Viper Energy Partners LP (VNOM) Q2 2021 Earnings Call Transcript

Image source: The Motley Fool.

Viper Energy Partners LP (VNOM)
Q2 2021 Earnings Call
Aug 3, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day, and thank you for standing by. Welcome to the Viper Energy Partners Second Quarter 2021 Earnings Call. [Operator Instructions]

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

Adam Lawlis -- Vice President of Investor Relations

Thank you, Peter. Good morning, and welcome to Viper Energy Partners' Second Quarter 2021 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 a 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' second quarter 2021 conference call. Viper's production during the second quarter was supported by concentrated exposure to Diamondback's Midland Basin development plan as well as an increasing activity from third-party operators. As a result of the strong production and enhanced by our best-in-class cost structure, Viper generated over $75 million in free cash flow during the quarter. This strong free cash flow generation and the resulting continued decrease in net debt has enabled Viper to increase our distribution to common unitholders to 70% of cash available for distribution.

This increase in our distribution marks the second consecutive quarter of increasing return of capital to unitholders and the $0.33 per unit distribution represents a 32% increase from the first quarter distribution. Looking ahead, we increased our production outlook for 2021 and continue to maintain visibility into Diamondback's expected forward development plan that includes several large pads where Viper will own a significant royalty interest in the second half of the year. Additionally, Viper initiated average production guidance for the second half of 2021, that implies almost 16,000 barrels per day of production at the midpoint.

Based on this second half 2021 guidance and assuming production is held flat at the stated midpoint of the range, Viper is expected to generate roughly $320 million of annualized free cash flow in the back half of the year, assuming $65 WTI. Importantly, given these same assumptions, we expected to generate over $360 million of annualized free cash flow in the first half of 2022 as our out of the money hedges roll off. This 2022 free cash flow amount equates to greater than 11% free cash flow yield as a percentage of our enterprise value or almost 13% of our current market cap. In conclusion, the second quarter of 2021 was another strong quarter for Viper, that once again highlighted our high-quality asset base, best-in-class cost structure and overall differentiated business model.

Given the strength of our balance sheet and our current distribution representing greater than a 7% yield, Viper plans to retain 30% of its cash flow for the foreseeable future to focus on acquiring Diamondback operated minerals as well as to buyback units. Our acquisition strategy is unique and that we have a clear understanding of our parent company's future development plans, and we plan to leverage that knowledge to provide further exposure to the Diamondback drill bit.

Operator, please open the line for questions.

Questions and Answers:

Operator

[Operator Instructions] And your first question will come from Brian Downey with Citigroup.

Brian Downey -- Citigroup -- Analyst

Hey. Good morning, thanks for taking the question.On cash flow allocation, as you just mentioned, you plan to retain 30% of cash flow for acquiring royalty interest and continuing to do repurchases, which implies about 70% payout ratio for the coming quarters. Could you give an update on what you're seeing today in the mineral A&D market and how you're thinking about allocating capital between that acquisition bucket and repurchase bucket?

Kaes Van't Hof -- President

Yes, Brian, good question. I think, generally, we're moving toward the 70% payout ratio, because traditionally, this business was funded 100% of equity. I think, the world has changed in terms of raising equity to pay for deals so in mineral space, but also just in the energy space in general. So reserving some of that cash to use cash in deals feels prudent, particularly, we're not looking to continue to lever up. So right now, we're still focused on Diamondback operated properties.

You can see in the quarter, we didn't do much but there are some deals in the works and a lot of undeveloped Diamondback acreage that's been acquired with the QEP and Guidon positions that has potential for Viper mineral purchases. And I guess to finish, I think, if we don't have line of sight to deals that we're going to use cash for, I think continuing to use cash to buy back units is a prudent use of that capital.

Brian Downey -- Citigroup -- Analyst

Makes sense. And then on the hedging strategy, you started hedging 2022 with relatively wide collars and deferred premium puts as you hinted at during last quarter's conference call, should we anticipate that strategy continuing going forward? And it seemed like you're adding, call it, mid to high-40s per barrel floors. Did you target that level intentionally in terms of how you see distributable cash flow and leverage protection at that level or is that just happen to be where the collar and deferred premium pricing shook out best?

Kaes Van't Hof -- President

No. I mean I think it's really solving for not going above two times leverage and also still being able to pay out a good amount of cash flow to unitholders. I think, in discussions with large shareholders as well as thinking about the business model coming out of this down cycle, I think having that insurance for a rainy day is money well spent.

I think, you'll see us continue to build a few quarters in advance the hedge position, so that we're never put in a position like we were in Q2 of 2020 again. So hedging out money, buying puts, with this business, you still generate a lot of free cash. Leverage doesn't blow out, and you can still distribute a lot of that cash to unitholders.

Operator

Your next question will come from Chris Baker with Credit Suisse.

Chris Baker -- Credit Suisse -- Analyst

Hey, Good morning guys. I just wanted to follow-up on the acquisition program. So I think a 70% payout ratio would imply maybe a little over $100 million of retained cash for next year. Is the intent to match that sort of pace of acquisitions with retained cash over time and entirely self funded?

Kaes Van't Hof -- President

Well you know, there's no guarantees. It really just depends what size of deals are presented to us. I think, we like 70% because our ground game -- our 70% distribution to our ground game has been a little slow year-to-date.

And we've kind of gotten the revolver down to where -- almost zero to where we set a goal out earlier this year. If there's larger deals, we have to find a different way to fund it than just retain cash flow but for smaller deals, I think the blocking and tackling deals that we do on a day-to-day basis, that number makes sense.

Chris Baker -- Credit Suisse -- Analyst

Okay. Great. And then just as a follow up. We've seen some E&P peers introduced or accelerate cash return programs and variable dividends. Could you maybe just highlight how you frame up Viper's differentiated value proposition today? Just thinking about where you might be able to see opportunities to strengthen that profile, given what's obviously a very lean cost structure today and as you mentioned, a quickly improving leverage profile?

Kaes Van't Hof -- President

Yes. I mean, Viper paid the first variable dividend in the E&P space in Q4 of 2014 and has been a variable dividend payer since then. So I think, we cut back on the percent distributed. The way I like to think about it as a mineral company. We distribute 70%, retain 30% without needing to go to the equity markets to fund deals. And E&P is kind of the inverse, where we have to spend capital and use 70% of cash flow for sustaining capital and the rest going to shareholders.

So I think, it's interesting to see the E&P business model evolve closer to what the mineral business model been for the last four, five years, starting with Viper and some of our peers in Canada. And I think, it highlights the value that minerals have. I think that value has been underappreciated by the market for the last five or six quarters. But in a rising commodity and price environment, when you can give almost all your cash flow back to unitholders, that's a pretty good business.

Operator

Your next question will come from Neal Dingmann with Truist Securities.

Neal Dingmann -- Truist Securities -- Analyst

Good mornign guys. My first question, Kaes, probably for you, just still a little bit more on this free cash flow allocation. Just want to make sure I understand. Can you give me an idea of that 30% of your free cash flow that's not part of the cash distribution? I know you mentioned about not using stock to obviously do fund acquisitions.

Would most of that then just go down to paying debt, paying the RBL down, and then you can use -- obviously, just use that again to do deals or I just want to make sure I'm understanding right about what you're thinking about that allocation of that 30%?

Kaes Van't Hof -- President

Yes. You're right, Neal. I mean, I just think it occurs to the balance sheet, either based on the RBL to zero or start build a cash position and I think, we want to think about our RBL as temporary funding and not permanent funding.

And so anything that gets put on that needs to have a path toward reduction and in a business like minerals, where you don't have to spend capital to sustain or grow production, that debt balance gets paid down very, very quickly.

Neal Dingmann -- Truist Securities -- Analyst

Yes. That makes a lot of sense. And then just secondly, beyond saying, can you just talk about, Travis just maybe talk about the -- confident to have activity for the remainder of this year and then into next, still be obviously beyond thing and really how quickly can these plans change? So just -- it does sound like you're confident about some stable activity going forward, maybe just any color around that?

Kaes Van't Hof -- President

Yeah. I feel really good about the Diamondback activity levels, particularly in the fourth quarter. We're announced, I think eights well in Spanish Trail and two wells in the Delaware that have a high mineral interest. So I feel really good about that plan. Non-op, while still a little murky outside of the next couple of quarters, we are seeing the rig count rise and we're seeing from a net well perspective in the forward outlook, the non-op peaks -- pick up steam here.

So I think we'll continue to guide conservatively, particularly on the non-op side. I think, this is our sixth consecutive quarter of being over 1% over the midpoint of our guidance on the oil front. And that's just due to non-op conservatism and being fair on the assumptions that go into the Diamondback plan.

Operator

And your next question will come from Gail Nicholson with Stephens.

Gail Nicholson -- Stephens -- Analyst

Good morning. You're going have an advantage tax structure. I think 80% of the 2021 dividend are estimated to constitute a non-taxable reduction to the tax world. How does this change in 2022 forward, especially with the higher commodity price environment we're currently in?

Kaes Van't Hof -- President

Yes. Gail, looking back, when we converted to a taxable partnership in -- a couple of years ago, we made sure that our unitholders at the time were not differentially affected by that conversion from an MLP to a taxable partnership. And what we did was allocated some income from the limited partners to Diamondback to shield their tax structure.

That amount -- special allocation is running, I won't say running out, but running lower, particularly with the commodity prices rising like they have. So instead of the last couple of years being 100% tax deductible to the mineral or the LP owner, it's down to about 80%. I'd say, if oil prices stay where they are right now, it's kind of going to be about 80% next year. So still protected, but a little less so than in the past.

Gail Nicholson -- Stephens -- Analyst

Okay. Great. And then just a follow-up on that -- on regards to M&A. How far in advance are you looking at the thing schedule in order to determine potential asset purchases? Are you saying you want to own something that will be developed in the next twelve to twenty four months? Are you looking at a post twenty four-month development plan?

Kaes Van't Hof -- President

Well, we certainly have more visibility in the next twelve to twenty four months, and that's the benefit of slowing down at the Diamondback level. You have less changes to the drill schedule and the completion schedule and the projects that are on the list are very likely to get completed. Another benefit of generating free cash, having a low breakeven versus commodity price is that commodity price goes down $5, $10 tomorrow, the plan of Diamondback isn't going to change.

So that gives us a lot of confidence in the mineral buying for the next twelve to twenty four months. I'd say that drives the majority of our decisions. We really like to look at deals and units that don't have permits today, because when a permit gets filed, the mineral -- the private mineral buyers get very aggressive in their pricing. So that's why we're focused on pads that are probably going to be developed in the second half of next year or into 2023, because we can get it cheaper.

Operator

[Operator Instructions] And your next question will come from Pearce Hammond with Piper Sandler.

Pearce Hammond -- Piper Sandler -- Analyst

Hey, Good morning. Congrats on a solid quarter. Just a couple of questions from me. Number one might seem a little off the wall, but some of the mineral companies are starting to dabble a little bit in solar and wind royalties. So just curious if you've looked at that or have any thoughts on that front?

Kaes Van't Hof -- President

Well, yes, I mean, we've seen it happen in the private markets here, too, Pearce. It's not something we look at. We don't own a lot of surface at Viper and what we do is a very small amount. So I don't think it makes a ton of sense for Viper today, but certainly seeing it and I think it's generally positive for the industry price to -- the industry doing a good job on ESG metrics and hopefully, the more this gets attention, the more outsiders realize that the oil and gas industry in the United States is doing what we can from an environmental perspective to clean things up.

Pearce Hammond -- Piper Sandler -- Analyst

Okay. Thank you, Kaes. And then my follow-up, it seems like the thesis has been over the past couple of years is there's a lot of minerals and private equity hands eventually will find their way into the public domain, either by the public mineral companies buying them or potentially some of the private mineral companies going public. Just curious, do you still see that unfolding or has it happened at a much slower pace than expected? Just curious your thoughts on that.

Kaes Van't Hof -- President

Yes. I mean, I think generally, private equity has done a good job deploying capital into minerals. I think, the issue is going to be monetizing. I think for us, a couple of years ago, we might have said we wanted to be the biggest mineral company in the Permian. I think, we'd rather be the best. So that kind of limits the private equity opportunities that work for Viper.

We have to have a lot of Diamondback operated minerals to be interested in a position owned by a private equity company, but the conversations we've had with private equity is that they're working to solve this. I would bet there are more public mineral companies than less in the next couple of years and I think that will be good for the industry, because you need -- you still need more flow and more attention to what I think is a great asset class, but it gets a lot of attention in the private markets and not a lot in the public markets today.

Operator

And your next question will come from Derrick Whitfield with Stifel.

Derrick Whitfield -- Stifel -- Analyst

Good morning, congrats on your update.With regard to your second half production outlook, could you provide some shape to the Q3 and Q4 trajectory?

Kaes Van't Hof -- President

Yeah. Good question, Derrick. I think, generally, we currently expect Q3 to be a little lighter than Q2, but probably a little better than Q1 on the oil side. And I think, we're going to exit the year in Q4, very similar to where we were this last quarter with a couple of large Diamondback pads coming on at the end of the year.

I think, the eight Spanish Trail pad I mentioned earlier and two Delaware wells with a high interest. So -- and the rest of the the year strong. I think, generally, we've tried to under-promise and over-deliver at Viper in the last few quarters and done so. So if we get surprised with the upside, that would be great, but the plan as we see it today is Diamondback activity in Q4 is going to kind of give us a strong exit rate for 2021.

Derrick Whitfield -- Stifel -- Analyst

Great. And then as my follow up, building on Neal's earlier question, I wanted to focus on the visibility or your high-level visibility, referencing your forward visibility slides on pages eight and ten. Is there -- is the near-term inventory at the, call it, fifteen net level, a good run rate based on Diamondback's 2022 outlook that you guys announced yesterday and third-party activity levels?

Kaes Van't Hof -- President

Yes. I mean, I think that's fair. I'd hope that third-party maybe surprises a little bit to the upside, given the increase in activity we've seen in the Permian. I guess, I'm a little conflicted on it because we want to keep production growth as low as possible to keep this good price environment going. But I think, it's inevitable that we'll see non-op and third-party visibility increase as we get toward year end and 2022 budgets come out.

Operator

Excuse me, speakers, I am showing no further questions at this time. I will now hand it back over to Travis Stice, CEO, for closing statements.

Travis D. Stice -- Chief Executive Officer and Director

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

Operator

[Operator Closing Remarks]

Duration: 22 minutes

Call participants:

Adam Lawlis -- Vice President of Investor Relations

Travis D. Stice -- Chief Executive Officer and Director

Kaes Van't Hof -- President

Brian Downey -- Citigroup -- Analyst

Chris Baker -- Credit Suisse -- Analyst

Neal Dingmann -- Truist Securities -- Analyst

Gail Nicholson -- Stephens -- Analyst

Pearce Hammond -- Piper Sandler -- Analyst

Derrick Whitfield -- Stifel -- Analyst

More VNOM analysis

All earnings call transcripts