restart the acquisition machine. But I also think part of the acquisition machine can be funded through asset sales rather than debt or external funding.

Our next question comes from the line of Jeff Grampp with Northland.

Kaes, maybe just to build on the last thought on kind of leverage and payout ratios, what do you guys kind of view if you formalized any thoughts internally about kind of target leverage and payout ratios in a normalized world, however you guys may want to define normalized?

Yes. I mean, in 2020, I don't know what normal is anymore, Jeff, but I do think it's kind of a mid-cycle oil price, $45 to $55 WTI, which is a long way from where we are today. We should be closer to 1 turn or 1.5 levered at most. And while I won't commit to a long-term payout ratio on this call, I do think it's something like the inverse of an E&P. So if an E&P is reinvesting 70% of its cash flow into maintenance capital and returns, maybe the mineral company can be the opposite.

I think we've heard a lot of talk about variable dividends in the E&P space, and I ask investors to go and look back at what we've done. And Viper has been a variable investment vehicle, a variable payout vehicle for 5 or 6 years now, and it's returned a lot of cash back to shareholders.

So I think a rule of thumb could be that it's the inverse of an E&P. I mean, a mineral company certainly needs to continue to add inventory. This is a depleting business. But to urge that inventory for a mineral company is much different than an E&P.

Got it. Appreciate that. And for my follow-up, how would you say a hedging philosophy integrates into some of those kind of longer-term goals? I know you guys put some on at the beginning of this pandemic, but it seems like it's been a little bit quieter on that front. Should we expect Viper longer term to return to an unhedged entity? Or does hedging have a role going forward?

I think through a down cycle, you always have to look at the decisions you made and figure out what were you doing before the down cycle, that was good, bad or indifferent. And one of the lessons learned, I think, for us at Viper is that if you have debt, you should probably hedge more than less. And Viper was always an unhedged vehicle because there was not a lot of debt. When we added that bond, we should have hedged, and that's shame on me for not doing that.

But I do think lessons learned is that while I don't want to trap Viper into a specific cash flow number, I do think protecting the downside from some sort of wide range of colors that guarantees our investors some form of return of capital on the downside and doesn't limit their exposure to oil prices on the upside is probably going to become part of the story along with continued debt reduction or if you use debt to buy something, a clear path to paying back that debt over a short period of time.

Our next question comes from the line of Gail Nicholson with Stephens.

Most of my questions have been asked. But just kind of curious, when you look at the volatility in the commodity that you've experienced in '20, how are you guys thinking about that maybe not hoarding cash but the need to potentially build cash on the balance sheet on a go-forward basis just to have as a safety net?

Yes, Gail. I mean, it's a good comment. I think it's probably less important at Viper than Diamondback to build cash just because the first step at Viper is to get that revolving credit facility down to almost 0 and reduce our reliance on bank funding. I mean, you've seen, obviously, the banks have had a tough time with energy companies through this down cycle, and we want to be as low-touch as possible with those banks. So I think we're a long way off from getting the revolver to 0.

But certainly, having the ability to buy back bonds in the open market, pay down debt and also call that because Viper is not investment grade, has a little less of a need to hoard cash, but I do recognize that having cash for a rainy day isn't the worst thing in running an energy company.

Our next question comes from the line of Neal Dingmann with Truist Securities.

Kaes, how many current rigs are currently operated in Viper acreage? And are you thinking that will be about the same assuming sort of going into next year?

Can you repeat that question?

How many current rigs -- how many rigs you operate right now?

We got 21 rigs running today.

4 of which are Diamondback-operated.

Yes, 4 Diamondback rigs, and I think we've seen something like 60 permits put on our position here in the last 3 weeks.

Wow. Okay. That sounds good. Good follow-up. Great details. And then secondly, I know Viper has always benefited from Diamondback's [FT] on EPIC and Gray Oak, and I know the pricing that's linked there. So I'm just wondering, are you expecting much change? I think, what, these are long-term contracts. So would there be much change in how we think about this for Viper going forward or not really given sort of the length and duration of these contracts?

No, I don't think there'll be a change. We set this Viper up to receive the same pricing as Diamondback. Other companies have -- other E&Ps have marketing entities that take possession of the barrel in their local market and then sell it to the international market or whatever they end up selling the barrel to. And in order to have full alignment between the 2 public entities, we sell at the wellhead, and therefore, Viper receives the same price as Diamondback.

I think Viper -- because of Spanish Trail being such a large piece of our production, Viper gets a little more MEH exposure versus Diamondback receiving more Brent exposure. But those are long-term contracts, and we want to make sure parent and sub are aligned on what they receive.

And our last question comes from the line of Leo Mariani with KeyBanc.

Just wanted to follow up on a comment you made around the production guide for 4Q '20 and 1Q '21. Did I hear you guys right that you're really not assuming much in the way of non-op activity at all in those numbers despite the fact that you're seeing these encouraging permitting transfer?

Yes. I mean, Leo, I mean, we're assuming some non-op activity. We're certainly not assuming we get back to levels seen in the end of 2019 or early 2020. I think non-op is going to help a little bit in Q4 and Q1, but Q4 will probably be mainly driven by the follow-through of these high NRI pads from Diamondback benefiting Q4. And then Q1 is still a little bit far away from us right now to make any bold predictions, but I do think Q4 is likely a bit stronger than Q1.

Okay. That's helpful. And I guess just from a perspective of the payout ratio, just kind of wanted to make sure I understood you guys correctly here. You obviously took it up from 25% to 50%, which is nice to see. Are you guys basically just saying that we're likely to kind of stay at this 50% for a while until we really see oil prices kind of recover to that sort of 45-plus type time frame?

Well, yes, I mean, I think a while in our industry is a relative definition. So we have confidence that Q1 and Q2 strip starts to improve, and we're going to receive a much higher price for our commodity, high 30s, low 40s. And then I think it's on the Board to look at that forward outlook and see if we're reducing debt to that 2x leverage kind of target at strip pricing and can we protect that a little bit via hedging. And if we can do that, then let's increase the payout even further.

Thank you. I'm not showing any further questions. I'll now turn the call back over to Travis Stice, CEO, for closing remarks.

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

Ladies and gentlemen, this does conclude the program. You may now disconnect. Thank you for participating, and have a wonderful day.