Rattler Midstream LP (RTLR) Q4 2020 Earnings Call Transcript

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Rattler Midstream LP (RTLR)
Q4 2020 Earnings Call
Feb 25, 2021, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen thank you for standing by and welcome to the Rattler Midstream Q4 2020 Conference Call. [Operator Instructions]

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

Adam Lawlis -- Vice President, Investor Relations

Thank you, Brian. Good morning and welcome to Rattler Midstream fourth quarter 2020 conference call. During our call today, we will reference an updated investor presentation, which can be found on Rattler's website. Representing Rattler 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 will now turn the call over to Travis Stice.

Travis Stice -- Chief Executive Officer

Thank you, Adam. And welcome everyone and thank you for listening to Rattler Midstream's fourth quarter earnings call. The fourth quarter of 2020 continued the trend of Rattler normalizing operations, volumes and capital spend to a business plan with low to no growth from its sponsor Diamondback. As a result, EBITDA increased over 9% quarter-over-quarter to $78 million and operated capex decreased by over 60% quarter-over-quarter to $12 million.

These metrics set the baseline for Rattler's 2021 forward outlook as Diamondback plans to maintain relatively flat production and activity levels at current commodity prices. Operated capex is expected to decline by approximately 50% year-over-year and will be down over 70% from levels seen two years ago. Setting Rattler up for significant free cash flow generation that will be returned to unitholders in the form of our distribution and common unit buyback program.

Rattler is also near the end of our multi-year investment cycle and non-operated equity method investments, with distributions from equity method investments nearly reaching parity with contributions in the fourth quarter. In 2021, we expect distributions from these investments to significantly exceed our expected remaining contributions. The remaining meaningful contributions are to complete the Wink to Webster pipeline project. And we are forecasting significant distributions from both our Gray Oak and OMOG investments in 2021.

Looking forward to 2021, with Diamondback planning to keep fourth quarter 2020 oil production volumes relatively flat, Rattler's 2021 guidance reflects a continuation of the strong results seen in the second half of 2020. The stable operated business underpinned by Diamondback's low cost development of its top-tier Permian assets, along with equity method distributions outpacing contributions is expected to deliver increase in free cash flow to Rattler's unitholders this year.

In conclusion, when we created Rattler to build out the infrastructure necessary to develop Diamondback's assets, we envisioned a midstream entity that combined conservative financial management, visibility to volumes and a clear and honest relationship with it's sponsor, the low cost independent producer in North America.

We still believe that each of these attributes apply today and is a clear advantage as Rattler adapts its business model from accommodating growth to optimizing operations and free cash flow, which will accrue to unitholders in the quarters and years ahead.

With these comments now complete, operator, please open the line for questions.

Adam Lawlis -- Vice President, Investor Relations

Operator, you can open the line for questions.

Questions and Answers:

Operator

[Operator Instructions]

Adam Lawlis -- Vice President, Investor Relations

Brian we're unable to hear the question.

Operator

Hello, Adam.

Adam Lawlis -- Vice President, Investor Relations

Yes. We're here, we're waiting on you to put the questions there.

Operator

Yes, we have a lot of questions here. First question from James Kirby with JPMorgan.

James Kirby -- JPMorgan -- Analyst

Just want to start, Diamondback had made comments following the recent acquisition with QEP about potentially dropping down the midstream assets held at QEP. Just wondering if you can provide any commentary there in terms of the nature of those assets? And is that something you're looking at in the near-term or kind of later dated growth?

Kaes Van't Hof -- President

Yeah, James. Good question. It -- QEP did a really good job building out their midstream assets in their county line area and the Mustang Springs area where they've been pretty active here for the last few years. There's a lot of fresh water assets, disposal assets, recycling assets and on top of that some small oil gathering terminals and assets.

So I think we're pretty excited about how they develop their midstream capabilities, and I think over the long-term those assets likely belong at Rattler, but we got to do a lot of work here post hopefully closing this deal in a few weeks and then working up the valuation and getting two boards aligned on valuation for a potential dropdown. But it's certainly our intent. I just wouldn't expect it to happen in the first half of the year.

James Kirby -- JPMorgan -- Analyst

Got it, that's helpful. And then just a follow-up on that, when you think about financing of it, leverage here is below 2, do you have any early thoughts in terms of how you'd go about financing the dropdown and if that would kind of coincide with buybacks maybe use the buyback pace in favor of the financing the dropdowns.

Kaes Van't Hof -- President

Yeah, I mean, I think it's too early to make that call. But I think in general, we're not going to lever up the company, we're not going to lever up the parent in exchange for the sub or vice versa. So I think it will be prudently financed. And I think it just depends -- I doubt we've put more than 2 turns of leverage on the assets that get dropdown and the rest gets funded with cash or other sources.

So we've been prudent in dropdown financing in the past at Viper and I think for us keeping Rattler below 2 times because that leverage consolidates up to the parent is probably the right thing for us to do.

James Kirby -- JPMorgan -- Analyst

Got it, that makes sense. And then maybe just a point of clarification, are you receiving full distributions from all your JVs in line with proportionate cash flows? And do you expect those distributions to remain stable or to grow across the portfolio over time?

Kaes Van't Hof -- President

Yeah, no, we're certainly not receiving 100% because there is some interest to be paid it at Gray Oak, but we're probably getting 80% to 85% of EBITDA there in the form of distributions, on the OMOG JV there is not a lot of debt at that subsidiary zero right now. So we are getting full distributions of EBITDA from that business.

I think we're pretty excited about the forward outlook for the OMOG JV this year. Diamondback is very active and a few of the other producers on the system are going to grow volumes. So I think that system is going to see pretty significant growth. Now with that comes a little bit of capital that needs to be spent, but overall I think the distributions from those two businesses are going to outperform our expectations.

And then on the FX side, we're not expecting distributions from that business. So I think it's fair to assume that there is probably $10 million to $15 million of EBITDA leakage to what we receive in the form of distributions from the investments.

James Kirby -- JPMorgan -- Analyst

Got it, I appreciate the color there. And then last one for me, just previously you guys pause the Amarillo build out there and just with current commodity prices where they are, is there any chance that maybe gets pushed accelerated ahead and you guys start maybe building something in this year or is that still later dated?

Kaes Van't Hof -- President

Yeah, I mean, I think it still later dated if we decide to even to build the plant. I think we're thinking pretty strategically about the asset and how it fits in northern Martin County. So right now, no intention to spend an extra $50 million to build a new plant in an area that -- that's probably low on capacity. So I think we're going to be smart with capital there.

James Kirby -- JPMorgan -- Analyst

Got it, that makes sense. I'll stop there. I appreciate the color, guys.

Kaes Van't Hof -- President

Thank you, James.

Operator

Next question Ujjwal Pradhan from Bank of America.

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Good Morning, everyone. Thanks for taking my questions. Kaes wanted to start first on ESG and the emission reduction targets, some of the items that Diamondback disclosed earlier this week. Diamondback has made significant strides in this area and in many aspects leads the industry with the recent emission reduction targets. So I was curious if you could discuss the emission profile for Rattler stand-alone and whether some of the ESG initiatives within FANG's broader ESG program include some at Rattler as well.

Kaes Van't Hof -- President

Yeah, no, it's a good question. And we talked about that a lot in the Diamondback call. I kind of see the commitment that Diamondback made as consolidated commitment. I think Rattler's carbon footprint is obviously a lot smaller than Diamondback's with everything on pipe. But we are doing things at the Rattler level to reduce Rattler's scope on carbon footprint, which is basically getting rid of as many generators in infield as possible, connecting all of our facilities to line power.

And then on top of that I think overall and this is debated if it's a Scope 1 or Scope 2 emission, but we are buying power from renewable sources and sourcing power from renewable sources and that power gets allocated between Diamondback and Rattler. So I think certainly the -- put -- building Rattler was ESG positive because you're putting so much stuff, so much production on pipe versus trucks. But on top of that, the next step is fulfilled electrification across all of our fields and sourcing that electricity from renewable sources.

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Got it. And a quick follow-up on that. So would this be sourcing renewables, are you able to do that from the grid, given where your operations are or is it actually investing in some renewable assets yourself?

Kaes Van't Hof -- President

No it's from the grid only by both power and this has been a hot topic for this week for Texas. But when you buy both power, you have the option to source it from 100% renewable sources with some assurances obviously, but it cost you a little bit more, but it wouldn't be a meaningful amount, and that reduces your total emissions profile.

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Got it. Thanks for that. And Kaes with FANG's production plants largely flat year-over-year and significant water disposal capacity at Rattler level, do you think you could approach third parties for opportunities to get higher utilization of those disposable capacity?

Kaes Van't Hof -- President

Yeah. We had discussions with third parties all the time. Usually it's an offload capacity. So I think those discussions will continue. I think there's a lot of consolidation to happen in the water business, particularly in the Delaware Basin and that means bigger relationships with more well-funded counterparties that can take water and vice versa.

So I think overall that's happening, I wouldn't bet on it in our financials, just because we want to bet on what we can control, which is the Diamondback plan, but certainly I think rationalization of capacity in all forms of fashion in midstream in the Permian is going to happen here.

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Got it. Turning to capex plans. This year, obviously the capex -- the operated capex have come down significantly and could be one of the last years where you have bulk contribution to your JV projects. Looking forward, are you able to comment on what we should expect be it run rate capex specific to Rattler would be? And following up on Amarillo build out comments earlier, how much of -- how much capex there could be for that build out?

Kaes Van't Hof -- President

Yeah. So if we built Amarillo Rattler, the build out would be probably less than we originally said probably close to $30 million or $35 million net to us. But that's very unlikely to happen. I don't think that's even a 2021 or even 2022 decision. But I can't speak to the operating capex and I think the team understands that Rattler's budget starts with zero and builds up from there.

We spent $11 million or $12 million worth of capital in Q4. Our guidance assume, somewhere in the range of $15 million to $20 million a quarter, but I think overall, we kind of break out the capex into mandatory capex and kind of flex capex. That just in case Diamondback's drill schedule or completion schedule changes and I'd say in the budget, we presented today 75% or two-thirds or 75% of it is kind of mandatory capex and there is a little bit of flex for the good guys in case things changed throughout the year.

But overall, that number need to continue to decline and particularly in a world where we're not growing at Diamondback. I think the capital spend will be extremely limited to areas that are growing rather than areas that are staying flat.

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Got it. Very helpful, Kaes. Thanks for the answers. And I'll jump back on the queue.

Kaes Van't Hof -- President

Thank you.

Operator

Next question goes from the line of Michael Lapides from Goldman Sachs.

Michael Lapides -- Goldman Sachs -- Analyst

Hey, guys. Thank you for taking my question. Just curious, a follow-up on the potential of maybe dropping down some of the QEP assets. Can you remind us or have you all disclosed, A, what's just kind of the book value or the asset value of the QEP Midstream assets? I'm just trying to get my arms around kind of how big of a potential series of multi-year dropdowns could that be or is it relatively small. That's my first question.

Second one is, how are you thinking about the cost of capital for Rattler, right, and the best use of cash? Meaning, is the best use of cash for Rattler to buy assets from Diamondback's some of the QEP assets or continue deploying it whether it's even more deleveraging or even more share buybacks at this unit price?

Kaes Van't Hof -- President

Yeah, Michael. Good questions. I'll start with the size of the dropdown, I think in general there is -- overall, we're going to drop everything down at once. I think life's too short for us with three earnings calls in a week to do a multi-stage dropdown. I will say -- I'll give you a range, it's kind of 10% to 20% the size of Rattler today.

So it's not a huge dropdown and certainly manageable with the amount of free cash that we have and the leverage capacity that we have. So like I said, we're not going to lever up the sub in exchange for the parent. So I think we'll be smart about funding it, but it will be all in one fell swoop.

Then your second question, use of cash I think that's the question we need to ask ourselves, every quarter and that's the question our Board ask to us, and talks about in every in every audit committee meeting is this the best use of our cash to buyback stock at these levels or should we bring back the distribution.

Now, It's a lot easier today -- or it was a lot easier in November to say Rattler had afford 18% free cash flow yield is the best place I could put my money maybe in North America, but that decision got a little harder this quarter, because the stocks rallied. But we're still trading at 11% free cash flow yield, with all of that cash being returned to unitholders in some form or fashion because there is not a debt issue at Rattler. So I think it's a fortunate place to be. I think in general we prefer this to be a higher distribution vehicle than a low-flow buyback vehicle. But I think that's a good discussion to have.

Michael Lapides -- Goldman Sachs -- Analyst

Got it. Thank you, guys. Much appreciate it.

Kaes Van't Hof -- President

Thank you, Michael.

Operator

The next question comes from the line of Tristan Richardson from Truist Securities.

Tristan Richardson -- Truist Securities -- Analyst

Hey, good morning guys. Kaes, I appreciate the comment just on kind of relative scale of the QEP asset, curious just about integration to the extent that that goes forward. Is there organic buildout potential or an integration spend potential in terms of linking up QEP Midstream assets with Rattler assets from a connectivity standpoint?

Kaes Van't Hof -- President

Yeah, that's a good question. I think if you look at the math, we're going to have an opportunity to build a very efficient system in Martin County and QEP, like I said did a really good job building out their midstream assets and basically on that county line area we are neighbors. So that's not a huge amount of capital to connect our systems. But I think overall, as you think about our development, there is not a lot of added capacity needed, with the combination of the two.

So I think there's going to be some nice efficiencies there, we'll minimize capital spend. And I think overall, I think investors will be surprised with how little capital was needed to integrate those assets because of how buildout they are at both companies.

Tristan Richardson -- Truist Securities -- Analyst

Appreciate it, Kaes. That's all I had. Thank you, guys.

Kaes Van't Hof -- President

Thank you, Tristan.

Operator

There are no further questions. I will now turn the call over to Travis Stice, CEO.

Travis Stice -- Chief Executive Officer

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

Operator

[Operator Closing Remarks]

Duration: 21 minutes

Call participants:

Adam Lawlis -- Vice President, Investor Relations

Travis Stice -- Chief Executive Officer

Kaes Van't Hof -- President

James Kirby -- JPMorgan -- Analyst

Ujjwal Pradhan -- Bank of America Merrill Lynch -- Analyst

Michael Lapides -- Goldman Sachs -- Analyst

Tristan Richardson -- Truist Securities -- Analyst

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