Good day, ladies and gentlemen, and welcome to the Viper Energy Partners first quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Adam Lawlis, Vice President, Investor Relations. You may begin.
Thank you, Lisa. Good morning, and welcome to Viper Energy Partners' first quarter 2020 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 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.
Thank you, Adam. Welcome everyone, and thank you for listening to Viper Energy Partners' first quarter 2020 conference call. Before we get started, I'd like to take a minute to extend our thoughts and prayers to all those affected by the COVID-19 pandemic. The challenges presented so far in 2020 are unprecedented, but our perseverance is evident in the decisive actions we've taken to preserve our strength through this cycle. Turning to the quarter, Viper grew oil production 6% sequentially and 37% year-over-year. This solid production performance, along with oil realizations of 99% of WTI, unfortunately has been overshadowed by the dramatic decline in commodity prices that began in March and has continued through today.
Viper took action and hedged almost 100% of expected 2020 oil production and over 50% of expected 2021 production in the form of WTI collars, putting a floor under future oil price realizations and cash flow. The advantaged business model of Viper as a royalty company is highlighted during these times of depressed commodity prices in that our high cash margins, no capital requirements, and limited operational costs drive continuous free cash flow generation through the cycle. To that end, even at current strip pricing, Viper is expected to generate an over 10% free cash flow yield assuming today's unit price. As it relates to the free cash flow from the first quarter of 2020, we have made the decision to retain 75% of that cash flow to fortify the balance sheet.
The board intends to review the distribution policy each quarter, but with the uncertainty in the forward activity outlook and strip pricing, the prudent decision is to retain a majority of the cash flow to reduce leverage and protect the business. Viper remains in strong financial shape with $447 million of liquidity after adjusted for the expected reduction in our borrowing base from $775 million to $580 million this spring. Looking forward, assuming there's a recovery in commodity prices, Diamondback expects to resume completions operations in the second half of 2020 with a focus on high-interest Viper-owned royalty acreage. Viper's relationship with Diamondback also provides the added advantage of Viper benefiting from Diamondback's firm transportation on the Epic and Gray Oak pipelines, with pricing linked to the more liquid Gulf Coast and export markets and Spanish Trail production linked to MEH pricing.
In conclusion, I want to underscore the fact that mineral ownership remains the safest asset in the oil industry because it's a perpetual real property interest that's a high-margin business that requires zero capital requirements. Within the mineral sub-sector, Viper is further distinguished due to our relationship with Diamondback as our primary operator. Times like these emphasize that relationship as Diamondback focuses its operations on areas where Viper owns the minerals due to the lower consolidated break-even economics. Operator, please open the line for questions.
At this time, I would like to remind everyone, if you would like to ask a question, please press star and the number one on your telephone keypad. Your first question comes from the line of Brian Downey with Citigroup.
Good morning. Thanks for taking the questions. I guess my first one's on the distribution policy. Could you provide guideposts on how you're thinking about that payout ratio on a go-forward basis? Understandably, there may be some leverage ratio implications with the senior notes, but how you're thinking about balance sheet goals, whether that's leverage ratio versus absolute leverage. Just trying to think how we should be dimensioning that payout ratio through the rest of the year.
Yeah, Brian, it's a good question. We really only have the data that we have in front of us, which is the strip, and we had to make the tough decision based on the first quarter being one of the biggest cash inflows that we're going to have over the next
five or six quarters based on where the strip is today. That resulted in us cutting the distribution to 25% of available cash. I think it's going to be a very fluid process. I can only really use the baseline of 25% for now. We'll say we run sensitivities every quarter with the Board, and the Board is going to have to have a real conversation about that policy going forward. I think overall, our best indication is where we are at strip, and if we pay out 25% at strip today, we're not messing with our secured leverage covenants at the revolver level.
Got it. I guess, how should we think about leverage reductions as it pertains to revolver paydown versus opportunistically buying back debt if available?
I think that's the key word. It's opportunistic. We don't have a lot of experience buying back bonds in the open market. It seems like our bonds trade a little bit, but not much. It's certainly probably going to be a combination of both parking cash and paying down the revolver and using the opportunity to buy back debt below par if the bonds are still trading below par.
Got it. Appreciate the color. Thanks, everyone.
Thanks, Brian.
Your next question comes from the line of Derrick Whitfield with Stifel.
Hello, good morning, all.
Yeah, good morning, Derrick.
With regard to your 2020 guidance, we're backing into an implied Q4 guide that's materially above the street. Is that a reasonable interpretation based on the expected resumption of Diamondback activity in the second half?
Yeah, Derrick, that's the key, right? Is are we getting back to activity? as we said on the Diamondback call, we need to first bring back our curtailed volumes and then get back to work. Now, the base case is that that happens, and the way we have it modeled right now, Viper has exposure to about 80% of Diamondback's future completions at about a seven or more percent interest. those are some pretty meaningful numbers when you look at Viper's production, and we hope that that's the case. Now, if things remain weak and Diamondback doesn't get back to work, then that only pushes that out a quarter or two.
Understood. As my follow-up, could I ask you to comment on your broader views on the M&A market for the balance of 2020? I suspect the Q1 acquisitions were largely a function of work in progress.
Yeah, that's correct. We closed everything in the first quarter with all those PSAs that have been signed in November, December, and January. We certainly weren't going to walk on a PSA that we signed, and we honored our commitments. Right now, our acquisition machine is silent for the foreseeable future. Now, mineral owners tend to be stickier with respect to perception of value, and there's often less leverage in the mineral space. I think it's going to be pretty quiet here for the next couple of quarters.
Helpful color. Thanks for your time, guys.
Thank you, Derrick.
Your next question comes from the line of Will Thompson with Barclays.
Hey, good morning. Travis and Kaes. I wanted to get your thoughts on the push-pull dynamics between E&Ps and mineral owners in terms of shut-ins and continuous drilling obligations. Now, Diamondback has guided to obviously relatively modest curtailment, so I think the shut-in aspect is less of an issue for FANG operated acreage. Maybe for non-op acreage and the modest override royalties that Viper has, do you expect the leases to terminate if E&Ps continue shutting production and/or don't activate rigs and frac crews in the near term? Love to get your just thoughts there.
Yeah, I think I can really only speak to the Diamondback portion of that. We've been very focused at Viper in buying mineral interests versus overrides. On top of that, most of our overrides are at the Diamondback level, and I can assure you that we expect to retain all of our production and leases that have a meaningful Viper component to it. I think as you think about Viper's production, we certainly modeled in some curtailments. I think Viper will be hit a little less than Diamondback from a percentage basis, just given the nature of the two working together to focus on the higher interest properties staying active.
Okay. maybe going back to Brian's question, understanding that covenants restrict Diamond's distributions in the 12-month trailing aspect of debt to EBITDA metric, how do you think about managing the payout ratio as production stabilize and oil prices improve? Are you comfortable going past three times leverage temporarily? I appreciate that three times leverage for Viper is less cumbersome than three times leverage for an E&P such as Diamondback, so just curious to get your thoughts there.
I think we're fortunate to make distribution decisions halfway through the next quarter. I think if we're seeing significant improvement in production and pricing, that it's a little easier to lean in and make distribution at a higher leverage ratio. I think it's all going to be very fluid, but I think overall, we're going to be as flexible as possible and recognize that this business model is meant to distribute cash to shareholders, the largest being Diamondback, and that's still our primary
objective here at the Viper level.
Yeah, Will, I just want to emphasize that. Viper is a yield company with Diamondback being the largest owner of that company. You can bet that the Viper level, we're focused on maximizing return of capital to our unit holders. Taking all these things into consideration, it's still about maximization of that return.
Okay. Thank you.
Your next question comes from the line of Brian Singer with Goldman Sachs.
Thank you. Good morning. Wanted to follow up on the debt and the covenants piece. You mentioned earlier the importance of the secured debt covenant, but can you talk a little bit more about the unsecured covenant and how that will impact the three times would impact the timing of and the consideration for the distribution policy?
Yeah, Brian, the high yield covenant, the unsecured covenant, is simply a restricted payment should you be above three times leverage. There are some baskets that you can distribute out of, the biggest being, I think, trailing net income that we can look at. On the secured piece, your revolver's looking at four times leverage at that covenant, and I think that goes a little beyond restricting payment. That's really the impetus for the decision we made today is we're not looking to mess with any secured covenants here.
Got it. Thank you. my follow-up is, you talked earlier about some of the assumptions that go in from the FANG operated acreage. What about what you're seeing activity-wise and shut-ins from operators outside FANG? Can you talk about what your base case expectations are for the second and third quarters from a shut-in perspective outside of FANG, and then what activity levels, if anything, you can characterize on expectations as you go through the rest of the year?
Yeah, I can take activity levels first. We're assuming zero wells get completed on and off acreage in the second quarter, with a small return to work in the third quarter. We haven't modeled shut-ins on non-op acreage as shut-ins, but we just take a bigger chop to the PDP decline that we're seeing on non-op acreage. instead of our normal high single digits % risking on PDP, it moves closer to high teens or mid-teens % risking on the non-op PDP.
Great. Thank you.
Thank you, Brian.
Your next question comes from the line of Jeff Grampp with Northland Capital Markets.
Good morning, guys. I was hoping you could maybe speak to longer term and kind of a more normalized, stable commodity price world. Should we think that the payout for Viper moves back to that 100% type of strategy, or would you guys maybe give some consideration to some sub 100% payout to maybe incrementally pay down more debt or organically fund some acquisitions when that starts ramping back up?
Yeah, Jeff, it's hard to predict what the future looks like, but I can tell you, I'll just reemphasize that point that I made, is the reason Viper's set up is because it's a yield company, with Diamondback as its largest shareholder. You can bet that our singular focus will always be maximizing that return of our capital to the unit holders.
Understood. For my follow-up, and I think in the slide deck, you guys kind of emphasized this some, too, with kind of how the lease works as the Delaware Basin example. Can you guys talk about what that economic opportunity set is this year? Do you see any opportunities for any kind of lease extension, renewal type of payments flowing through to Viper and any, I guess, high level characterization of what that economic opportunity could look like for you guys this year?
Yeah, Jeff, this slide is very important to where we are today because while we're not acquiring acreage, our team is focused on our highest value tracks and what are the lease requirements with respect to continuous development, primary development, or cessation of production. We're really digging into all these leases and making sure we're communicating with the operators on their plans. I don't think it's going to be big dollars coming into Viper, but in this market, every dollar matters. I think that's the benefit of being the mineral owner is that the acreage reverts back to you if the operator doesn't meet the obligations of the lease. That's the strongest form of security in the oil field. If the operator wants to let go of that acreage, we can re-lease it at some point.
most of the discussions we're having right now are about extensions on obligations and extensions on continuous development.
All right. Understood. I appreciate the time, guys.
Thanks, Jeff.
Your next question comes from the line of Gail Nicholson with Stephens.
Good morning. Just any thoughts on how we should think about oil price realizations the remainder of the year?
Yeah, Gail, on the Diamondback operated side, Viper and Spanish Trail gets the Diamondback deal, which is kind of an MEH less $3. That's about a third of Viper's oil production. Most of the rest of Viper's oil production on the Diamondback operated piece will get a Brent less pricing, and there's just so much moving around on that front that. In a normal world, it would be Brent less, six or so dollars, but it's probably a little higher today. On the rest of the acreage, we get Midland pricing and that's why we've hedged that exposure and hedged all of our WTI exposure.
Okay, great. Thank you. just a higher level question. Viper has a durable free cash flow profile and really does provide security in this tumultuous world that we find ourselves in right now. when you look at today's environment and going forward, what do you think is the biggest challenge for the business?
I think the biggest challenge is making sure we're getting paid for what we deserve to get paid and making sure our operators are honoring these leases. The leasing boom in the Permian of the last 10 years has put some pretty onerous terms into some of these leases and Viper needs to spend a lot of its time making sure those obligations are honored.
Okay, great. Thank you.
Thank you, Gail.
Your next question comes from the line of Jason Wangler with Imperial Capital.
Hey, good morning. Kaes, you just had a couple questions about it, but curious, slide seven talks about 2021 being where the theoretical lease expires. Is that mostly where we start to see that happen? Is 2020 more of a year where you're going to see extensions and things, but 2021 is where you may well see more of that opportunity come up for you and for Diamondback?
I would say so since we're already so far into 2020. This was just an illustrative example. I think a lot of leases in the Delaware were taken in the '14, '15, and '16 timeframe, and they've either been extended by now or development has already occurred. The question is how much continuous development is going to continue to occur on those properties.
Okay. something to watch for going forward. Okay, I appreciate it. Thank you.
Yeah, definitely something to watch for. Where our business development meetings used to be about what minerals are we looking to acquire, it's now about what are we hearing from our operators and what are the offers on the table for extensions or new leases.
Thanks so much.
Thank you.
Your next question comes from the line of Leo Mariani with KeyBanc.
On the leverage side here, just wanted to get a sense of whether or not you guys have a leverage target for VNOM. Fully get that it might have grown a little bit more than expected in this unprecedented downturn here. Just wanted to get a sense of where do you guys want to see that debt to EBITDA going here maybe in the medium to long term?
Yeah, I think overall, we've tried to be pretty conservative at both the Diamondback, Viper, and Rattler levels. On a consolidated basis, I think given the weakness in commodity prices, leverage is going to look higher than we've traditionally been comfortable with. I think overall, Leo, the business is probably going to have to look at are we at two times levered at $40 oil? Are we at a turn and a half of leverage at $40 oil? Because you can enter a year at 60 and be at 20 within three months. I think the volatility of this business is continuing to point towards lower leverage, even with a business like Viper that has pure free cash flow.
Well, that certainly makes a lot of sense for sure. I guess just to that end, I know that the distribution policy is clearly an ongoing event, but from a high level, is it fair to maybe think about some of this as when you think you get the leverage a little bit more comfortable, that's when you can play a little bit more offense on the distribution? Is that how investors should think about it?
Yeah, I think that's fair. Just as Travis said, this vehicle is set up to return cash to shareholders, and that big shareholder being Diamondback, and we intend to get back to that as soon as we can.
Yeah, the driver's always maximizing unitholder value. We'll continue to emphasize that as we talk about distributions.
Got you. Okay. Just a follow-up in terms of an earlier comment you guys made, and I just wanted to make sure I understood. When you guys are looking at the guide here for VNOM for the rest of the year, I don't know if I heard you correctly, but did you guys say that there was assumption that there were no turn-in lines in the second quarter of 2020, and those resume in the second half? Just want to make sure I understood that right.
Yeah, that's correct.
Okay. Is that on both an operated basis and a non-op basis, or is there just not really any line of sight on the non-op right now?
On non-op, we're assuming zero. Diamondback, we're assuming the existing schedule, which Diamondback's not completing a lot of wells in the second quarter.
Okay. Thanks, guys.
Thanks, Leo.
Your next question comes from the line of Pearce Hammond with Simmons Energy.
Good morning, and thanks for taking my questions. Kaes, appreciate that you're not very heavily drawn on your revolver right now, but it definitely seems like the debt market has improved quite a bit with the Federal Reserve, the activity that they are engaged in. Are you seeing opportunities to maybe go do a debt issuance and then pay down the revolver? If you did that, would that give you a little bit more flexibility on the distribution?
That's a good question, Pearce. Unfortunately not, because the revolver covenant is based on total debt. You can't be replacing secured with unsecured debt. I think Viper's bonds are still trading a little below par, and that might be an opportunity to buy back some debt below par here.
Okay. My follow-up is just housekeeping. When do you expect to file the 10-Q?
End of this week.
Thank you.
Thanks, Pearce.
Once again, if you would like to ask a question, please press star then the number one on your telephone keypad. Your next question comes from Welles Fitzpatrick with SunTrust.
Hey, good morning.
Hey, Welles.
Hey, Welles.
Just one quick one for me. I would imagine that most of your leases have pretty ironclad force majeure clauses, but do the shut-ins, do they create any opportunity for incremental leasing revenue, either from companies proactively trying to extend those leases that already exist or potentially from broken leases then being able to be re-leased?
Yeah, the lease would have to be broken, and it really depends on each lease, and what the cessation of production clause is in that lease. It's various forms of cessation of production, and I will say, with my Diamondback experience, where we're curtailing volumes, you're not getting close to those cessation of production issues. I think if you're forced to shut in for two, three, four months consecutively, then you start to trip those cessation of production clauses in the leases.
Yeah, Welles, I can tell you just from a historical perspective, that's one of the first decision nodes that our land organization goes through is cessation of production clauses in all these leases. That's standard operating procedure for all operators. The only time that would occur would be by omission or by accident from other operators. It's certainly nothing we can plan on.
Okay. That's what I figured. Thanks, guys.
Thank you, Welles.
At this time, there are no further questions. I would like to turn the call back over to Travis Stice, CEO.
Thank you again to everyone participating in today's call. If you've got any questions, please reach out using the contact information provided.
This concludes today's conference. You may now disconnect.