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Viper Energy Partners LP  (NASDAQ:VNOM)
Q4 2018 Earnings Conference Call
Feb. 06, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen, and welcome to the Viper Energy Partners' Fourth Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. Adam Lawlis, Director of Investor Relations. Sir, you may begin.

Adam T. Lawlis -- Director of Investor Relations

Thank you, Shinelle. Good morning, and welcome to Viper Energy Partners' fourth quarter 2018 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; Tracy Dick, CFO; and Kaes Van't Hof, President.

During this conference call, the participants may make certain forward-looking statements relating to the Company's financial conditions, 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 D. Stice -- Chief Executive Officer and Director

Thank you, Adam. Welcome, everyone, and thank you for listening to Viper Energy Partners' fourth quarter 2018 conference call. 2018 was a transformational year at Viper Energy Partners for many reasons. First, we completed our conversion to a taxable entity, which enabled us to present our market leading investment opportunity to a significantly expanded investor universe, while also showcasing a unique tax strategy due to our relationship with our parent company Diamondback.

Second, we continued to execute on our strategy of delivering unmatched return on and return of capital as we generated a full year return on capital employed at over 15% and increased our annual distribution by over 50%, while also growing reserves 65%, in production 57% year-over-year. Lastly, our acquisition machine continued to consolidate Tier 1 properties as we closed 88 accretive deals for $615 million and we grew our asset base by over 5,000 net royalty acres or 55% year-over-year.

Moving to 2019, we continue to see healthy activity levels across our acreage position as represented by the 40 rigs currently operating on our properties. As a result, we are providing full year 2019 production guidance that implies 25% annual organic growth without the need to spend $1 of capital to achieve this growth and while providing investors with a high single-digit implied free cash flow yield.

In an industry where capital discipline is now a common universal theme, Viper offers an unmatched combination of both organic growth and free cash flow yield. Our ability to forecast multiple years of organic growth due to our relationship with Diamondback are largely undeveloped acreage position and our continued accretive acquisition strategy and drop-down visibility from Diamondback are important catalysts for our distribution and per unit metrics to continue to improve even in a flat commodity price environment for many years to come.

I'll now turn the call over to Kaes.

Kaes Van't Hof -- President

Thank you, Travis. Turning to Slide 6, we show our 2018 annual growth on several key financial metrics as well as give an update on our rolling six month and annual production guidance. Importantly, we show the range of estimated 2019 distributions based on our full-year production guidance in a range of realized oil prices.

Slide 7 through 9 showcase the differential business model and investment opportunity presented by Viper. As shown on Slide 7, Viper offers an unmatched combination of growth and free cash flow yield versus energy industry peers and across multiple yield-based alternatives, some of which trade at significantly higher multiples than Viper. Assuming flat year-over-year commodity prices in 2019, Viper is estimated to provide roughly 25% organic production growth and a 7% free cash flow yield, all without spending $1 of capital.

It is important to note that Viper's full-year production guidance is typically conservative in nature given the limited visibility to third party operations beyond the next six months. With that said, we feel a high degree of confidence in our expected growth in the first half of the year and at a macro level, we expect that the Permian as a whole will see increased activity levels in the back half of 2019, which is not currently accounted for in our full year guidance.

Slide 9 provides a detailed assessment of Viper versus precious metals streaming vehicles, which have a very similar business model. Viper owns mineral rights in perpetuity on Tier 1 largely undeveloped acreage with significant remaining reserve life, has a mid-teens corporate return profile with over 90% cash margins, and 25% estimated organic growth, all metrics which compare very favorably to the precious metals peers outside of the disparity of relative trading multiples.

Slide 11 and 12 highlight the continued success of our acquisition machine and accretive acquisition strategy, which had its most successful year yet in 2018. As shown on Slide 11, since our IPO in 2014, Viper has now closed over $1.2 billion worth of acquisitions across almost 300 transactions, with over $600 million completed in 2018 alone. The opportunity set for acquisitions in the Permian Basin remains extremely robust and we believe Viper is in a unique position to continue to accumulate Tier 1 acreage through immediately accretive transactions, given our unmatched size, scale, and expertise.

Slide 13 and 14 detail a highly undeveloped nature of Viper's acreage position across both the Midland and Delaware Basins and illustrates why we believe Viper can deliver robust organic production growth for many years without the need to complete one more acquisition, or spending $1 capital. In total, we estimate our Permian acreage to be roughly 80% undeveloped and contain over 300 million barrels of net undeveloped resource using conservative spacing and type curve assumptions.

Moving to Slide 17, we provide an update on the remaining drop-down inventory currently held at Diamondback. Diamondback still owns almost 1,200 net royalty acres in the Southern Delaware Basin and over 900 net royalty acres in the Midland Basin or almost 15% of our current acreage position. Over 90% of this acreage is operated by Diamondback, giving Viper a line of sight for years of organic production growth. Additionally, Diamondbacks acquisition of Energen Resources has provided another 250 net royalty acres of minerals and more importantly, a significant amount of production and associated cash flow that qualifies for a drop-down to Viper. We expect to continue working toward the drop-down transaction of some, if not all, of these assets at some point in 2019.

With these comments now complete, I'll turn the call over to Tracy.

Teresa L. Dick -- Executive Vice President, Chief Financial Officer and Assistant Secretary

Thank you, Kaes. Viper's fourth quarter 2018 consolidated net income was $40.7 million, our operating income for the quarter was $73.7 million, up 24% from $59.2 million in the fourth quarter of 2017.

As shown on Slide 19, Viper ended the fourth quarter with a cash balance of $23 million and liquidity of $167 million. Also, on Slide 19, we provide details on our updated production and unit cost guidance. Importantly, Viper is initiating full year 2019 production guidance of 20,000 to 23,000 BOE per day, the midpoint of which implies 24% organic year-over-year growth.

Separately, Viper's second and third quarter 2018 distributions, which were the initial distributions after Viper's election to be treated as a taxable entity for federal income tax purposes or determined to not constitute dividends for US federal income tax purposes. The distributions should instead generally constitute non-taxable reductions to the tax basis.

With these comments complete, I'll turn it back over to Travis.

Travis D. Stice -- Chief Executive Officer and Director

Thank you, Tracy. In closing, Viper truly stands alone, both in the energy industry and versus other asset classes when it comes to offering a combination of both growth and free cash flow yield. Viper's largely undeveloped asset base consisting of Tier 1 acreage throughout the Permian Basin can support many years of substantial organic growth and with our high margin business will lead directly to continued distribution growth with no capital spending required to generate this growth. In addition to the robust organic growth potential, we remain excited about the continued execution of our acquisition strategy, including both the consolidation of the private minerals market as well as significant expected drop-down opportunities from our parent company.

Operator, please open the line for questions.

Questions and Answers:

Operator

Thank you. (Operator Instructions) Our first question comes from the line of Neal Dingmann of SunTrust. Your line is now open.

Jordan Levy -- SunTrust -- Analyst

Good morning, all. This is actually Jordan Levy. Just a quick question for you guys. Post Eagle Ford deal, looking back, wondering how you guys are thinking about that deal after the fact and kind of the opportunity set outside of the Permian, whether it's in the Eagle Ford or another basin? Just curious Travis or Kaes or anyone, your thoughts on that. Thanks.

Travis D. Stice -- Chief Executive Officer and Director

Sure, Jordan. We looked back at the acquisition in the interim we made into the Eagle Ford, we are extremely pleased. We've -- in fact, you can look in one of the slides in the deck and see what its current yield is right now. That was an opportunistic trade that we did at the time and while we are not currently looking significantly outside the Permian Basin, we do feel like we've got an obligation to continue to look. But I'll tell you, Viper's focus is growing the mineral position here in the Permian Basin.

Jordan Levy -- SunTrust -- Analyst

Got you. Great. Thanks for the color. And then just a quick second question. Looking at Slide 13 and 14 where it shows the amount of undeveloped acreage outstanding in the Midland and Delaware, how does that -- given it's probably toward the lowest it's ever been in terms of developed assets, how do you think about that in tandem with Viper's growth going forward? And does that equate some higher growth than we've seen before? Are you optimistic about that?

Kaes Van't Hof -- President

Yes, I mean, we are still very optimistic about our growth profile for the next decade plus. I think the important thing to take away from Slides 13 and 14 is, as you model this business long term, we have decades of running around. If these locations are drilled, say, over the next 15 years, Viper has a huge organic growth runway ahead of us without needing to do another deal. So I think that's kind of been a misunderstood part of the Viper story. So we wanted to add some clarity around just how undeveloped these assets are. Spanish Trail was a very important asset for Viper when we went public. But now Spanish Trail is 20% of our production and we have a huge Delaware position that's only 8% developed. So we're pretty excited about the runway and the inventory ahead of us.

Travis D. Stice -- Chief Executive Officer and Director

And, Jordan, I'll just add to that commentary that, in our prepared remarks, we emphasized a couple of times, there is 300 million barrels of total resource there and as Kaes pointed out, decades of future development in front of Viper Energy Partners. But what again stands unique in this investment space is that all of these resources, all of this development, all of this organic growth occurs without one single dollar of capital being required, and I just challenge anyone to find as unique a vehicle as this with this growth, this yield, where you don't have to spend any money to get it. It's just -- it stands alone.

Jordan Levy -- SunTrust -- Analyst

Absolutely agreed. Thanks for the color.

Operator

Thank you. Our next question comes from the line of Tim Rezvan of Oppenheimer. Your line is now open.

Timothy Rezvan -- Oppenheimer -- Analyst

Good morning, folks. Thanks for taking my questions. I was hoping to start, in a worst-case scenario for 2019, if there is pipeline delays and maybe the rig count kind of deteriorates, how many rigs would Diamondback need to run on Viper royalty acreage to sort of support that production guide that you put out?

Travis D. Stice -- Chief Executive Officer and Director

Tim, the baseline for our production guidance or the midpoint of our production guidance is the actual Diamondback drill schedule at the midpoint of Diamondback's guidance plus what we can see over the next six months from third party acreage. So Diamondback operates 40% of the acreage, buys a 60% of the production. So we have a pretty good visibility into that growth. Now, Diamondback is taking care of its takeaway position and we're very confident in our ability to execute on Diamondback's capital program, which supports the midpoint of this guidance here.

Timothy Rezvan -- Oppenheimer -- Analyst

Okay. I'm just trying to understand if there is subsequent rig drops, Diamondback's ability or kind of inclination to backstop that growth guidance?

Travis D. Stice -- Chief Executive Officer and Director

Yes, I mean, certainly the combined economics of owning the minerals on some of these acreage incentivizes Diamondback to drill on the mineral acreage first. So, we feel very confident that Diamondback's midpoint of 20 rigs for the year that we released last December certainly holds up Viper's production for the year.

Timothy Rezvan -- Oppenheimer -- Analyst

Okay. Then just moving on to the tax status of every distributions, certainly seems like positive news. How long does that stay in place? Is that sort of a forever item or is that really related to the NOLs put up by Diamondback and it won't happen in theory if those NOLs will work through out three or four years?

Kaes Van't Hof -- President

Yes, well, Diamondback's Board approved $300 million support for the public unitholders of Viper stock, so that our conversion from MLP to a taxable NAV did not produce cash taxes and then wasn't expected to produce cash taxes for the foreseeable future. Now, I can't speak for what happens four or five years down the line and that's something that we can reassess at a later date, but certainly over the foreseeable future, pending a large increase in oil price or significant acquisitions, we expect that the dividend income from Viper will be non-taxable.

Timothy Rezvan -- Oppenheimer -- Analyst

Okay. That's all I had. Thank you.

Kaes Van't Hof -- President

Thank you, Tim.

Operator

Thank you. Our next question comes from the line of Jeff Grampp of Northland Capital. Your line is now open.

Jeffrey Grampp -- Northland Capital Markets -- Analyst

Good morning, guys. Wanted Kaes to talk maybe a little bit more on the drop-down strategy and can you guys talk to maybe the extent to which drop-downs may be predicated on success on your third party acquisition strategy, say, to maybe manage how many acquisitions or the dollar amount that you guys feel comfortable doing within a certain time-frame? And then, can you also touch on your interest and given equity to Diamondback in any drop-down scenarios such that they maintain that kind of 50% to 60% type of ownership?

Kaes Van't Hof -- President

Yes, Jeff. I can't speak for the Diamondback and the Viper boards on how they're going to negotiate this transaction, but certainly we think about Diamondback growing within cash flow, having a significant and growing dividend. We don't necessarily need the cash at the Diamondback level and we really like our 59% ownership of Viper and I think over time that should logically get larger. Now, speaking to the drop-downs, we certainly understand that these assets should be in the Viper vehicle, especially the minerals and the overrides that we carve off from the Energen acquisition. We want to get that done as quickly as possible to continue to execute on the synergies that we presented at the Diamondback level six months ago. So we're actively working on it. I mean, it's a very sizable drop-down, so we want to get it right. But certainly, it's something we're proactively working on. And back to your other question about other acquisitions, I think those two discussions are mutually exclusive, the drop-down is one particular work stream we're working on and want to get done. But the other side of the business is the $100 million or so a quarter of acquisitions that we've done over the last 10 quarters and we certainly expect that to continue to carry-forward.

Jeffrey Grampp -- Northland Capital Markets -- Analyst

All right. Great. That's really helpful. Appreciate that. And for my follow up and perhaps this is maybe more of the Diamondback question as well, but can you guys touch at all on -- about activity levels of assets where Energen has those higher NRIs. I know you guys disclosed the average of 77%, but I assume there's maybe areas where it's higher or lower or whatnot. I guess I'm trying to get a sense of the $60 million to $80 million of cash flow that you guys disclosed on those -- that excess NRI. Do you think that's growing faster or slower or maybe similar to what Diamondback's overall production has been guided to in '19 and anyway to kind of give us a flavor for that?

Kaes Van't Hof -- President

It's tough. I would assume it's -- I would assume it's equal to what Diamondback's growth is. We're sorting through the details. Some sections will have a better NRI than others and that's the key -- the key works being done is to rightsize this drop-down and make sure it's, one, accretive to Viper, but, two, in areas where Diamondback is actively developing over the next five years.

Jeffrey Grampp -- Northland Capital Markets -- Analyst

All right, great. Appreciate the time guys, thanks.

Travis D. Stice -- Chief Executive Officer and Director

Thank you. Jeff.

Operator

Thank you. Our next question comes from the line of Eli Kantor of IFS Securities. Your line is how open.

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

Hey, good morning, guys.

Travis D. Stice -- Chief Executive Officer and Director

Hey, Eli.

Kaes Van't Hof -- President

Good morning, Eli.

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

Can you give some color on how the size of the private minerals market has changed relative to a year ago and what inning you think we're in, in terms of seeing the minerals change hands from private owners to public companies?

Kaes Van't Hof -- President

That's a good question. I'd to liken the opportunity set to assuming that there are 5 million good Permian acres. That would make their -- the availability of 1.25 million Viper acres as we define it, available to change hands. Certainly not all those minerals are going to change hands. There are some families and ranches in the Permian that they're going to hold their minerals forever. But if you look at that 1.25 million acre opportunity set, Viper only owns 15,000 of those and we're the largest public vehicle in the space. So, I could say, we're in the first or second inning. We've certainly seen the mineral space evolve. We have a lot of small mineral buyers and owners that are now bringing us deals on a regular basis. So the opportunity set for us has only increased over the past couple of years.

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

And then, as far as the uptick in rig activity, those that you guys disclosed relative to the third quarter, it looks like most of that increase was from private operated -- privately operated rigs. Can you talk about -- are there any specific areas either geographically or stratigraphically where those rigs are focused?

Kaes Van't Hof -- President

Yes. If you look on Page 11 of our deck, you can see on the right side where the rigs are operating. So, really we'd like to focus on buying minerals where -- also our Diamondback operator would like to operate. And that's usually in the Northern Midland Basin and the eastern portion of the oily Delaware Basin.

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

So last one for me, along the same lines. The Central Basin Platform, the Mexico portion of the Delaware Basin and then Mexico Shelf have been areas where historically Viper and Diamondback haven't been active. Are there opportunities anywhere in either of those areas where you think you'd see some growth for Viper in the future?

Kaes Van't Hof -- President

No, I mean, I'm sure there are opportunities. We just don't have a lot of G&A dedicated to that acreage. We really like to focus on buying minerals in acreage that we would want to operate at the Diamondback level and we've been pretty clear at Diamondback that Central Basin Platform is not part of our go-forward plan. So it's really not part of Viper's either.

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

Great. Thanks for the color.

Travis D. Stice -- Chief Executive Officer and Director

Thank you, Eli.

Operator

Thank you. (Operator Instructions) Our next question comes from the line of Jason Wangler of Imperial Capital. Your line is now open.

Jason Wangler -- Imperial Capital -- Analyst

Hi. Good morning, everyone. Was just curious, Kaes, maybe on the 40 active drilling rigs, do you have a flavor for how many of those are drilling kind of the bigger pads these days? I know you guys kind of continue to talk about the increased visibility there, so just curious kind of how you see that rig count breaking down at this point?

Kaes Van't Hof -- President

Yes, I'd say the vast majority of those 40 rigs are drilling multi-well pads and we gave some clarity on Page 16 of our deck, showing where those large pads are and those are -- those wells with the large interest is exactly what we at Viper are looking for an acquisition. So I think that separates us from maybe some other mineral peers that want to own on a smaller percentage of a larger area, we'd rather own a high percentage of the smaller area because it gives us that visibility and ability to forecast.

Jason Wangler -- Imperial Capital -- Analyst

Okay. And then as you look at liquidity, obviously, you made a bunch of good acquisitions again in the fourth quarter, you still have -- obviously the debt level is very low and you have still some liquidity, but how you think about that portion? Would you look at terming some of the debt out or is there a plan to repay some or just how you think about liquidity going forward? Could you have lot of options on the table?

Kaes Van't Hof -- President

Certainly, our revolver has continued to increase as the reserves and production has increased over the past couple of years. Now, it's up to $555 million revolver. I think at some point it's logical to assume that Viper, given the strength of its parent company and its investment grade like balance sheet to try to turn off some debt or turn out -- turn a permanent leverage at the Viper level.

Jason Wangler -- Imperial Capital -- Analyst

Perfect. I'll turn it back. Thank you.

Operator

Thank you. Our next question comes from the line of Philip Stuart of Scotia Howard Weil. Your line is now open.

Philip Stuart -- Scotia Howard Weil -- Analyst

Good morning, guys. Just one quick one for me. At the Diamondback level, I know the Quinn Ranch acreage is still kind of in legal uncertainty, but just curious if at the Viper level you guys own any minerals under Quinn Ranch, and if not, should Diamondback be successful in winning that lease? Do you see material mineral opportunities on the Quinn Ranch acreage?

Kaes Van't Hof -- President

Yes, we do not own anything on that ranch this time. I'll say that anytime Diamondback comes into acreage or requires acreage, whether it's Ajax deal, the Exl deal, the Energen deal, our Viper team gets very active and they get a much larger sandbox to play with. So, it's logical to assume that any acreage we buy or trade into the Diamondback level becomes priority number one for our Viper team to buy minerals.

Philip Stuart -- Scotia Howard Weil -- Analyst

Okay. I appreciate the color there, guys.

Kaes Van't Hof -- President

Thank you.

Operator

Thank you. And I'm showing no further questions at this time. I would now like to turn the call over to Mr. Travis Stice, CEO, for closing remarks.

Travis D. Stice -- Chief Executive Officer and Director

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

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.

Duration: 26 minutes

Call participants:

Adam T. Lawlis -- Director of Investor Relations

Travis D. Stice -- Chief Executive Officer and Director

Kaes Van't Hof -- President

Teresa L. Dick -- Executive Vice President, Chief Financial Officer and Assistant Secretary

Jordan Levy -- SunTrust -- Analyst

Timothy Rezvan -- Oppenheimer -- Analyst

Jeffrey Grampp -- Northland Capital Markets -- Analyst

Eli Jacob Rassow-Kantor -- IFS Securities, Inc. -- Analyst

Jason Wangler -- Imperial Capital -- Analyst

Philip Stuart -- Scotia Howard Weil -- Analyst

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