Viper Energy Partners LP (NASDAQ:VNOM) Q2 2023 Earnings Conference Call August 1, 2023 11:00 AM ET

Company Participants

Adam Lawlis - Vice President, Investor Relations
Travis Stice - Chief Executive Officer
Kaes Van't Hof - President

Conference Call Participants

Neal Dingmann - Truist Securities

Operator

Good day, and welcome to the Viper Energy Partners' Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator instructions] Please be advised that today's conference is being recorded.

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

Adam Lawlis

Thank you, Abigail. Good morning and welcome to Viper Energy Partners' second quarter 2023 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; Kaes Van't Hof, President; and Austen Gilfillian, General Manager.

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.

Travis Stice

Thank you, Adam. Welcome everyone and thank you for listening to Viper Energy Partners' second quarter 2023 conference call.

Starting first with operations. The results from the second quarter demonstrate the high-quality nature of Viper's royalty assets as well as the advantage to relationship we have with Diamondback. In the broader landscape of relatively flat production in the Permian Basin, Viper's oil production increased 5% quarter-over-quarter and set a fifth consecutive company record.

Looking ahead, we expect Diamondback to continue to focus on their large scale development on Viper's high-concentration royalty acreage. And as a result, we have initiated production guidance for the third quarter that implies roughly 4% oil growth relative to the second quarter.

Importantly, as assumed in our updated guidance, it is expected that Viper's Diamondback-operated net oil volumes will increase over 15% for the full year 2023 with a further increase of roughly 10% expected for the full year 2024.

With Diamondback doing almost exclusively large scale development and with Viper owning varying interests across the different developments, this growth will not always be ratable from quarter-to-quarter, but we expect the trend of meaningful growth on an annual basis to continue.

On the return of capital front, Viper announced an 8% increase to its annual base distribution, now up to $1.08 per common unit. This increase is a natural progression of our enhanced return of capital program that was implemented with the second quarter earnings last year.

Over the past year, we have further improved our balance sheet. Growing oil production by 7% and reduced our unit count by over five million units. With the increased base currently representing over a 4% annualized yield, Viper has the balance sheet strength and durable cash flow profile to support this level of committed return of capital through the cycle.

Further, this base distribution represents approximately 50% of estimated free cash flow at $55 WTI and is protected all the way down to $30 oil. And while we still plan to opportunistically repurchase units, this increase to our base distribution highlights our commitment to a sustainable and growing return of capital through cash distributions over the long-term.

Separately, Viper also announced yesterday our intent to convert our legal status from a Delaware Limited Partnership into a Delaware Corporation. In connection with the conversion which is expected to be completed by year-end, Viper intends to adopt a corporate governance structure designed to meet the eligibility requirements for certain indices and benchmarks. Because Viper has already treated as a corporation for federal income tax purposes, the conversion is not expected to impact the current tax treatment for our existing unitholders.

Just as with our increased base distribution, this announcement is an important step in the growth and evolution of Viper. Simply put this conversion will deliver increased corporate governance rights to our current investors and is intended to position Viper such that the value of our mineral and royalty assets can be fully recognized. We believe that having a structure that will enable index inclusion will further broaden our investor base and improve our trading liquidity.

Operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Neal Dingmann with Truist Securities. Your line is open.

Neal Dingmann

Well, thanks for the time. Travis for you and Kaes my first question is just -- it was exciting to hear about the -- see about the new structure. You all mentioned I think there will be no tax changes. But just wondering is there any other maybe things we should be aware of being cost or are there any other particular changes we should be aware of? And then what impact do you think this will have on particularly getting picked up by maybe the various indices out there?

Kaes Van't Hof

Yeah, Neal, good question. We studied this a lot. We clearly didn't want to impact either the public unitholders or Diamondback's tax position, and we think that this conversion does just that. We were taxable partnership before, we're basically moving to a corporation kind of an Up-C structure. And the rules for index inclusion have seemed to have loosened to allow a lot more Up-Cs into various indices. I don't know exactly how long it's going to take to get in all those indices, but certainly seeing some higher index ownership from some of our peers gave us the idea to do this. Viper only has about 1% index ownership and someone like Diamondback has 30%, right? I mean, these are big numbers. So there's going to be a lot of improving liquidity. And also I think for unitholders becoming shareholders governance is important and moving their direction as well. Diamondback still plans to be a large holder of Viper. We haven't sold any shares that we own at Diamondback. But I think this allows for future consolidation growth opportunities and more volume and more flow for this business.

Neal Dingmann

Yeah. It'll be exciting to see that opportunity. And then my second question is on the capital allocation. Specifically, can you speak to how you think about maybe the debt repayment versus divs, versus buybacks? I'm just wondering sort of looking at it if you -- wondered a lot if you think we'll be better off, focusing more on debt repayment, given in the near term, given I think it's what about 9% of interest expense goes towards earnings. So just wondering, how you think about those three potential outcomes?

Kaes Van't Hof

Yes. I mean, we don't quite think about interest expense as a percent of earnings. It is -- cost of capital has gone up for minerals business and for our revolver. We certainly want to get that revolver closer to zero than where it is today. But we also don't want to sacrifice getting dollars back to our unitholders. At the end of the day, this is a return of capital business. We think allocating 75% of our free cash to equity is a good number with 25% going to the balance sheet and being able to do small deals. And Yes. I mean while the interest expense has gone up because of interest rates, we don't want to sacrifice returns to the equity holders.

Neal Dingmann

That makes sense. Thank you.

Travis Stice

And also Neal, the last thing, it's really one of the only major costs of this business, right? I mean this business runs at a 90% EBITDA margin, no CapEx. The only other expenses are G&A which is $6 million to $8 million a year of cash G&A and severance taxes which is 7% to 8% of revenue. So, it's a pretty incredible business. We want to keep it lowly levered, so that we can keep distributing cash to equity holders.

Neal Dingmann

Great point. Thanks guys.

Operator

[Operator Instructions] That concludes the question-and-answer session. At this time, I would like to turn it back to Travis Stice, CEO for closing remarks.

Travis Stice

Thanks again for everyone that was listening in on today's call. If you got any questions, please reach out using the information we previously provided. Have a great day. Thank you.

Operator

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