Kimbell Royalty Partners, LP (KRP) Q2 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Kimbell Royalty Partners Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jack Lascar. Mr. Lascar, you may begin.

Thank you, Omar, and good morning, everyone. Thanks for joining the Kimbell Royalty Partners conference call to review financial and operational results for the second quarter of 2018. This call is also being webcast and can be accessed through the audio link on the Events & Presentations page of the IR section of kimbellrp.com. Information recorded on this call speaks only as of today, August 9, 2018. So please be advised that any time-sensitive information may no longer be accurate as of the date of any replay. I would like also 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 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 and other risks 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 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?

Thank you, Jack, and good morning, everyone. Thanks for joining us. 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; Jeff McInnis, our Chief Accounting Officer; and Blayne Rhynsburger, our Controller. I would like to begin with a quick recap of the recently completed Haymaker acquisition, then look at our operational performance for the second quarter and our most recent distribution increase. I’ll finish with a recap of our strategy and expectations for the rest of the year. Then I’ll ask Davis to cover our financial performance in more detail. After that, we’ll take your questions. We closed the acquisition of Haymaker Minerals & Royalties on July 12, and we are very pleased with Haymaker’s recent performance, as well as the future prospects to that acreage. This was a transformative acquisition that increases our distributable cash flow and EBITDA significantly. It also cuts our cash and G&A costs per Boe by approximately half, which represents tremendous operating leverage for the company. We believe the Haymaker acquisition, combined with our planned conversion from a pass-through to a taxable entity has the potential to unlock significant value for Kimbell that is not currently being recognized or valued in the market. With Haymaker, we had a significant scale and with the conversion to a taxable entity, we expect to greatly enhance our liquidity. The conversion will provide a significantly larger universe of investors by an estimated factor of 60, including both U.S. and international to our potential investors in our common shares, which would, of course, improve the trading volume. A lot of U.S. institutional investors are restricted from investing in MLPs, and it is also difficult for certain international investors to purchase MLP units due to their tax situations. So converting to a taxable entity would bring more new potential investors into the Kimbell story. In addition, with this improved liquidity, we believe our equity is now more attractive as a currency for future acquisitions. We financed half of the Haymaker acquisition with common equity, which allows us to maintain a conservative balance sheet. The fact that KKR and Kayne Anderson, two of the most sophisticated energy investment firms in the world, were willing to accept our units with 50% of consideration speaks volumes about the attractiveness of our units and the potential for equity appreciation in the future. We also have the financial capability and flexibility to make additional acquisitions in the near-term, particularly those where the seller is interested in taking equity in Kimbell, as we did with KKR and Kayne Anderson and the Haymaker transaction. There are a record number of private equity-backed mineral companies looking to exit and we are well-positioned to capitalize from that. Now let’s look at the performance of our assets in the second quarter. And I should footnote that I’ll be discussing results from our legacy assets only. We are very pleased with our overall performance this past quarter with another quarter of record revenue, adjusted EBITDA and cash distribution. From our legacy assets, average daily production was essentially flat quarter-over-quarter at 3,633 Boe per day, compared to a year ago, production in the second quarter was up more than 18%. On a revenue basis in Q2, 73% of our production was from liquids, 61% oil and 12% NGLs, 23% was from natural gas and 4% was from lease bonuses. We are continuing to see robust activity. On our legacy acreage, the rig count increased from 23 at the end of the first quarter to 25 at June 30, which is up 9% quarter-over-quarter. Following the Haymaker transaction, more than 95% of the lower 48 rig count is in counties in which we have acreage. Currently, 60% of those rigs are working in the Permian Basin, 20% in the Bakken-Rocky Mountain region, 12% in the Mid-Continent, 4% in the Eagle Ford and 4% in the Haynesville-Cotton Valley zones at Louisiana. There has been a lot of concern over the last several quarters about takeaway from the Permian. So far, we haven’t seen a sizable change in our realized commodity prices resulting from widening overall differentials in the Permian. This may be due largely to the fact that our most significant operator, Oxy, has more than adequate takeaway capacity from the Permian, according to what they have disclosed publicly. Most importantly, one of the greatest strengths of our portfolios is its diversity, with more than 65% of our legacy production coming from outside of the Permian. We increased our quarterly distribution in July by $0.01 per unit to $0.43, or $1.72 on an annualized basis. This is our fifth consecutive increase in the quarterly distribution since we went public in February 2017. Our second quarter distribution that we paid on August 13 to unitholders of record as of August 6. Now I’ll turn you over to Davis.

Thanks, Bob, and good morning, everyone. Since we now have a clean year-over-year numbers comparison, I’ll be citing changes both quarter-to-quarter and year-over-year. Please keep in mind that 2018 versus 2017 changes are partly influenced by the fact that prior to the Haymaker Acquisition, we made about $30 million of acquisitions in the last year that added approximately 475 Boe per day of production and divested about 9 million of acreage in the Permian that represented only 24 Boe per day of production. Second quarter total revenue from legacy assets was essentially flat from the prior quarter at $10.7 million, including the impact of a roughly $0.5 million loss on our commodities hedges, and up from the $7.8 million the year earlier. Operating income was $1.9 million versus $2.3 million in the prior quarter, excluding the impact of the asset impairment and versus about $0.5 million in 2Q of 2017. This sequential decline in operating income was largely due to the one-time costs of converting to a taxable corporate entity, more on that later. Cash G&A for the quarter, excluding onetime costs related to the corporate conversion was flat sequentially at about $2.1 million. Adjusted EBITDA was $7.7 million, a new record, versus $7.6 million in the prior quarter and $4.7 million a year ago. Cash available for distribution was $7.2 million, also a new record, versus $7.1 million in the prior quarter and $4.6 million a year ago. You’ll find a reconciliation of both adjusted EBITDA and cash available for distribution at the end of our news release. I should note that the number of common units outstanding as of the record date for the second quarter distribution included 10 million common units issued as partial consideration of the Haymaker acquisition. Under the terms of the Haymaker acquisition, we are entitled to net revenues or production from the acquired properties on and after the effective date of April 1, 2018. We paid a portion of these net revenues at second quarter 2018 distribution. Net revenues for production from Haymaker properties will be recorded on our income statement for periods on and after July 12, 2018, which is the closing date of the transaction. Our average realized price per Boe was down slightly from the previous quarter, down $0.09 a barrel at $32.81, but up from $27.78 per barrel a year ago. Realized oil prices were 4% higher from Q1 at $63.45 per barrel, but gas prices were down 4% at $2.59 per MMBTU and NGLs are up by 6% sequentially at $25.03 per barrel. As you’ll recall, when we initiated a fixed price swaps program at the end of 2017, we hedged about 10% of our oil and natural gas production to match the percentage of debt as a percentage of our enterprise value. We increased our hedges in July, which is consistent with that same strategy taking into account both our debt and preferred equity as a percentage of enterprise value since the close of the Haymaker acquisition. As a result, we have layered on additional hedges that approximate 30% of our daily oil and natural gas production for the next two years. Details are included in the supplemental schedule of our news release. Now let’s look at the balance sheet. As of June 30, we had cash on hand of $8.3 million at about $43 million outstanding on our revolving credit facility. Shortly following the closing of the Haymaker transaction, we had $16 million of cash and $148 million outstanding under our new larger $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 debt-to-adjusted EBITDA ratio remains conservative at 1.4 times as of June 30, 2018. In closing, I want to say what an exciting and transformative time it is for our company. We have now generated more than 30% total return to our IPO investors since the time of our initial public offering in – on February 3, 2017, which is something we are very proud of. With the Haymaker acquisition, we have added to our portfolio a large set of diversified assets and the best resource plays nationwide. The economies of scale generated as a result of this transaction will drive significantly higher distributable cash flow and production, while also cutting our general and administrative costs approximately in half on a per-unit basis. Simply put, it was the right opportunity for us at the right time. We have tremendous respect for the Haymaker management team, which we have known for well over a decade, and their sponsors, KKR, and Kayne Anderson, whose support and ownership of our common unit, speaks for itself. Moreover, our conversion to a taxable entity from a pass-through will dramatically improve our access to new investors and over time, should result in a significantly greater liquidity in our units. Putting it all together, we are – we believe we are very well-positioned to create value for our investors and capitalize on the tremendous opportunities that currently exist in the minerals and royalties space. With that, operator, we are now ready for questions.

Thank you. we will now be conducting a question and answer session. [Operator Instructions] Our first question comes from John Freeman, Raymond James. Please proceed with your question.

Hi, guys, and our congrats on closing the Haymaker acquisition.

Hey, thanks, John.

Good morning, John.

So the first question I have, it’s nice to see the increase in activity on the legacy properties during the quarter, especially in light of everything going on in the Permian as you all mentioned. Where did you all see most of the increase in activity, or was it pretty broad-based in terms of regions?

Yes, mostly Permian in terms of increased activity on our portfolio nationwide. And within the Permian, pretty broad-based but I’d say mostly focused on Midland Basin production.

Correct.

A little bit of uplift too on the platform in terms of activity.

Also, completion of docks in the Bakken is, I think, everybody’s kind of noticed too has helped.

Yes. We’ve got a big backlog of Bakken docks that they’re kind of finally turning on, because differentials have improved and that’s been helpful so.

Great. And then sort of a higher-level question. I know that on a pro forma basis for the Haymaker deal, you’ve kind of talked about on more of a longer-term, kind of five-year outlook that the average kind of PDP decline rate kind of stays sub-10%, obviously. I just wanted to make sure that I’m kind of thinking about this the right way? So the legacy Kimbell, I can always – had it sort of a, call it a 8% to 10% kind of base decline and kind of a 2% to 3% organic growth. And then Haymaker, I kind of thought of as a kind of 12% to 13% base decline with the higher organic growth rate of kind of 4% to 5%, is that kind of, I guess, first, is that right?

Yes, that’s exactly right. I’d say decline to be a little more conservative. I’d say, for Haymaker’s assets, decline would be 12% to 15%, but obviously, with a significantly higher organic growth rate, too. So I think you’ve got it within those parameters.

Okay, perfect. So just kind of in the near-term, you see the base decline goes up some while the organic growth rate goes up some in the near-term, that’s kind of the right way to think about it.

That’s exactly right.

Okay. And then just – if I was able to sneak one more question in. When I sort of think about with – if I go back to earlier in the year when you all did that really nice divestiture of some of the properties in the Permian, sort of take advantage of the big price disconnect on where kind of the bid-ask spread was for assets. When I think about now with the Haymaker deal and sort of just the broader set of properties that you now have access to, should I think about, it basically kind of widens those opportunity set to kind of take advantage of those same kind of pricing disconnects, that maybe happened either high grade kind of the overall properties, if you will?

Yes. I think that’s small. I mean, we think of it as portfolio optimization. If we can sell something at an outrageous multiple in a really hot area and then deploy that capital in a very reasonable accretive multiple somewhere else, we’re more than happy to do that. I think that’s one of the strengths of our business strategy is having diversified assets throughout every basin, and so we can make those judgment calls when opportunities present themselves. I would say that the – that you’re thinking about it exactly right. I mean, we’ve now more than doubled the size of the company and then we’ll roughly double the acres count. So once we kind of get things fully under our ownership and fully under our control, yes, we’re going to look at ways that we can potentially optimize shareholder value through potential divestitures of what we would consider highly valued assets in the Haymaker portfolio. And I’d say those would be in the Midland Basin and then also they have an excellence SCOOP/STACK position, and we’re not looking to sell things. But again, if people come to us with what we feel are pretty frothy multiples, we’re – our job is to maximize value and we’re going to seriously consider those sales when and if opportunities present themselves.

That’s great. I appreciate, guys. Thanks a lot. Well done.

Yes. Thanks, John.

Thanks, John.

[Operator Instructions] Our next question comes from Jason Wangler, Imperial Capital. Please proceed with your question.

Good morning, all.

Hey, Jason.

Hey, Jason, how’s it going.

How was your summer month?

Good. Good, hope you guys are doing well. Just wanted to ask, you’ve mentioned it on your prepared remarks about the production on the Permian and kind of the differentials. If I recall correctly, too, from previous discussions, is there a situation to have a lag period there, where perhaps there’s a few months more before you would see that just given the way that you guys get it, or are you seeing that more in real-time as you look at them?

Lag periods, we have not seen it yet. We are optimistic that it’s not going to hit us as hard as some other folks for a few reasons. One, Oxy, as you know, is by and large our largest operator in the Permian. And from everything we hear from them directly and read through public statements, they appear to have arguably one of the best situations there in terms of takeaway capacity. Again, we have a healthy amount of production on the platform, too, with other operators. And I would – it’s kind of our sense just based on what we’re hearing that the differential blowouts are happening a little bit more in kind of frontier areas on the Delaware, particularly in the Delaware and also in some areas that are kind of extensions at the Midland Basin. As you know, we have a more conservative kind of core acreage position within the Permian between those three areas. So we can’t guarantee anything. But I think we’d be surprised if kind of the differential carnage that some of these operators are reporting affected us the same way that it affects them if that makes sense. So we haven’t seen it yet – yes, we haven’t seen it yet. I think, it’s possible. So I don’t want to say that it’s not going to happen, I think, it’s possible. We even included, I think, some reduction in – or some increase in the differential the Permian is part of our Q2 accruals, is that right?

Yes.

So we’ve already baked in some expectation for something in the numbers you’re seeing. But I just can’t, for the life of me, I kind of look around our management team, we’re just not expecting to see the same amount of deterioration that other folks are seeing, so.

Sure. And like you said, you’re kind of partnered with probably some of the right guys. So that’s really going to help. It’s certainly – we’re starting to see that each company is kind of its own?

Yes. I mean, when you think, I mean, and not to drag us out too long. But when you think about having minerals in like some of the most prolific field that are ELR projects, right? I mean, those – some of the fields that are producing sets the 1940s and 1950s. I mean, this isn’t anything new, if they’ve had it, they’d get oil out of there, they have infrastructure in place for a really long time. So I think that’s a little bit different than, okay, let’s go drill a super pad in the middle of nowhere and then try to figure out how to get the oil out of there. So, I mean, that’s just kind of a high-level way of thinking about it from our perspective so.

That’s helpful. Thank you. And then with the balance sheet and the acquisition, I mean, obviously, you still got a good liquidity position and a pretty low EBITDA ratio. But how do you think about moving forward as a bigger entity and now as you’re switching over to a C-Corp, too? Are you comfortable where you’re at? Is there something that you’re looking at, maybe certain metrics or anything we should be thinking about going forward? And I assume, obviously, still pretty focused on M&A, how we should think about that?

Yes. I think we’re happy where we are in terms of leverage. We like, as we’ve said, since we went public, we like leverage less than 2 times debt to EBITDA. So we’re below that right now. I think that when we think about M&A, again a big differentiator for us, which you feel like is underappreciated, it’s just the fact that we have such a big dropdown inventory. So I think, that’s going to be a focus for us in the near to medium-term, and we’ve been saying that since the beginning of last year. So we’re working on that on consummating a dropdown. I think, it’s very helpful that Viper just did one successfully, I think, that’s quite a first upstream dropdown that’s happened in what eight years? So I think that, that’s what we’re going to focus on. And what should be important from your perspective I think about is that, our sponsors want units, so it doesn’t even have to require that we draw on our revolver to finance a dropdown, we can do it accretively through units directly. And so that has kind of two benefits: one, it will eventually lead to higher flow in the units over time if the sponsors decide to sell anything; but then secondly, it just naturally delevers the company, right? Because we’re growing production and EBITDA without any associated increase in leverage. So that we kind of look at it as a win-win.

Perfect. Thank you. I’ll turn it back.

Thanks, Jason.

Our next question comes from Tim Howard, Stifel. Please proceed with your question.

Hi, thanks for taking our question

How are you, Tim.

Hi, how are you?

Good.

Could you outline the remaining steps for the tax conversion? And if you guys have a target date when do you think that may be effective or maybe the last set that would kind of create the target date?

Yes. I’m going to turn it over to Matt Daly, our Chief Operating Officer to answer that question.

Yes. How are you doing? So we’re targeting the latter part of this month, early September, where it will be effective. And we do that similarly in the Viper deal, we would send out a press release a couple days before the actual effective date. So the information data was filed preliminary 14C, and so that’s usually about a 30-day period before it becomes effective.

Okay, great. Thanks.

Thanks, Tim.

There are no further questions at this time. Now I would like to turn the floor back to management for closing comments.

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

Thanks, everyone.

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