Kimbell Royalty Partners, LP (KRP) Q3 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the Kimbell Royalty Partners 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, Mr. Rick Black. Thank you, Mr. Black. You may begin.

Thank you, operator, and good morning, everyone. Thanks for joining the Kimbell Royalty Partners conference call to review financial and operational results for the third quarter 2018. This call is also being webcast and can be accessed through the audio link on the Events and Presentation Page of the IR section of kimbellrp.com. Information recorded on this call speaks only as of today, November 8, 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 provisions 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 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?

Thank you, Rick 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 by giving an overview of our operational performance for the third quarter and our increased distribution. Then I will provide a quick recap of our tax status conversion and our oversubscribed and successful offering on a 3.45 million common units. I’ll finish with comments about our strategy and expectations going forward. Then I’ll ask Davis to cover our financial performance in more detail. After that, we’ll take your questions. The Haymaker acquisition is proving to be the transformational acquisition that we had envisioned. The full integration will be completed this year ahead of schedule, and the asset performance and quality is excellent. In the third quarter, a record-setting result included contribution from Haymaker. And with Haymaker now included, we have significant scale to continue to grow our distributable cash flow and EBITDA. In addition, our cash in G&A costs per Boe are substantially reduced, which represents tremendous operating leverage for the company moving forward. Now let’s look at the performance of our assets in the third quarter. For the quarter, our results were outstanding across the board with impressive growth of revenues, adjusted EBITDA and cash distribution. From our assets, average daily production was 8,546 Boe per day, up 135% from Q2 and up 159% from Q3 last year with total Q3 production of 731,253 Boe. Please note, as we mentioned in our press release, third quarter results include the contribution from Haymaker for all but a 11 days of the quarter due to the timing of the close. Davis will discuss more in his section. On a revenue basis in Q3, 65% of our production was from liquids; 53% oil and 12% NGLs; 33% was from natural gas, and 2% from lease bonus and other income. On our acreage, the rig count was 71 at September 30. Approximately 94% of the lower 48 active drilling rigs are in counties in which we have acreage. Of the 71 active rigs, currently drilling on our acreage and no cost to us, currently 39% of these rigs are working in the Permian Basin, 25% in the Mid-Continent, 21% in the Rocky Mountain region, 7% in the Haynesville-Cotton Valley zones of Louisiana, 6% in the Eagle Ford and 2% in other regions. Please note that, none of our Rocky Mountain region rigs are located in the DJ Basin. We increased our quarterly distribution in the third quarter to 45% per unit, which is up 5% per unit sequentially and up 45% year-over-year. This is our sixth consecutive increase. We have grown our cash distribution every quarter as a public company, and have grown our distribution by 50% since our first full quarter after our IPO in 2017. To be clear, we expect to have minimal corporate taxes due to our significant tax shields for next several years and our distributions are substantially non-taxable as they are considered a return of capital. These factors are something that we don’t think the market appreciates. In early October, we closed the issuance on a 3.5 million common units in a follow-on equity offering. This offering was oversubscribed and priced $19 per common unit. These net proceeds were used to delever our balance sheet as well as significantly increase our float. We also had a large number of extremely high-quality institutional investors in mutual funds to our expanding investor base. We’re also very pleased to complete our conversion to C-corporation for tax purposes, which we believe will be a significant driver of increased investor interest within the energy yield space. With this much larger universe of institutional investors, trading volumes have already increased tremendously. In addition, with this improved liquidity, we believe our equity is now more attractive as a currency for future acquisitions. As you recall, we financed half of the Haymaker acquisition with common equity, which allows us to maintain a conservative balance sheet. With the added scale of Haymaker, the conversion to a taxable entity and the increased public float, we have greatly enhanced our optionality in how we finance future accretive acquisitions for Kimbell. On average, daily trading volume has increased nearly 300% since we increased our equity offering and we expect this to continue to improve over time. Turning to acquisitions. As we’ve stressed in the past, our strategy is to be well positioned to benefit from the next big play as part of a well diversified portfolio that would perform well for our investors, both in the near-term and long-term. We do this by assembling a high-quality diversified Royalty portfolio that generates positive cash flow and offers low-risk, high-return growth potential with no additional capital outlays In fact, we are virtually immune to the cost inflation that working interest E&P companies experience. The portfolio’s long-life production and modest average decline curve, not only enables us to generate current income, but also has significant upside potential for organic growth through additional field development for application of new technology. This upside is cost free to Kimbell, since we are a royalty owner, not a working interest owner. That’s a very important distinction in our investment thesis. Today the acquisition deal flow is higher than we have ever seen. We remain very active and continually evaluating opportunities. In addition to acquisition opportunities, we’re also diligently working on our first drop-down from our sponsors later this year or possibly in early 2019. Just like every acquisition, we consider the assets to be included in a drop-down from our sponsors would have to be acreage that is held by production and has strong potential for a low-risk, high-return, future development and exploration. And must also be accretive to distributable cash flow on a per unit basis and it must contain long-life reserves with a shallow decline curve that will provide a stable income stream to support our distributions. Before turning the call over to Davis, I’d like to reiterate that we are very bullish on our business and on the royalty sector. I’d also like to thank our team for their hard work and dedication as we have significantly transformed the company in a very short period of time and now we are even better positioned for continued growth with greater scale and a more appealing corporate structure. It has been a very busy year and we look forward to more positive developments in the future. Now I’ll turn you over to Davis.

Thanks, Bob and good morning, everyone. Please keep in mind that the third quarter results include a contribution from Haymaker for all but a 11 days of the quarter, as Bob mentioned. Third quarter total revenue was $18.4 million, which was up from $10.7 million in the prior quarter and from $8.4 million a year earlier. Cash G&A for the quarter was $4.1 million, up from $2.1 million in the prior quarter and $1.9 million in the third quarter last year. Approximately $1.4 million of the cash G&A in the third quarter represented integration costs from Haymaker. Adjusted EBITDA, a new record, was $14 million versus $7.7 million in the prior quarter and $5.3 million a year ago. Cash available for distribution was $12 million, also, a new record, versus $7.2 million in the prior quarter and $5.1 million a year ago. 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 third quarter cash distribution was $0.45 per common unit, up 5% per unit from the second quarter and up 45% compared with the third quarter last year. Please note that since the Haymaker acquisition closed on July 12, under GAAP, the company did not commence recording revenues from the Haymaker acquisition until that date and beyond. Thus, a 11 days of revenues from the Haymaker assets were not included in the third quarter financials. However, since we were entitled to those revenues from the Haymaker assets from the effective date of the transaction of April 1, 2018, we paid out a distribution in the third quarter that approximates as if those 11 days of revenues were included in cash available for distribution in the third quarter of 2018. Our average realized price per Boe was down 12% from the previous quarter at $28.83 per barrel, but up from $26.95 per barrel a year ago. Realized oil prices were 2% higher from Q2 at $64.77 per barrel, but gas prices were essentially flat at $2.56 per MMBtu and NGLs were up 10% sequentially at $27.45 per barrel. As of September 30, 2018, our hedges were approximately 30% of our daily oil and natural gas production for the next two years. Looking now at the balance sheet. As of September 30, we had cash on hand of $16.5 million at about $148 million outstanding on our $200 million revolving credit facility. Post the pay down of the credit facility after the completion of our equity offering in early October, the current balance of the credit facility is approximately $87 million, which gives us liquidity and availability of $113 million. 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 was 2.6 times at September 30, 2018 and 1.4 times now, reflecting the pay down of the credit facility. Lastly, I would like to make some important high-level observations about the current state of the company. From the time of our IPO, our production has nearly tripled, our balance sheet is rock solid with debt to EBITDA of 1.4 times, and we are a pure mineral and royalty company with no working interests, unlike some of our peers, and with no operating costs or capital expenditure requirements. We have proven our ability to execute on our growth strategy through acquisitions and we have changed from an MLP to C-corp tax structure to attract more investors and most importantly, we’ve continued to grow our cash distribution every quarter and have grown our distribution by 50% since our first full-quarter after the IPO. As a result of the C-corp conversion announcement and the follow-on equity offering, our average daily trading volume is up nearly 300%. We do not believe that the market fully appreciates our growth strategy and the fact that because of our high tax shields, we expect to have only modest corporate taxes for the next several years and our distributions will be a substantial return of capital, which is non-taxable to unitholders. We continue to believe that we are significantly undervalued at an approximate 9.5% current yield with the near 100% tax shield, given our continued record-setting operational performance, more than doubling of our average trading volume, especially considering that as a diversified royalty company, we are the least risky asset class in the upstream oil and gas universe. Where else can you find a nearly tax-free 10% yield with proven growth every quarter since the IPO. For these reasons and more, we continue to believe that we are significantly undervalued. Notwithstanding all of this, we are very encouraged about the operating performance and macro tailwinds for our business and believe that our results will ultimately speak for themselves and be appropriately valued by the investor community. 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 the line of John Freeman of Raymond James. Please proceed with your question.

Good morning guys.

Hai John, how are you doing?

Good thanks.You commented that you all are seeing a record number of deals and I’m curious just given sort of the recent pullback we’ve had in oil and then at the same time the pop that the natural gas has gotten, if you are you seeing any sort of material impact in sort of the types of deals and/or the values that you’re seeing due to that?

I would say that – first of all, I think that deal volume this year – I think I saw a recent comment from one of your peers that I think mineral and royalty space is at aggregate M&A volume. There were $3 billion this year, which is a doubling from the prior year. So, just some statistics there to kind of speak to the level of deal volume. I’d say that we are seeing more motivated sellers right now than perhaps at any anytime, since frankly I’ve been in the business. Seller expectations have gotten much more realistic. I think that when you look at ourselves, I mean right now I’m looking at the screen, we’re trading in over a 10% yield right now. I mean this is crazy. I think a year ago, people were expecting what 9%, 8% yields when they’re selling to public companies. I think now that expectation for yield or multiple that they’re going to receive has gotten much more realistic, because they know what it takes to – for something to be accretive to us. So, that dynamic has been very favorable to us. John, since we’ve known you for a long time now, we don’t try to time oil and gas prices. So we’re not – we’re not out there saying oil is cheap and so we’re only going to go after oil and gas is expensive. We’re really just looking for quality acquisitions that are accretive and it will grow in the future at a faster pace than even the standalone company. So all that being said, I’d be shocked if we didn’t see some – some larger accretive, really interesting M&A opportunities for ourselves that are successful in the next couple of quarters, including the drop down that we spoken to earlier.

I appreciate that. And then I guess from a high-level basis, as the Haymaker integration continues, has there been anything through that process either positive or negative surprises? Just sort of maybe processes that you have now implemented as a result of kind of integration or is it just sort of business as usual? Just any sort of thoughts on takeaways as that integration process has progressed?

Yes. Glad you asked about that. I think two thing. Number one, the integration process has gotten far smoother than I think anybody here expected and just given the size of the portfolio that we are taking on, I think a large part of that is due to the Haymaker management team. They are exceptional and we have a great relationship with them and they’ve done a wonderful job helping us transition that. So frankly the accounts on our team – we almost about laugh about – we’re really surprised by how seamless it’s gone, which is nice. What I’ll also add, which is important, and we didn’t say this on the call, Haymaker volumes – so, we just isolate Haymaker alone and look at the performance of those assets, we were hoping for and I think we have in our investor presentation that over the last, let’s call it 10 years, the average compound annual growth rate for volumes has been about 4%. So, we were hoping for somewhere between – depending on hydrocarbon pricing and drilling activity, we were hoping for kind of 3% to 6% growth on the Haymaker assets for a full year. What we’ve seen from Q2 to Q3, which is amazing, is actually 6% growth quarter-over-quarter. So, in effect we’ve been – which is outstanding and I can speak to why this is happening. We have some more detail. We basically hit our full-year production growth target in one quarter on the Haymaker assets alone. They’re growing significantly faster than KRP standalone, I’ll add that as well. And it’s been driven in large part by drilling activity in the Midland Basin. We’ve seen some new well drills from Oxy, from Parsley and then also some drilling on older KRP assets in the Eagle Ford, and also in Weld County. So anyway, we’re very happy with how the Haymaker assets are performing. They’re frankly ahead of schedule. Maybe we were too conservative in our underwriting assumptions and we’re also very happy with how the process is unfolded in terms of integration and us taking over full ownership of the assets. Thanks guys.

Thank you guy, I will appreciate that.

Our next question comes from the line of Tim Howard of Stifel. Please proceed with your question.

Hi thanks for taking that question. Going back to that annual kind of 3% to 6% growth, just kind of, into what you’re hearing or seeing for setting your expectations for 2019 growth, just anything you could provide either for the legacy asset base or Haymaker or the combination of?

Yes. Great question. We’re putting our heads together here. We’re going to start issuing guidance at some point in the near future. So that we can be a little bit more transparent in terms of what we’re expecting. We haven’t done that in the past, frankly, just because we’ve been growing so quickly, it’s really hard to issue guidance because every time we make an acquisition that guidance is a beatably antiquated. So, I think from our perspective, we continue to believe that the best indication of long-term growth is somewhere in that 3% to 6% range, so that’s probably what we’ll end up guiding to, so we’re going to want to look at dark send and PDNP inventory on our assets to help inform that LTM guidance number, but – and that will be forthcoming, but for now, I can tell you that we continue to see kind of that 3% to 6% growth number is being – it’s been pretty realistic absent any acquisitions that we would make and again I’d said that we expect significant M&A next year so.

Got it. Helpful. And then, just given the kind of nosiness of the quarter, could you help us think about – so you will get the full-run rate of Haymaker, maybe an update on the integration costs. I think those are expected to kind of remain elevated through 4Q and then kind of normalize in 1Q 2019. Just anything else that we should be thinking about given this quarter and looking the next quarter and 2019?

So the integration costs for Q3 were elevated in Q4, then it go down probably in the neighborhood of around $581,000.

Yes, we’re going to have a full quarter of the pref now. Pref is going to go up.

And then if you look at on the third quarter cash flow statement, we had a partial quarter on the pref being $700,000. In Q4, we’ll have a full quarter of the pref dividend at $1.925 million, but in terms of that integration costs –

Interest expense also going down.

Yes. We paid down the facility, so that have begun as well. So it will be a – the good news is integration cost is almost over, it’s going down. I mean, any other color from your side?

No. And, Tim, we can follow up with more granularity on that, but there is kind of three levers. So, we paid down, what, $60 million of debt?

Yes.

Okay, paid down $60 million of debt, so we’re going to get some bank interest savings in 4Q that was not reflected in 3Q, that’s going to be offset to a certain extent by a full quarter of the pref dividend, but then we’re also going to get the benefit of those integration costs stepping down as well. So –

And then in Q1 2019, they will be totally gone.

Exactly.

We’re looking at – by the way, no one is more annoyed by the noisiness in the quarter. I mean it’s just not – because none of that revenue numbers or production numbers reflect – it only reflects 81 days of Haymaker and so I think, a lot of people are looking at our earnings release right now and seeing numbers that are lower, everybody need to keep in mind, I know you know this, I’m saying as for the benefit of everybody else. I mean keep in my mind this does not reflect – these numbers under GAAP, we can accrue for Haymaker until you close the deal. So we’re missing a 11 days of Haymaker production and that’s particularly meaningful for a royalty company, I want to point this out because of our relatively fixed G&A. So when you miss a 11 days of production, that’s all – that all flows down to the bottom line, it is one-to-one to distributable cash flow and EBITDA. So it’s a bigger impact than just 11 over 92 days, which is 12%. Actually it’s a more meaningful impact on what EBITDA and production will be, and that’s, again, I think that’s something that people are not understanding right now.

All makes sense. It’s good to grow. And then last, just – if you could provide any more details on the drop down or just update kind of how that process is moving along, just any specifics you can provide would be great.

Yes, I think what I’ll say is that we are very actively working on it. We fully expect for it to be consummated by the end of the year. We want to give ourselves and add that for a little bit and that’s why we said that it could happen in early 2019. It’s going to be meaningful in size. So I can add color on that, and it’s obviously going to be accretive, which is nice and there are assets that we’ve owned and managed for quite some time, and so it’s exactly our type of properties, they’re going to be – they’re diversified in nature in multiple basins. I think the preponderance of it is – it’s going to be unconventional in nature, but there’s still a nice conventional in there. As you know, our business model, we like to have conventional assets mixed in with unconventional, because it provides more stability and wins itself to a shallower PDP decline curves. And it’s exciting. I mean what I’ll say about the drop-down for us is, we have all the respect in the world for our peer companies, but when they announced $100 million drop-down and your market cap is $4 billion, it doesn’t really do anything. $100 million on $4 billion is nothing. $100 million drop-down for a company like ours is meaningful. I mean that makes a big difference and it allows us to have captive deal flow here within our sponsor group. So, we’re not dependent upon third-party M&A to grow. So, it – we are the only company that have that ability right now to do that. And I think that’s just another thing that people aren’t fully appreciating about us. So –

Yes, appreciate the details. Thanks guys.

Thanks Tim Howard.

Our next question comes from the line of Jason Wangler of Imperial Capital. Please proceed with your question.

I’m doing okay. Most of the questions I was – had have been answered. But one I was curious on major being the combination with you and Haymaker. Certainly thought that the liquids content went up a bit, more than I had expected with the combination. I didn’t know that was something, maybe I just had missed or if you guys saw something as you combine these two or maybe if there are some activity that perked up. So, it looks like that actually had perked up a bit now that look pretty nice.

So you’re saying that – what you’re seeing is liquids increase that was greater than what you had expected?

Yes. I just what I – maybe moved up a little higher and again it may be due to the combination of the two, but –

Thank you for bringing that up and I should have mentioned that earlier. So, I’ll be even more granular. So big activity related to Haymaker – in the Midland Basin, we had some uptick and it's the [indiscernible] west on field that’s operated by Oxy and added 108 BOE per day, is that right? And then also the Brinlea horizontal wells operated by [indiscernible] that added another 27 BOE. Those would both obviously be very heavily liquids-focused in nature. And then additionally three big wells in the Morro Creek operated by a PE backed company called Protege down on the big Briscoe Ranch and the Eagle Ford Dema County that added another 26 BOE per day. That’s obviously heavily liquids-focused and then nine wells, the powder wells in Weld County. We have a very small DJ presence by the way. So, we the announced this so to be honest, that’s great. But anyway we have only a small position in Weld County, but it’s very good and it’s operated by Anadarko. They drilled nine wells on a pad that added 7 BOE per day to our production. So, thank you for asking that, because it allowed me to give more granularity. Almost all the activity we saw, it was meaningful in Q3 over Q2, was heavily liquids-focused and I suspect that’s why you’re seeing the shift that you’ve seen.

Sure. And then maybe just kind of jumping on, as you talked about the drop-down as we look forward. Could we assume that that the mix is relatively similar to where you’re at or it's different as far as the property…

Maybe a little bit more liquids…

Over 80%.

Okay. Yes, over 80% wells. Yes, I would say it’s going to be more liquids-focused than our existing company is today.

Okay I will turn you back thank you.

Thanks Jason.

There are no further questions over the audio portion of the conference. At this time, I would like to turn it back over to management for closing remarks.

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

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