Sitio Royalties Q1 2023 Earnings Call Transcript

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May 10, 2023

There are 8 speakers on the call.

Operator

Good morning, and thank you for attending CTO Royalty's First Quarter 2023 Earnings Call. My name is Felicia, and I'll be your operator today. All lines will be muted during the presentation portion of the call with an opportunity to questions and answers at the end. I would now like to pass the conference over to your host, Ross Wong, Vice President of Finance and Investor Relations. You may proceed.

Speaker 1

Thanks, operator, and good morning, everyone. Welcome to the Citadel Royalty's Q1 2023 Earnings call. If you don't already have a copy of our recent press release and updated investor presentation, please visit our website It's Chris Conisenti, our Chief Executive Officer, Kerio Cica, our Chief Financial Officer and other members of our executive leadership team. Before we start, I would like to remind you that our discussion today may contain forward looking statements and non GAAP measures. Please refer to our earnings press release, Investor presentation and publicly filed documents for additional information regarding such forward looking statements and non GAAP measures.

Speaker 1

And with that, I'll turn the call over to Chris.

Speaker 2

Thanks, Ross. Good morning, everyone, and thank you for joining FITIO's Q1 2023 earnings call. There is one word that captures the theme from this quarter, uneventful. For the first time in 2 years, we did not announce or close any acquisitions during the quarter. And for the first time since becoming public, there are no pro formas or partial period results in our reported financials.

Speaker 2

Integration of the Brigham assets and personnel is complete with nothing unexpected to note. During the Q1, production associated with Scitio's assets Averaged 34,440 barrels of oil equivalent per day, which is comparable to the 34,424 BOEs per day produced from these assets in the Q4 of 2022. 1st quarter production volumes were in line with our expectations, and we are reaffirming Cythio's Full year 2023 production guidance range of 34,000 to 37,000 BOEs per day. We estimate that in the Q1, there were 7.3 New net wells that started producing on Scitio's acreage, more than 95% of which are in the Permian Basin. These new net wells represent Scitio's interest in wells publicly known to have come online during the quarter, plus Scitio's interest in net wells still identified as spuds and public data sources, but are estimated to have started producing During the quarter based on market intelligence and our forecasting methodology.

Speaker 2

As of March 31, we had 42.8 net line of sight wells, which implies Steady operator activity over the next 12 to 15 months on our assets, particularly relative to the cumulative total of 141.3 net wells that have come online since the beginning of 2019. The Q1 of 2023 demonstrated quite Different M and A dynamics in the past 3 years. During the Q1, we evaluated multiple acquisitions totaling approximately 50,000 net royalty acres in aggregate, But we're unable to find any opportunities that met our returns criteria. Buyers and sellers are still transacting, But at different underwriting assumptions and return thresholds than CFIOS. We remain focused on achieving a minimum of mid teens unlevered returns Using strip pricing and future development assumptions aligned with actual operator behaviors.

Speaker 2

I will provide you with one recent example of a private buyer and private seller. The market clearing purchase price in this example was approximately 2 times the price that Physio could have paid using our returns parameters. The only way we could have justified paying the same purchase price would have been to either assume a near term production profile of 4 times to 5 times Our base case production assumptions or an average oil price of approximately $140 per barrel in perpetuity using our production assumptions. In this example, paying the market clearing purchase price would have resulted in mid single digit returns for our shareholders, Which clearly does not meet our hurdle rate. We believe attractive consolidation opportunities exist with mineral owners we know and have been pursuing for years We will continue to be disciplined and good stewards of capital.

Speaker 2

Now turning to some key financial metrics for the quarter. Overall, our financials came in as expected And we're within the range of our full year 2023 guidance metrics with the exception of our implied cash tax rate, which I will describe in more detail later. Our average hedged realized price per BOE for the Q1 was $48.87 which was $8.61 or 15% below the Q4 of 2022. And we reported adjusted EBITDA of $140,000,000 and discretionary cash flow of $120,000,000 1st quarter cash G and A was $6,100,000 a $2,200,000 increase relative to 4Q 2022 since this was the 1st full quarter with However, we achieved a significant milestone with 1Q 'twenty three cash G and A of $1.97 Per BOE, the lowest ever in Physio's history and the Q1 in which cash G and A per BOE has been below $2 Another important point on the G and A topic is the magnitude of the absolute G and A savings that have been achieved through the 2022 combination of DesertPeak and Falcon to form Scitio and Scitio's merger with Brigham. If you add up the cash G and A from the Q1 of last year, When all three of those companies were independent of each other, the total cash G and A was $11,300,000 Compare that to our Q1 2023 cash And you can see that we have reduced the absolute amount of cash G and A from all three entities by 46%.

Speaker 2

This is a great illustration of the scalability of our business model and of the value to be created for our shareholders by consolidating this highly fragmented industry. Due to timing differences, cash taxes in our financials can be somewhat confusing relative to our guidance. So I wanted to go over this in more detail. 1Q 'twenty three cash taxes reported in our financials represent the cash taxes paid in the Q1, not the taxes payable related to taxable income for the In January, we made a cash tax payment of $550,000 for income taxes related to taxable income in the Q4 of 2022. This was the only cash tax paid during 1Q 2023, so the implied reported cash tax rate is 1% for the Q1.

Speaker 2

Similarly, in April, we made a cash tax payment of $5,900,000 for income taxes related to taxable income in the Q1 of 2023. So the Q1 2023 estimated cash tax rate would have been 11% without timing differences. In addition to the $5,900,000 Cash taxes that was paid in April, we plan to make another cash tax payment during the Q2 related to income taxes due for 2Q 2023, Which we expect to be approximately 11% to 13% of 2nd quarter pretax income. Our Board declared a dividend of $0.50 per Using a payout ratio of 65% for the Q1 of 2023, which will be paid on May 31st to record holders at the close of business on May 19. This dividend is down by $0.10 per share relative to the dividend in the Q4 of 2022.

Speaker 2

So I wanted to provide some details to help explain the variance. Lower commodity prices decreased the dividend by roughly 0 point 11 dollars Lower production volumes driven by 2 fewer days in the quarter decreased the dividend by another $0.016 and the combination of lower lease bonus, higher cash G and A and higher Cash interest decreased the dividend by $0.018 These decreases were partially offset by an increased dividend of $0.26 Due to lower cash taxes and the combination of lower severance and ad valorem taxes, lower gathering and transportation expenses And higher realized hedging gains, which added another $0.018 to the dividend. Our Q1 dividend of $0.50 per share benefited from paying cash Taxes related to the Q1 in April and if all income taxes had been paid in the quarters that they were related to, our Q1 dividend would have been Approximately $0.47 per share. Moving on to the balance sheet at the end of March, we made another amortization payment at par of $11,250,000 on our unsecured notes, Bringing the remaining amount outstanding principal to $427,500,000 We also paid down our credit facility balance by $23,000,000 during the Q1. On April 28, our lenders reaffirmed our $750,000,000 borrowing base.

Speaker 2

And as of May 5, 2023, We had reduced the outstanding balance on our credit facility to $441,000,000 which is an additional $46,000,000 reduction since the end of the first quarter, Providing liquidity of approximately $315,000,000 including $6,000,000 of cash and $309,000,000 of remaining availability on our credit I want to remind shareholders that we filed our 2023 proxy statement on March 31 and that our virtual Annual Investor Meeting is scheduled for Tuesday, May 16, 2023 at 11 am Central Time. Whether or not you plan to attend the Annual Meeting, it is important That your shares be represented, so I highly encourage all shareholders to vote. I'm proud of the differentiated business that we have built And think the proxy statement does a good job highlighting the accomplishment of the company and our best in class governance model, which provides strong alignment between the Board, Management team and shareholders to drive long term value. That concludes my prepared remarks. Operator, please open up the call for questions.

Operator

Thank you. We will now begin the question and answer session. We have a first question from Tim Rezvan from KeyBanc Capital Markets. Please go ahead, sir. Your line is now open.

Speaker 3

Good morning, everybody. Thank you for taking my question. First question I had is on The payout ratio, you paid out 65% again. I believe that's the sort of the near term target given work on the balance sheet. I was wondering, Chris, if you could talk from either your seat as CEO or as a member of the Board, kind of how folks are thinking about The intensity, the former repayment, our repurchases being considered and what level of Leverage or debt reduction would cause you to reconsider that 65% payout ratio?

Speaker 3

Thanks.

Speaker 4

Hey, good morning, Tim. Thanks for the questions. Yes. As a Board, we do talk about repurchases. As I mentioned last quarter though, unfortunately, we're a bit hamstrung by the unsecured notes that are in place right now That have a limitation on what we can do in terms of return of capital to shareholders.

Speaker 4

As a team, we've been prioritizing that dividend. We've committed to paying out 65% of Discretionary cash flow in the form of a dividend and we don't want to cannibalize any of that for buybacks right now. I think when the time comes when it's appropriate to refinance those unsecured notes and we put a different structure in place that allows for buybacks, It will become a more vibrant conversation and I think you'll see us put something in place at that time. In terms of your second question, The sort of metrics that would allow us to do that, I think there's 2 things. It's 1, it's the company size And then 2, as you mentioned the leverage, company size as we think about as we get larger in that 35% retained cash flow becomes a larger number.

Speaker 4

And then second, when the leverage starts to drift down towards that Target we have for long term leverage of one times or less, that's when we start to get really interested in returning more capital than the 60 5% we're already committed to returning to shareholders. We'd love to be in a position to do that, but unfortunately with the notes we have today, we're just not.

Speaker 3

Okay. So we should look for that potential refinancing as a first step on other changes. Okay. Correct. I appreciate that color.

Speaker 3

And then just final one on the M and A comments, I appreciate them in your prepared statements and It's pretty clear you're trying to get a message out in the actual release. Are you trying to get a little more color. Are you sort of frustrated? Do you think the market is going to kind of normalize As maybe some of this private capital dries up or how do you see the landscape playing out or how do you hope it kind of plays out over the next year or 2 To allow you to get more scale.

Speaker 4

Yes. I wouldn't describe it as frustrated. I think different people have different underwriting Discipline and requirements and different cost of capital. And so there's different drivers for everybody. So I wouldn't describe it as frustrated.

Speaker 4

We're going to Just focus on what we do. We've seen this before. We saw it in 2020 when we were trying to make a lot of acquisitions and the sellers weren't willing to transact and We just we kept at it and kept those relationships warm. And when the timing lined up and We were able to act, we did in 2021 2022. It just feels like this we're in a period here where it's going to be a bit more challenging to reach A bit ask that makes sense for our shareholders.

Speaker 4

We're making some progress, but clearly nothing in the Q1 and We're pretty deep into the Q2 right now and haven't announced anything yet. So, I think it's going to be one of those years where it's going to be a bit lumpy relative to the past couple of years.

Speaker 3

Okay. Thanks for the comments.

Operator

The next question we have comes from TJ Schultz from RBC Capital Markets. Please go

Speaker 5

ahead. Hey, good morning. I guess first on the 50,000 NRAs you looked at, where were you focused?

Speaker 6

And then

Speaker 5

I guess just from a commodity perspective, Have lower natural gas prices changed at all the focus for you on where you want to transact or the conversations with sellers?

Speaker 6

I'll just leave it there.

Speaker 4

Thanks, TJ. Good morning. So the bulk of what we looked at in the Q1 was in the Permian Basin. We did look at a couple of things in the DJ Basin And then 1 or 2 things that were more diversified. We really haven't looked at anything that's just purely gas focused, meaning anything In the Haynesville or anything in Appalachia, but that day may come, but we found we have just a bit of a More localized knowledge and skill set in areas where we currently have assets.

Speaker 4

And so when we look at things in the Permian and DJ, we feel like We have a better grasp on the underwriting. And candidly, that's where we feel like there's the most remaining inventory that's economic today. And so for us acquiring these minerals and now having to deploy additional capital for additional production in the future, There's the greatest potential for that in the Permian Basin and the DJ Basin relative to some of these other places. I don't think The gas price softness of the past 6 months plus has really impacted us in terms of M and A or in terms of seller mind Really the natural gas is a bit of a byproduct in the Permian and people don't get very anchored on gas prices when they think about monetizing assets. So Hasn't really played a role there.

Speaker 4

It has played a role I think in some of the transactions we've been watching, not evaluating ourselves, but we've seen some transactions that have been pulled Or had trouble getting financed in other purely gas basins.

Speaker 5

Okay. Makes sense. And then we've seen some recent deals get done with a mix of Stock and cash, when you're looking at deals, how are you considering the financing mix and how high are you willing to take that leverage to Transact on M and A. Thanks.

Speaker 4

So we do consider different consideration mixes. It's really driven by the sellers and what they're open to taking in terms of consideration. So it's not really our decision to dictate. We can express a preference, but ultimately if the seller needs or wants one form of consideration that's going to drive the conversation. We're open to using the stock, but it has to be accretive, just like it would have to be accretive in a cash situation.

Speaker 4

But we've used stock In the past for the Brigham transaction Falcon, Rockridge, Source, so the bulk of what we've done in the past has been for stock And we're willing to do it again, but it just has to meet those accretion metrics that we've used in the past.

Speaker 6

Okay. Thank you.

Operator

The next question we have comes from John Annis from Stifel. Please go ahead.

Speaker 7

Hey, good morning all and thanks for taking my questions. For my first question, I wanted to focus on a bigger picture question for the Permian and activity within the Permian. If we were to assume strip pricing, do you think we've seen peak activity for at least the immediate term given that privates Generally, you have less quality inventory depth and are more likely exposed to weaker gas pricing?

Speaker 4

I think you're seeing the continued discipline by operators. So I think the basin certainly is capable Of running at higher activity levels, but if we're assuming current commodity prices, current capital discipline, then yes, I think we're sort of steady state. I think that's what our guidance suggest in terms of volumes for our company. And if you look at our footprint, if you look at just gross DSU acreage within our footprint, it covers about 1 third of the entire Permian Basin. So when you look at our Production volume cadence, it really reflects that of the broader basin.

Speaker 4

And With the guidance we put out there, it doesn't suggest anything beyond single digit growth, which is what we'd expect For operators at this time, I do think that there are private operators that do have a lot of Tier 1 remaining inventory. I look at folks like Endeavor and CrownQuest Mewbourne and others that have really fantastic assets. I think some of the later stage private equity backed Companies that are looking to sell, maybe trying to had tried to ramp up production ahead of a sale so they could have some better metrics for the buyers And make it a more appealing asset for buyers. That may be what you're referring to, but there are still a lot of privates that do have a lot of remaining Tier 1 inventory.

Speaker 7

Makes sense. And for my follow-up, In reference to Slide 7 where you highlight the synergies achieved today from your past transactions, can you comment on whether there's still more runway to achieving further synergies or have the lion's share of those gains already been realized?

Speaker 4

So in terms of the assets we have today, I think there are opportunities for additional synergies and we talked a little bit about it on last quarter's call. We've had some 3rd party vendors that we've worked with data providers that are trying to gouge us on pricing and they have not been Really rational with respect to how they're approaching pricing. And so we're looking for alternatives and some things just Doing things on a proprietary basis that will eliminate those costs altogether. And so we're making some modest investments this year as we look to eliminate those line items. I wouldn't look at those as multiple 1,000,000 of dollars in terms of savings, but they matter and they're in So there are investments we make today and benefit from for the rest of the company's life.

Speaker 4

So we're excited about those. We get excited about our data and ways to Access it and work with it. So it's important to us and it's a real focus for this year. In terms of personnel, we're still investing in people. We find ways that even adding people can add efficiencies.

Speaker 4

So we're looking at some of those alternatives as well. So I think there's the bigger gains to come are from further consolidation though. I think as you see us continue to add assets and not have to The headcount linearly with the asset growth, that's where you're going to see additional cost savings on a dollar per BOE basis And on an absolute dollar basis.

Speaker 7

Terrific. Thanks again for taking my questions.

Speaker 4

Thank you.

Operator

The next question we have comes from Noel Parks from Tuohy Brothers. Please go ahead.

Speaker 6

Hi, good morning.

Speaker 4

Good morning.

Speaker 6

Just a couple of things. Thinking about the Acquisition path that you've gone along with Britham being the Biggest and most recent. What hurdles would a new entrant into the royalties market Have to overcome in order to attempt to follow your strategy or mimic your strategy realistically today?

Speaker 4

So one would be finding high quality opportunities like we have in the past. 2 would be access to sufficient capital to replicate what we've done. But I think one of the bigger challenges is candidly that the people and systems that we've built And that's very difficult to replicate. From the outside looking in, it can appear that the Minerals business is a very easy one. But to manage it optimally, it requires the right people and the right systems To really extract the most value for shareholders and that's taken us quite a while to build and we're still investing every day in that.

Speaker 4

And I think that's where we have a real advantage over anybody Just starting

Speaker 6

today. Great. Thanks. And And as you look at the different basins, with we've had this sort of Fairly steady oil environment now for over a year, mostly 70 plus for WTI and then tremendous volatility And Natgas. And I wonder as you look at the various basins, it seems like some of them Our at different stages of life cycle, I guess, I don't know if I call it consolidation, but like on a land Management basis, there are some basis where there's a lot of trading of interest, non operated interest, You're trying to block up acreage and so forth.

Speaker 6

And I assume that situations like that might The opportunities might jar some things loose. And then there seems to be other basins where they are just not in that sort of stage right now. I was wondering if on I'm sorry, the land management basis, if you're noticing any particular trends with the different basins?

Speaker 4

We make the same observation you do about the relative maturity of different basins. It feels like places like the Eagle Ford And the Williston have a lot less remaining organic growth and there may be more of a maintenance mode or in slight decline And that leads to a different opportunity set for operators in terms of who's going to be the ultimate holder of those assets longer term. Now for the mineral owners, for us, as we look at these opportunities, we like a balance Of current production plus remaining development potential. And so when we look at opportunities that were, let's say, just Eagle Ford or just Williston Basin compared to something that's just in the Permian or just in the DJ Basin? It's a harder comparison for us to Make the same sort of underwriting assumptions about future growth just because we know that there's less remaining running room in those places.

Speaker 4

So That's why you see us continue to come back to places like the Permian and the DJ.

Speaker 6

Sure. Fair enough. Okay. Thanks a

Speaker 4

lot. Thank you.

Operator

Since we have no further questions registered, This concludes today's call. Thank you all for attending. You may now disconnect your line.

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