Rattler Midstream LP
Q4 2020 Earnings Call Transcript

Published: 25 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by, and welcome to the Rattler Midstream Q4 2020 Conference Call. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Adam Lawlis, Vice President, Investor Relations. Thank you. Please go ahead, sir.

[Adam Lawlis:]

Thank you, Brian. Good morning, and welcome to Rattler Midstream’s 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.

[Travis Stice:]

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 2 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 multiyear investment cycle in 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. Our only 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 increasing 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 its 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. Operator, you can open the line for questions.

[Operator:]

First question from James Kirby with JPMorgan.

[James Kirby:]

Just wanted 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-day growth?

[Travis Stice:]

Yes, James, good question. 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 freshwater 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 2 boards aligned on valuation for a potential drop down. But it’s certainly our intent, I just wouldn’t expect it to happen in the first half of the year.

[James Kirby:]

Got it. That’s helpful. And then just a follow-up on that. When you’re thinking about financing of it, leverage here is below 2. Do you have any early thoughts in terms of how you’d go financing the drop down, and if that would kind of coincide with buybacks? Maybe you ease the buyback pace in favor of the financing of drop downs?

[Travis Stice:]

Yes, 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 put more than 2 turns of leverage on the assets that get dropped down and the rest gets funded with cash or other sources. So we’ve been prudent in drop-down financing in the past at Viper. And I think for us, keeping Rattler below 2x because that leverage consolidates up to the parent is probably the right thing for us to do.

[James Kirby:]

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:]

No, we’re certainly not receiving 100% because there is some interest to be paid 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 at 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.

[James Kirby:]

Got it. I appreciate the color there. And last one for me. Just previously, you guys paused 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?

[Travis Stice:]

Yes, I think it’s still later-dated if we decide to even 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’s probably long capacity. So I think we’re going to be smart with capital there.

[Operator:]

The next question, Ujjwal Pradhan from Bank of America.

[Ujjwal Pradhan:]

Just 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 standalone and whether some of the ESG initiatives within FANG’s broader ESU program includes some at Rattler as well.

[Kaes Van’t Hof:]

Yes, that’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 commitments. 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 it rid of as many generators 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, 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 full field electrification across all of our fields and sourcing that electricity from renewable sources.

[Ujjwal Pradhan:]

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:]

No, it’s from the grid. When we buy both power, and this has been a hot topic 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 costs you a little bit more, but it wouldn’t be a meaningful amount, and that reduces your total emissions profile.

[Ujjwal Pradhan:]

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

[Kaes Van’t Hof:]

Yes, we have discussions with third parties all the time. Usually, it’s in 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 or fashion in midstream in the Permian is going to happen here.

[Ujjwal Pradhan:]

Got it. Turning to CapEx plans, this year, obviously, the operating CapEx has 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 the run rate CapEx specific to Rattler would be? And following up on the Amarillo build-out comments earlier, how much CapEx there could be for that build-out?

[Kaes Van’t Hof:]

Yes, 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 operated CapEx, and I think the team understands that Rattler’s budget starts at 0 and builds up from there. We spent $11 million or $12 million worth of capital in Q4. Our guidance assumes 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 2/3 to 75% of it is kind of mandatory Capex, and there’s a little bit of flex for the good guys in case things change throughout the year. But overall, that number needs 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.

[Operator:]

The next question goes from the line of Michael Lapides from Goldman Sachs.

[Michael Lapides:]

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 multiyear drop-downs could that be, or is it relatively small? That’s my first question. The 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 from 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:]

Yes, Michael, good questions. I’ll start with the size of the drop-down. I think in general, overall, we’re going to drop everything down at once. I think life is too short for us with 3 earnings calls in a week to do a multistage drop-down. I will say, I’ll give you a range of kind of 10% to 20%, the size of Rattler today. So it’s not a huge drop-down and it’s 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 to 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 asks of us and talks about in every audit committee meeting, is this the best use of our cash to buy back 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 at a forward 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 an 11% free cash flow yield, with all of that cash being returned to unitholders in some form or fashion because there’s 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-float buyback vehicle. But I think that’s a good discussion to have.

[Operator:]

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

[Tristan Richardson:]

[Kaes Van’t Hof:]

Yes, that’s a good question. I think if you look at the map, 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’re 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’s not a lot of added capacity needed with the combination of the 2. 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 is needed to integrate those assets because of how built-out they are at both companies.

[Operator:]

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

[Travis Stice:]

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

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you all for participating. You may now disconnect.