Viper Energy Partners: Going Up

Summary

• Management again increased the distribution.
• The common units are appreciating.
• The oil price rally and rising production assure more good news ahead.
• The percentage of available cash distributed will rise once management achieves desirable debt levels.
• 27 active rigs on leases with ORRIs assures another growth year ahead.
• This idea was discussed in more depth with members of my private investing community, Oil & Gas Value Research. Learn More »

Photo by Liliboas/E+ via Getty Images

This sailboat caught a very good wind. Ever since the second quarter, it has all been an upward trend for Viper Energy Partners (NASDAQ:VNOM). The distribution is heading up as oil prices continue to rally from the second quarter low and the stock market recognizes the returning value in the form of a rising price.

Source: Seeking Alpha Website February 28, 2021.

As the chart shows, it certainly has not been straight up since the end of the second quarter. But the stock price has rallied nicely off its low. In fact, the stock has tripled from its low. Now that the common appears to be taking a short breather, it may be time to consider a further investment on this beneficiary of rising commodity prices.

In the meantime, management just announced a 40% increase in the quarterly distribution. Production also climbed 10% from the previous quarter. In short, everything is going up. But there is still far more room to run in this recovery. Diamondback has some of the best acreage around as shown by the 27 rigs working in its acreage. Therefore, it may be one of the few entities to report production growth in fiscal year 2020.

Some royalty trusts just purchase a lot of acreage knowing that some is fairly useless and really only a portion of the purchased acreage is very good. Those royalty trusts often reflect the industry cycle as they own overriding royalties that basically reflect the variations in geology throughout the industry.

Evidently, Viper management has been a little more picky. It favors a growth strategy which is not something you see every day in an overriding royalty company.

Source: Viper Energy Partners Fourth Quarter 2020 Earnings Conference Call Slides

Basically, Viper management went after acreage that would be developed. In fact, this company reported good activity during the recent downturn. Now should some acreage appear to be idle for awhile, then management attempts to sell some of that acreage as they did in the fourth quarter. The finances are strong enough that there is no rush. But this constant portfolio optimization is going to keep that rig count relatively high.

This is very good news for investors because constant growth will mitigate the downswings that are inevitable for the upstream business. The evidence points to some darn good acreage that was purchased or was dropped down for those overriding royalty interests. Not only were many of the deals accretive when they were done, but now during the coronavirus demand destruction, this royalty company is showing growth when most of the industry is not growing.

Source: Viper Energy Partners Fourth Quarter 2020 Earnings Conference Call Slides

Diamondback Energy (FANG), the main operator of the royalty acreage, has a busy schedule on the properties in question. That is going to lead to another year of production growth.

So many times there is a question about recovery prospects. In this case, the growing production assures an even higher royalty payout than the peak of the last cycle. That means future prospects of the recovering common units are excellent.

Management cannot control the activity on the royalty acreage. But management can make sure the geology is excellent so that the activity on the acreage remains above average at all times because it is the most profitable acreage to drill. This is one of the things that sets this royalty company apart from many of the competitors.

Source: Viper Energy Partners Fourth Quarter 2020 Earnings Conference Call Slides

Diamondback is generally a debt-averse organization. The experience of the second quarter in fiscal 2020 has led management to believe that a pay down of debt needs to be top priority. Therefore, management will likely keep about half the cash flow for the time being to reduce debt. The first goal is to clear the revolving bank line credit facility and to build an adequate net cash position after the bank line has been repaid.

With recovering oil and natural gas pricing, that goal should be easily met in the current fiscal year. After that then, management will likely announce a long-term goal that allows for self-financing of deals while paying the rest out to common unit holders.

Management has also launched a common unit repurchase program. This has been conducted by opportunistic market purchases. So far more than 2.5 million shares have been retired. That would represent more than 1% of the shares outstanding.

How Royalty Companies Work

Generally a royalty company gets its money "off the top". Only direct production expenses are usually included. Generally, things like exploration expenses, drilling, and completion are not a royalty company expense. There is therefore very little to deduct from the selling price when compared with upstream company expenses.

From an earlier article:

As a royalty company, it owns, acquires and exploits oil and natural gas properties (mostly land), and sells the royalty interest (or the right to drill) and takes a percentage of the profits. Its only expenses are usually the cash expenses (administrative & taxes), plus gathering, transportation and depletion associated with the production. VNOM does not explore or drill, and therefore the most expensive and risky parts of the industry are eliminated. Only drilling successes matter to VNOM."

Source: Seeking Alpha

Royalty companies allow an investor to participate in industry growth while eliminating many of the upstream risks. Now there is still the variations in distributions due to levels of industry activity and varying commodity pricing. However, there is not the expenditure required to get that income.

Summary

This royalty company did not suffer the lack of growth prevalent throughout the industry in the current fiscal year. Now that most of the challenges have passed, there is another growth year on tap.

Source: Viper Energy Partners Fourth Quarter 2020 Earnings Conference Call Slides

Production was up sharply in the fourth quarter. That bodes very well for the current fiscal year. This is a fairly small royalty company. Therefore production increases can be lumpy (and make it challenging to forecast average production for the year).

The ongoing oil price rally should allow many operators to revise their activity levels during the second half of the fiscal year should prices maintain themselves at a reasonable level. The situation can rapidly change without much notice, however. The ongoing activity on the acreage should bode well for the current fiscal year. The absence of a repeating second quarter 2020 should also bode well for average production in the current fiscal year.

Once debt approaches management goals, then investors can expect a greater percentage of available cash to be distributed. However, the days of 100% distribution are gone. Mr. Market really does not tolerate that approach anymore.

Analyst’s Disclosure: I am/we are long FANG VNOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Disclaimer: I am not an investment advisor, and this article is not meant to be a recommendation of the purchase or sale of stock. Investors are advised to review all company documents and press releases to see if the company fits their own investment qualifications.

Comments

[cenc]

Long FANG, sold RTLR with a nice profit. I keep an eye on vnom, but have a hard time convincing myself to grab the sharp end of that snake. Better to hold on to the back. LOL

[Long Player]

@cenc Enjoy

[Chico2012]

What do you estimate to be the optimal payout ratio target once management is content with amount of debt repayments? Perhaps 80%?

[Long Player]

@Chico2012 That is what I am thinking once we get to a point where they are satisfied with debt levels. This last downturn has everyone rethinking debt strategies.

[Vejrup]

Great article

[Long Player]

@Vejrup Thanks