Viper Energy Partners LP (NASDAQ:VNOM) Q1 2023 Earnings Conference Call May 2, 2023 11:00 AM ET

Company Participants

Adam Lawlis - VP, IR
Travis Stice - CEO & Director
Austen Gilfillian - General Manager
Kaes Van’t Hof - President

Conference Call Participants

Neal Dingmann - Truist Securities
Paul Diamond - Citigroup
Derrick Whitfield - Stifel, Nicolaus & Company
Leo Mariani - ROTH MKM
Timothy Rezvan - KeyBanc Capital Markets

Operator

Good day, and thank you for standing by. Welcome to the Viper Energy Partners' First Quarter 2023 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. And I would now like to hand the conference over to your speaker today, Mr. Adam Lawlis, Vice President of Investor Relations. Sir, please go ahead.

Adam Lawlis

Thank you, Chris. Good morning, and welcome to Viper Energy Partners' First 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' First Quarter 2023 Conference Call. The first quarter was a strong start for the year as Viper's oil production set a company record for a fourth consecutive quarter. The advantaged nature of this royalty business model was highlighted during the quarter as we maintained our strong free cash flow conversion despite the volatility in commodity prices. Further on that point, Viper's low operating costs and 0 capital requirements allow us to convert over 80% of our operating cash flow into free cash flow during the quarter. This measure compares favorably to many operators at around a 40% free cash flow conversion and insulates Viper's free cash flow profile in return of capital during times of commodity price volatility.

Additionally, Viper announced it completed the drop-down transaction of certain royalty interests from Diamondback on operated properties located in Ward County. This transaction was a $75 million acquisition of an overriding royalty interest, representing 660 net royalty acres that will provide high NRI exposure to Diamondback's expected development plan in the Southern Delaware Basin. Production on the acquired asset was roughly 300 barrels of oil per day during the first quarter and is expected to increase through the remainder of the year to average over 500 barrels of oil per day for the full year 2023.

Looking ahead, we have initiated average production guidance for Q2 and Q3 2023 that implies over 8% growth relative to the first quarter. Importantly, on an organic basis, so excluding the impact of the drop-down acquisition, production is growing at over 5% in this period, primarily as a result of large Diamondback operated ads with high Viper NRIs being turned to production.

On the capital return front, Viper took advantage of the volatility experienced during the quarter due to our flexible return of capital program by opportunistically repurchasing over 1 million units. Since the inception of our unit repurchase program, we have now repurchased over 11 million units for an aggregate of roughly $250 million, reflecting an average price of under $23 per unit. In addition to the unit repurchases, our return of capital program during the quarter is going to also deliver a distribution that represents a roughly 5% annualized yield at today's price.

In conclusion, the first quarter was an outstanding quarter for Viper and the forward outlook continues to improve as our high-quality asset base continues to attract outsized activity levels. Viper remains differentially positioned to grow production without having to spend a single dollar capital and with only limited operating costs. And as a result, we look forward to continuing to efficiently return substantial amounts of capital back to our unitholders.

Operator, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question will come from Neal Dingmann of Truist Securities.

Neal Dingmann

My first question is on future activity specifically. Can you remind maybe just in really broad terms how much of your acreage has what I would call maybe more relatively virgin units where we could see continued large pad boosting the already record volumes versus a lot of the other acreage out there, I know, is more on what I would call developed assets where we're seeing more child type wells.

Kaes Van’t Hof

Yes. Good question, Neal. I mean, I would say almost all of the Diamondback operated position that we bought from Swallowtail is still -- or the vast majority of it is still completely undeveloped. I mean we haven't even brought on our first pad yet in the Robertson Ranch area, where we own essentially half the minerals at Viper. So I think what's fundamentally misunderstood on Viper's growth profile is that this growth profile is not going to be a flash in the pan over the next couple of quarters. I think this business can grow significantly over the next few years, even with the E&P business growing slower or in some cases, in maintenance mode. So that's the benefit of this mineral business. There's a lot of growth to be had because when we allocate capital on the drilling side of Diamondback, we take into account the 58% ownership of Viper into those economics.

Neal Dingmann

Great point. Okay. And then second question, just on capital allocation of the shareholder return. Just wondering, while I know [indiscernible] asked earlier, I know at FANG the allocation decision is largely driven by how you view your share price versus the assumed value based on mid-cycle prices. And I'm just wondering if you think about that the same way the Viper, and obviously, with oil down today now approaching , is there any change to your thinking?

Kaes Van’t Hof

Yes. Let me say a couple of things about mineral valuations because this is important and why we changed our capital allocation philosophy at Viper to not just distribute every dollar we make. We wanted to retain some flexibility between a buyback of units and a variable dividend. Now we have a higher base dividend Viper, so that was put in place for a reason. But I think generally, the public markets are fundamentally mispricing mineral interest relative to upstream assets. Therefore, we've allocated a lot more capital to own more of the mineral business. And if the market continues to miss price mineral values and not understand the benefit of a mineral versus an upstream asset, we'll just simply own more and more of this business like we did in Q1.

Second to that, we do look at our NAV at Viper. We're significantly undervalued relative to our NAV at a mid-cycle deck and mid-cycle at Viper is $60 a barrel, just like it is at Diamondback. And the other validation we have in the mineral market, while I'm not going to hang our hat on 100% of this, but we are getting blown out in the private market, absolutely blown out on deals in the private market. We're losing deals by 50%, 60%, 70%, and these deals, Neal, are much lower quality than the acreage position that Viper has today. So -- well, that's an anecdote, and we don't base our business on where third-party deals are trading. If third-party deals are going to continue trading at 50% to 70% above where we're trading, we're going to buy back a lot of units.

Neal Dingmann

Yes, I agree. Glad to see you all lean into the unit repurchase.

Operator

[Operator Instructions]. Our next question will come from Paul Diamond of Citi.

Paul Diamond

Just a quick one for you, talking about as it is going. Just a quick one for you talking about -- you just noted that some of the private deals are going for 50%, 60%, 70% above what you think is a good value, but you still got a few things done last quarter. Is that kind of a trend you're seeing is going to be a lot more like nuanced and specific? Or do you guys see the market opening up a bit more and just kind of coming back to, I guess, rationality on that front?

Kaes Van’t Hof

Yes. I was also referring to where Viper is trading on a mineral acre basis. But I think your point is valid. I think we're getting a pretty [indiscernible] in a lot of the, I would say, mid-market deals, $20 million to $80 million deals or $20 million to $100 million. I think Viper has a unique advantage with our size and scale to compete in the $500-plus million mineral deals. Now I think those are fewer and further between. But I do think eventually, like a deal like Swallowtail, we have a unique advantage to get that deal done. That's kind of our playground because right now, in the middle market deals, the numbers being paid are astronomical.

Operator

[Operator Instructions]. Our next question will come from Derrick Whitfield of Stifel.

Derrick Whitfield

Congrats again on a solid quarter and drop-down transaction. With regard to the drop down, and I think it about some of your comments on the mispricing of mineral assets, I mean this drop down was extremely impactful from the perspective of line-of-sight activity at elevated NRIs as this was sourced from a ward acquisition at Diamondback over a year ago. I wanted to ask if there are other potential carve-outs from the FireBird or Lario acquisitions that could make sense in the future.

Kaes Van’t Hof

Yes, Derrick, there are none today that came with the Lario or FireBird packages. Now that when we do get a new playground to buy minerals and that -- that does allow some opportunities to try to buy minerals in those new areas, but no drop-down opportunities.

To comment on the drop down specifically, this deal, we have the benefit of figuring out the right timing of when to drop something down between the 2 companies. This deal wouldn't have made sense to do a year ago, but now that development is happening and there's that forward visibility made a lot of sense to be able to get that done ahead of the first large pads coming on in March. Austen, do you want to add anything to that?

Austen Gilfillian

No, that's right. I mean we got it done right around the ramp-up in production and then still quite a bit of visibility to some high-interest pads over the next couple of years. So it made a lot of sense for Viper, and I think Diamondback, to do a deal here this past quarter.

Derrick Whitfield

Terrific. And with my follow-up, I wanted to focus on a bigger picture question for Permian activity, which I think placed your benefit relative to your peers. And that question is, if we were to assume strip pricing, do you think we've seen peak activity in the Permian for at least the immediate term, given that privates generally have less quality inventory depth and are likely more exposed to weaker gas pricing? Again, the benefit part would just be what percent operated you guys carry today and the visibility you have with that?

Kaes Van’t Hof

Yes, I think that's a good -- a fair statement. I think we've probably seen peak activity in the Permian. Now, we -- we did make a lot of comments on service cost reductions on the Diamondback side. I would say part of that is attributable to other basins' equipment opening up. But we kind of said that this is a year where publics kind of stay flat and Diamondback and Viper benefit from that activity wise, majors increase, and we don't own a lot of minerals under majors and privates in general are slowing down to either preserve inventory or sell the company. So this does put us in advantage with the Diamondback piece, particularly with us allocating so much upstream capital to areas where we have mineral interest, particularly Central Martin County.

Operator

Our next question will come from Leo Mariani of ROTH MKM.

Leo Mariani

I was hoping you provide a little bit more color around this kind of additional $41 million of acquisitions that you guys did kind of apart from the $75 million drop down, was that just kind of a bunch of little stuff? In the aggregate, obviously, you commented that it's kind of hard to get deals these days given the overpricing in the markets. So maybe just some color around the recent $41 million of activity.

Austen Gilfillian

Yes, Leo, that was mainly a result of what we call -- kind of call our ground game acquisitions. So we're constantly out there talking to smaller mineral owners. We've seen a lot of competition on more than marketed deals like Kaes mentioned, on the middle market side. But on the smaller deals, kind of the nuts and bolts, picking up little pieces here and there. We've had a couple of more deals here. So we've been focused on areas where we like the rock, whether Diamondback is the operator or it's an active operator in the area. The [indiscernible] are mainly Pioneer, Exxon and Martin County. So still rock that we feel really good about and have a lot of confidence in what that forward outlook looks like. But certainly differentiated subset of deals than -- than the deals where we've seen so much competition.

Leo Mariani

All right. That's helpful. And then obviously, in your prepared comments, you talked about how you guys are comfortable sort of deemphasizing the variable dividend for the foreseeable future, it sounds like and doing kind of more buyback just based on where you see the disconnect sort of on the value here. I guess just curious if you guys kind of look at this, do you guys kind of take into consideration kind of relative yield of your securities, say, versus alternatives in the market? I know a lot of people look at either the 10-year treasury yield or even the 2-year these days with the inversion. Do you guys kind of pay any sort of attention to kind of where you're trading kind of relative to that on a yield basis when you make these decisions?

Kaes Van’t Hof

I wouldn't say it impacts us on a yield basis, certainly from a cost of capital perspective, we do a lot of work on looking at where rates are and where our debt is and what our -- cost of our debt is, cost of equity. At the end of the day, the value of the equity is the present value of the future cash flows of the business. And we think that is fundamentally undervalued for a security that is as we said, the highest form of security in the oil field, right? Mineral interest, if an operator loses a lease for whatever reason, they have to re-lease from the mineral owner. If other zones become economic, like some of the deeper zones in the Midland Basin are being discussed today, operators have to come to someone like Viper to pay a bonus and re-lease those mineral interests. So I would say it's part of the calculus. It doesn't drive the final decision. Really, the final decision is net present value based at a reasonable discount rate.

Operator

[Operator Instructions]. Our next question will come from Tim Rezvan of KeyBanc Capital Markets.

Timothy Rezvan

My first question -- just following up on a prior one on the acquisitions. You've been absent from a lot of the larger acquisitions that have happened. You seem to have in that $41 million deal got some third-party minerals. How actively do you look at third-party kind of minerals? Because it seems like you're sort of posturing that you were really focused on just Diamondback. Is it just if the price is right, you'll do it? How should we think about kind of your willingness to go to third party going forward?

Kaes Van’t Hof

Yes. Good question. We've kind of shied away from a significant amount of third-party acquisitions. I think we're certainly still looking at them today. They're just harder to get across the finish line because we don't have, what I would say, differential knowledge as to the development pace of those positions. And so you've seen a few deals trade where they're concentrated positions that you could probably underwrite some sort of pace of development. But we still just kind of got -- got blown out in terms of value. So I think it's good discipline to not have your name on every trade, but we still think we have the differential knowledge on the operated side.

Timothy Rezvan

Okay. And then if I could circle back to the cash return framework. In the Diamondback call this morning, Kaes, I think you said when the stock is down, the variable dividend doesn't matter. And that seems to be what you've indicated with your capital allocation in the first quarter. And I believe there is different opinions in the marketplace about the role of a minerals company and the role of yield to investors. So you've also talked about the discount to NAV, which is probably apparent in any public equity across the energy landscape. So how do you think about the competitiveness of the Viper equity when you have a distribution now that's half of public peers? And what is the role of -- holistically the role of Viper to investors that are looking for yields?

Kaes Van’t Hof

Yes. I mean I think the role of Viper is to create value. And the best value we can create right now at these prices is to spend more money buying back units. I think the public markets don't see what's going on in the private markets and the public markets maybe misunderstand what the value of a mineral is relative to the upstream. I mean, I think what's happened over the last couple of years is that the upstream model actually converged to what the mineral model was prior, right? The upstream models are becoming yield and distribution models, some changing their capital allocation to more buybacks versus distributions. I think at the end of the day if you had to -- if we had to pick, we would prefer to distribute more cash at Viper and repurchase more shares at Diamondback. But when there are extreme dislocations, like we've seen over the last 6 months or so in pockets, we'll lean into the buyback. And Tim, [indiscernible] at the end of the day, we think creating value over creating a story makes more sense.

Timothy Rezvan

Okay. I appreciate that. I just -- yes, I think I just have a different view on that from our conversations with shareholders that might prefer that yield. So -- but I appreciate your insights on that.

Kaes Van’t Hof

Yes. Listen, those are discussions we're happy to have. At the end of the day, we're also the largest shareholder, right, at 58%. We are taking money away from ourselves by not distributing it and buying back -- I mean buying back open interest in the market. But we still think it's -- we think that is the best long-term value lever for both us, Diamondback, and the public shareholders that remain.

Operator

And I'm seeing no further questions in the queue. I would now like to turn the conference back over to the CEO, Travis Stice, for closing remarks.

Travis Stice

Thanks again for everyone participating in today's call. If you've got any questions, don't hesitate to reach out using the numbers we provided. Thank you again. Have a great day.

Operator

This concludes today's conference call. Thank you all for participating. You may now disconnect, and have a wonderful day.