Kimbell Royalty Partners, LP
Q1 2019 Earnings Call Transcript

Published: 12 May 2019

[Operator:]

Welcome to Kimbell Royalty Partners first quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the presentation. [Operator Instructions]. And as a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rick Black, Investor Relations. Thank you. Please go ahead.

[Rick Black:]

Thank you, operator, and good morning, everyone. Welcome to the Kimbell Royalty Partners conference call to review financial and operational results for the first quarter of 2019. This call is also being webcast and can be accessed through the audio link on the Events and Presentations page of the IR section of kimbellrp.com. Information recorded on this call speaks only as of today, May 9, so please be advised that any time-sensitive information may no longer be accurate as of the date of any replay. I would also like to remind you that the statements made in today's discussion that are not historical facts, including statements of expectations or future events or future financial performance, are considered forward-looking statements, made pursuant to the safe harbor provision of the Private Securities Litigation Reform Act of 1995. We will be making forward-looking statements as part of today's call that, by their nature, are uncertain and outside of the company's control. Actual results may differ materially. Please refer to today's press release for our disclosure on forward-looking statements. These factors, as well as other risk factors and uncertainties, are described in detail in the company's filings with the Securities and Exchange Commission. Management will also refer to non-GAAP measures, including adjusted EBITDA and cash available for distribution. Reconciliations to the nearest GAAP measures can be found at the end of today's earnings press release. Kimbell assumes no obligation to publicly update or revise any forward-looking statements. I would now like to turn the call over to Bob Ravnaas, Kimbell Royalty Partners' Chairman and Chief Executive Officer. Bob?

[Robert Ravnaas:]

Thank you, Rick, and good morning, everyone. I'm here with several other members of our senior management team, including Davis Ravnaas, our President and Chief Financial Officer; Matt Daly, our Chief Operating Officer; Blayne Rhynsburger, our Controller. I would like to begin by providing an overview of our performance for the first quarter, followed by our expectations going forward. Then I'll ask Davis to cover our financial performance in more detail. After that, we'll take your questions. We had an excellent first quarter, exceeding our expectations. Most notably, we had record high average daily production of 11,958 Boe per day, an increase of 19% from Q4 2018 and up 228% from Q1 2018. This reflects average daily production during the period from March 25 through March 31, after giving effect to the Phillips acquisition. Organic production growth between Q4 '18 and Q1 '19, accounting for a full quarter of the Phillips acquisition, was 2.4%, which implies an approximate 10% annual organic growth rate. Total production was 902,877 Boe. The Phillips assets are performing very well, above our expectations, and we expect many years of additional development across this newly-acquired mineral position. As of the end of the quarter, we now have royalty interest in over 92,000 wells, with 89 rigs drilling on our acreage. We don't see any slowdown in drilling activity across our properties, which isn't surprising, since 50% of our 89 rigs are currently drilling in the Permian and Mid-Con, which have among the lowest break-even costs across the United States. In addition, we have some of the strongest and most efficient operators drilling on our acreage, at no cost to us, including ExxonMobil, Occidental Petroleum, Pioneer, Concho, Parsley, EOG, and many others. Oil natural gas and NGL revenues in the first quarter were $22.8 million, up 111% from Q1 last year, which generated consolidated adjusted EBITDA of $16.1 million, up 111% compared to Q1 2018, including a full quarter of the Phillips acquisition, which would have resulted in consolidated adjusted EBITDA of $20.6 million. Our first quarter distribution of $0.37 per common unit, which will be paid on May 13, 2019, implies an approximate 9% yield. This brings our total distributions paid since our IPO just two years ago to $3.27 per common unit, which is 18% of our IPO price. And since our conversion to a C corp in September 2018, we expect substantially all of the Q4 2018 and Q1 2019 distributions to common unitholders will not be taxable dividend income, and instead should generally constitute non-taxable reductions to the tax basis. As a reminder to anyone who might be new to our company, we are a variable distribution partnership. That is, we distribute 100% of available cash each quarter. We have no operating costs or capital expenditures, so the key influences on our distribution come from production volume, the fluctuation in commodity prices, and the pace of acquisitions. To that end, we continue to experience the best of both worlds from our broad, stable and diverse portfolio of assets across all of the major basins in the Lower 48, featuring organic growth from our recently-acquired assets coupled with the stability of the industry's lowest PDP decline rate of 12% from Kimbell's broad and diverse mineral portfolio. We are strategically adding production through acquisitions, while also growing PDP reserves organically year-over-year. We are very pleased with our first quarter results, and we have reaffirmed our guidance for 2019. We have a proven strategic model that continues to fuel growth. In a little over two years since our IPO, we have nearly quadrupled our production, and we remain very bullish about our asset class within the upstream sector and Kimbell's strategic growth model moving forward. Now I'll turn you over to Davis.

[Davis Ravnaas:]

Thanks, Bob, and good morning, everyone. Total first quarter 2019 revenues increased 65% from the first quarter of last year, to $17.9 million. First quarter 2019 consolidated net loss, including non-controlling interest, was $5.3 million in Q1, compared to a net loss of $52.8 million in Q1 2018. The consolidated net loss this quarter was primarily a result of a non-cash, full-cost sealing test impairment of $2.8 million. As a reminder, last year we had a full-cost sealing test impairment of $54.8 million. General and administrative expenses were $5.3 million in Q1, of which $3.6 million was cash G&A expense, which is approximately $3.95 per Boe, the low end of our guidance range, as we continue to capture efficiencies through the integration of our acquisitions and our existing portfolio of minerals. Cash available for distribution attributable to the common units was $5.2 million. You will find a reconciliation of both adjusted EBITDA and cash available for distribution at the end of our news release. As Bob mentioned, our first quarter cash distribution was $0.37 per common unit, a 7.5% reduction as compared to the fourth quarter of 2018, primarily due to a 9.4% reduction in realized prices between quarters. Substantially all of this distribution will not be taxable dividend income and, instead, should generally constitute a non-taxable reduction to the tax basis. The reduced tax basis will increase an investor's capital gain when the units are sold. To be clear, we expect this distribution to be 100% return of capital and free from dividend income taxes. Moreover, we expect to have minimal corporate taxes due to our significant tax shields for the foreseeable future. These factors are something that we don't think the market appreciates. We are also working with our tax advisors and plan to put out a much more detailed forecast of our advantageous tax structure in the near term. We are nearly done with this analysis and intend to issue a detailed press release with our findings. Average realized price per barrel for oil was $50.89, natural gas per Mcf was $2.68, and natural gas liquids per barrel were $19.70, which all represented declines compared to Q4 2018. As of 3-31-2018, our hedges were approximately 20% of our daily oil and natural gas production for the next two years. Looking now at the balance sheet, as of March 31, we had cash on-hand of $13.5 million and about $87 million outstanding on our $200 million revolving credit facility. As we've indicated before, our plan is to use the revolver to provide short-term financing for acquisitions. Our balance sheet remains conservative at approximately 1.1x debt-to-consolidated adjusted EBITDA, reflecting a full quarter of the Phillips assets. Before turning the call over for questions, I'd like to again provide some perspective on the mineral space and what we believe are clear drivers that differentiate our company and growth strategy. The market size for minerals is huge. It's over $500 billion in size. Some even believe it's over $800 billion. However, public companies still only represent about 2% of this market size, and additional consolidation is inevitable. By our estimates, over $13 billion has been invested by private equity sponsors and institutional investors into the private mineral market over the last five years. These diverse mineral holdings will need an exit. This creates a tremendous opportunity for Kimbell and our public peers to make accretive acquisitions from the private markets. We believe we have a unique opportunity to continue to lead the way, along with our peers, in growing the public royalty sector. We believe that as our sector grows in size, it will inevitably attract more institutional capital and interest, which will lead to more liquidity, and along with that will come increased attention from generalist investors. Through our proven growth strategy, with no operating or capital expenses and with organic growth and accretive acquisitions, and a variable distribution that pays out 100% of available cash each quarter, we have built a billion-dollar business in just two years. Even with the recent stock market volatility, we are still one of the top-performing mineral stocks year-to-date, with a total return of over 20%. We believe that we have earned the right to call ourselves a leader in the royalty sector and have proven our ability to close complicated, accretive acquisitions and to treat sellers fairly. We also provide an extremely advantageous and favorable tax structure for our investors. We will continue to be a leader in this space and execute our strategy to enhance value for our unitholders. In addition, we are maintaining a very active schedule, attending conferences and meeting with investors to get our story heard and understood. Given our record-setting operational performance and the fact that we are a diversified royalty company with a best-in-class PDP decline rate, we believe that we are the least risky asset class in the upstream oil-and-gas universe. As we've mentioned before, where else can you find an approximate 9% tax-free yield in a company with low risk, stable assets, and with a business model that has proven its ability to grow both organically and through acquisitions? To conclude, while the oil-and-gas royalty business has been around for over 100 years, its place as an institutional asset class within the upstream sector is just getting started. With that, operator, we are now ready for questions.

[Operator:]

[Operator Instructions]. Our first questions are from the line of John Freeman with Raymond James.

[John Freeman:]

So last call, you all mentioned looking to build possibly a strategic relationship with kind of a micro accumulator of royalty assets. I thought that was a pretty interesting idea. Is there any updated thoughts on that concept?

[Davis Ravnaas:]

Yes. Thank you for asking about that. We are actually very close to signing some kind of partnership agreement exactly in line with that, with a group in Dallas that we've known for a very long time, over a decade, and has an incredible track record. So we're working on a framework whereby we would invest with them under certain parameters that are, obviously, very accretive and very attractive to us. This partnership allows us to do that without having to hire 20 or 30 people to have a ground game here in-house, so it's, we believe, very advantageous from a G&A perspective. We hope to announce something - nothing guaranteed, no definitive documentation has been signed, but we hope to have something to report next quarter in terms of entering into an agreement of that kind.

[John Freeman:]

And then my follow-up question - you only have one other peer with a drop-down potential component, and I think that's still really underappreciated by the market, just because your sponsors and contributing parties are not public. And while I know you've done the one drop-down, I still don't think it's really well-understood. I'm just - maybe you could just sort of remind everybody sort of how you view the drop-down potential.

[Davis Ravnaas:]

Yes, absolutely. Thanks for asking that too, John. We have several hundred million dollars of assets that are held by the private sponsors for our company. It is our hope that those assets are dropped down over time. We have nothing imminent right now, but it is coming at some point in the future, and I think we're inundated right now with third-party M&A opportunities. So the drop-down assets, I totally agree with you, it's a huge advantage we have that I don't think many people appreciate. The benefit we have, though, is that third-party M&A activity has been so high, we've been focusing more of our time on that because those opportunities, obviously, go away if we don't pay attention to them, whereas the drop-down inventory is more or less captive and staying out. And just kind of a general comment, I saw your quick note this morning, John, and I think you hit the nail on the head. I mean, this was an across-the-board dramatic quarter for us. I mean, we grew production volumes organically 2.5%. We had some outstanding performance on our Phillips assets. More specifically, they're about 27% above on production volumes what we underwrote at the time we did the acquisition, so it was a gangbusters quarter for us. It's frustrating to see the stock price down 4% after the best quarter we've ever announced, but we're going to continue to execute and continue to just kind of beat people over the head with our performance. And I think also our entire peer group is undervalued, in our opinion, but I believe we might be the only one of the publicly-traded royalty companies that actually grew production this quarter, and several of our peers are expected to be higher-growth entities than us, and we're, at least so far, outperforming. So I think in an environment like this, with this being really the first quarter where we've seen capital discipline on the part of the E&P companies and CapEx cuts, I think this is showing how, on a relative basis, how resilient our strategy is through not only commodity price cycles, but also through capital allocation cycles. So this is a huge quarter for us. I think it's proving that our assets are performing even above expectation, and we really couldn't be happier with the performance of the business. It's very disappointing to see that the investor community doesn't seem to understand any of this.

[Operator:]

Our next questions are from the line of TJ Schultz with RBC.

[Torrey Schultz:]

So the partnership with the accumulator that you're considering, is that just in response to you getting bigger and your need to kind of evolve on sourcing new mineral deals, or is it more asset-specific to what kind of they bring to the table, relationships they have? I'm just trying to understand, with more public mineral companies out there, how you're seeing the competitive dynamic change a little bit.

[Davis Ravnaas:]

Yes. No, great question. I think it's a number of factors. I think, first of all, the largest segment of the mineral market is the micro-cap market, so it's $500 billion in size, but the biggest portion of that is held by mineral owners that have assets that are sub-$1 million in size. And so I think, and what we've seen, is that often in that market, you can get very, very, very attractive deals. We have never played in that market, in the micro-cap market. We've always been interested in moving into it, and we've been trying to find a partner over the last, really, two to three years that has an incredible track record and experience in that field and relationships on the ground that we could benefit from. And so I think it's - we want to continue to execute not only on these huge M&A opportunities, which are driving significant growth and appreciation and production per unit and DCF, but we also want to be able to address kind of the smaller market by drawing a modest amount on our revolver every quarter to finance assets in the - some of these deals are $20,000, $30,000, $40,000 in size, but you roll up enough of them and they can be very meaningful. And so we think this is a new avenue for growth for our company that we didn't previously have. Some of our competitors already do this. Every quarter, they very successfully - Viper has got an excellent ground game, for example, buying assets in West Texas, and there are so many of those deals, that there isn't any one group that's getting all of them. The competitive pricing could be quite attractive, so it's something that we think is very interesting. We think we've found the right group to back, and we hope that we can form a formal partnership going forward.

[Torrey Schultz:]

And then you mentioned that kind of $500 billion in mineral market size. We've kind of seen that out there for a while. You're saying maybe $800 billion, so I'm not exactly sure the differences in the calculations, but just trying to break that down a little bit. When you think about for the public mineral companies, do you kind of think of a subset of that mineral market size that's a realistic sandbox or opportunity set for you all to go acquire minerals? And then just second to that, I know what private equity has kind of invested, but do you have a ballpark for what maybe the mineral market size held by public E&Ps that may want to monetize some of those minerals?

[Davis Ravnaas:]

Yes. We're in discussions with various E&P companies about doing potential deals where they carve out their minerals, or even an override, and monetize to us. I think of that overall market size, our estimate is $500 billion. We've seen other people with size $800 billion, but we're just relying on our own math and our own estimates at the $500 billion level, so that's why we mentioned that. I think that for us, frankly, the Permian is, what, 30% now of the U.S. oil production, so we're still active in the Permian, but we're really one of the only groups that is very happy and has been very successful investing not only in the Permian, but also outside of the Permian. So I'd say, let's call it, the 70% that's non-Permian of the market - perfect candidates for us, less competitive, allows us to deploy capital and generate better returns. But we're still going to participate in the Permian market. It's just more competitive and more of our peers are very active there. So to answer your question, I'd say that half of the Permian opportunity is probably going to be taken by folks that are Permian specialists, and I'd say - but I'd say the other half is open game for anybody, including us, and then the other 70% is, obviously, right in our wheelhouse. So I think 85% of that market - I'm just talking out loud here, and I'm looking at my team and they're nodding - is probably our sandbox.

[Robert Ravnaas:]

And the other thing, TJ, is that the overall royalty interest market right now, we've had a flurry of inbound calls from E&Ps that are looking for ways to - alternative financing techniques rather than using their credit facility or bonds, and so that's probably another $100 billion to $200 billion of market size, I would think.

[Davis Ravnaas:]

Yes, exactly. And, look - I mean, and you know this, TJ, because you've been following us since we went public. I think one of the reasons we're doing so well in this environment is that, obviously, when you have a 12% PDP decline rate, it really doesn't take a whole lot of activity on your acreage to generate positive production growth, and that's exactly what we're seeing. I mean, we had some big wells come on with EOG in Gonzales County. We had some wells come on in Dewey, some big ones in Glasscock, so kind of just across-the-board activity that's really driving meaningful production growth for the company. We really - I mean, to reiterate what I just said, we could not be more happy with this quarter. I mean, it was just an outstanding quarter for us on - not only on an absolute basis, but also on a relative basis.

[Operator:]

Our next questions are from the line of Tim Howard with Stifel.

[Timothy Howard:]

Just on the tax analysis, maybe if you could provide some more details on timing, what's all going to be included, and potentially a preliminary conclusion, if that's available.

[Davis Ravnaas:]

Yes, I think I can speak in some generalities. I'd rather - because it's so complicated, I'd rather wait to give specifics, and we're going to have a very thoughtful press release that gives a lot of detail. We had hoped to actually have something to announce today, but taxes are always very complicated, and we had to involved a Big 4 accounting firm and then also our legal tax experts to weigh in on this, but the plan is to - one of the questions we receive most often is the current tax shield is, obviously, basically 100%, what's it going to be for the next several years, and so we've been building out a model to quantify that. And so the hope would be, Tim, to - our goal as management is always to provide as much transparency as we possibly can to you and our investors, and so what we want to do is be able to release kind of a multi-year outlook on what the tax shield is, not only at the corporate level, but also the percentage of the distributions that our unitholders will receive that will be treated as return of capital. And so we're going to be as specific as we can and as conservative as we can so that we're putting out thoughtful, conservative guidance that our investors can use in making decisions. I mean, it's obviously - it's a huge number. I mean, if you're someone that cares about taxes and you're an investor in our company, the 9% yield that you're getting on our assets is - that's an after-tax yield. So when you compare it to other opportunities that you can be investing in in other industries to generate yield, you should really be comparing it to like - take 9% and divide it by 1 minus 0.37, which is the top tax rate. It's really like a 13% opportunity, and it's in a low-risk asset class. So I think that that's not being understood by people, and it's really - we keep getting asked questions about it, and that's why we've done the work and hope to have something out I'd probably say in the next week or two. And then you asked about the general consensus. I mean, it's going to be that a very high percentage of our distributions are going to be tax free for a number of years.

[Robert Ravnaas:]

Yes, I agree.

[Timothy Howard:]

And then just on the guidance provided, maybe if you could speak to that at a high level, the 2Q through 4Q. The range was pretty wide. It seems like 1Q kind of end of quarter run rate is well above that, so just is there any headwinds we should anticipate into the second half, or is that just a conservative guidance? Thanks.

[Davis Ravnaas:]

Yes, great question. We anticipated that one. Conservative guidance - this is the first year that we've provided guidance, and so I think it's important that we establish credibility with the numbers that we put out there. So our plan, Tim, as many other well-run companies do, as the year goes on - it might not be next quarter, but possibly the quarter after - we'll probably narrow that range significantly so that - because by that point, most of the data is in for the year. So we would intend to narrow that range over time to provide you guys with more specificity when looking at the company and modeling.

[Matthew Daly:]

Hey, Tim. This is Matt. The rig count as of 3-31 was 89 rigs. As of 5-1, it was 88 rigs, so basically flat. There's been a big movement of rigs to the Permian outside the Eagle Ford, but our overall rig count has stayed flat, so we don't see any slowdown whatsoever in terms of our production, and everything looks really good so far for the rest of the year.

[Davis Ravnaas:]

Yes, I mean, Tim, frankly - this is Davis just talking off the cuff here. We were surprised by how robust the activity has been on our acreage. I mean, it's been pretty remarkable, and we've been - I'm not just being a salesman here. I mean, I think the numbers speak for themselves. I mean, we've really - 2.5% organic growth quarter-over-quarter, that would equate to 10% annualized growth if it keeps up, so it's been - we've been very, very pleased.

[Operator:]

Our next questions are from the line of Wei Jiang with Credit Suisse.

[Wei Jiang:]

I just wanted to follow up on your comment earlier just on the activity. Thank you for the additional details in the presentation that you have 89 rigs running on the asset. How does it compare to your rig activity in 2018? And how should we be thinking about the interest of those assets compared to your average net royalty interest in the portfolio?

[Davis Ravnaas:]

Good question. Matt, do you want to take that?

[Matthew Daly:]

Yes, I mean, the activity - I mean, last year, we didn't have Phillips. We closed Haymaker in July, so it's sort of apples and oranges. We don't have the same - but I would say it's relatively flat to up slightly in terms of the rig count. The interest level is going to be roughly 1%, on average. That's sort of the average net -

[Davis Ravnaas:]

0.5% to 1% on horizontal wells, maybe slightly higher than 1% on some of the older, mature stuff that we have. Would you guys agree with that being directionally correct?

[Robert Ravnaas:]

Yes.

[Davis Ravnaas:]

So I think pretty - Wei, I guess in the way of answering your question, which is a good one, the interest we have in Phillips and Haymaker and others would be pretty much in line with KRP legacy holdings, so kind of that 0.5% to 1.5% kind of level on average. Some units we have - some big stuff we had this quarter was where we had really high net revenue interests, and then we have other areas where we have very low net revenue interest, so it fluctuates, but pretty similar, Betty. I wouldn't - if you're getting at like should you start thinking about our exposure to these rigs being lower now on a net basis than before, I would say it's pretty similar.

[Wei Jiang:]

And then one question on the acquisitions. As you're evaluating opportunities in the market, has your appetite evolved at all to have greater emphasis on unconventional assets, perhaps, which is a bit more higher decline than what you had historically pursued? And then which region do you see as the most attractive opportunities right now?

[Davis Ravnaas:]

Great question, and I'm going to give you kind of a long answer. I'll try to keep it short. So most of the private equity money that is invested in minerals is, obviously, unconventionally focused, right? And so that's been kind of the near-term M&A or A&D focus in the market, has been private equity groups that have done a good job buying ahead of the drill bit, and now these properties are producing cash flow in the shale basins and they're looking to monetize. So that presents to us I think the more near-term opportunity set for making acquisitions, but we are very cognizant of making a lot of those acquisitions changing the company's strategy, right? We don't want to buy a lot of shale assets that have 40% or 50% decline rates, because that's just not consistent with our business model. So what we would attempt to - what we intend to do is balance acquisitions of that kind with acquisitions in more mature basins that have very shallow declines. And so, again, it's just kind of the same strategy of you might see us announce a big acquisition that has a lot of unconventional exposure, and then another one after that that's a little bit more flat decline and stable to balance it out. So that would be how we would, ideally, look at the M&A opportunity set here. And then what was the second part of your question, Betty? I apologize.

[Wei Jiang:]

No, just I guess which regions do you see the most acquisition opportunity, because you mentioned earlier that Permian is getting a lot more competitive, so where would you go next?

[Davis Ravnaas:]

Yes, I mean, there are just a lot of groups that have a mandate from their sponsors that they can only buy in the Permian, and so they're being forced just to look at the Permian alone. In fact, I'd say that's the majority of mineral buyers now. I think we've had the most success probably in places like the Eagle Ford, Appalachia, the Haynesville and the Bakken, maybe in that order. Bob, would you have anything to add to that?

[Robert Ravnaas:]

Yes. No, I agree. I agree. And always an advantage we have, too, is looking at assets that are multi-basin, so it isn't a sale of just assets in one basin, but multi-basin, because we're familiar and comfortable buying in all the major basins.

[Davis Ravnaas:]

Yes, and I think - again, I think a benefit we have when buying assets is that most buyers don't want to have multiple-basin exposure. They want to be specialists in a particular basin, and so if a package comes up that's 20% Permian, but 80% of the assets are in the Eagle Ford, the Haynesville, the Bakken and the Marcellus, most buyers, either from their sponsor or from kind of just the strategic level, aren't interested in that, right, because it's not in their wheelhouse. It's not their scope. They don't understand assets outside of one specific basin. And for us, that's perfect for us, and I think that's what's allowed us to pick up assets at better valuations, which is what you've seen recently in the acquisitions we've made. I mean, just to reiterate, Phillips is performing 27% above the volumes that we underwrote when we did the acquisition, so it's been a home run for us so far.

[Operator:]

Thank you. This concludes our question-and-answer session. I'd like to turn the floor back to Bob Ravnaas for closing comments.

[Robert Ravnaas:]

Thank you, everyone, and thank you all for joining us this morning. This completes today's call.

[Operator:]

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines, and have a wonderful day.