Sitio Royalties Q2 2024 Earnings Call Transcript

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August 8, 2024

There are 10 speakers on the call.

Operator

Hello, everyone, and a warm welcome to the City of Royalty's 2nd Quarter 2024 Earnings Call. My name is Emily, and I'll be coordinating your call today. I will now turn the call over to our host, Ross Wong, Vice President of Investor Relations and Finance. Please go ahead.

Speaker 1

Thanks, operator, and good morning, everyone. Welcome to the City of Royalty's Q2 2024 Earnings Call. If you don't already have a copy of our recent press release and updated investor presentation, please visit our website at www.cidio.com, or you will find them in our Investor Relations section. With me today to discuss Q2 2024 financial and operating results is Chris Conoscente, our Chief Executive Officer Cary Otsuka, 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.

Speaker 1

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

Speaker 2

Thanks, Ross. Good morning and thank you for joining CITIO's Q2 2024 Earnings Call. The momentum from our strong start to the year continued in the Q2 as the company set several operational and financial records, closed on acquisitions of approximately 15,000 net royalty acres and announced return of capital of $0.71 per share, a 45% increase relative to the Q1. In the 2nd quarter, production from our mineral and royalty interest reached record high volumes of 39,231 BOEs per day, up 3% compared to pro form a 1st quarter volumes, which included a full quarter of production from the previously announced TJ Basin acquisition. Several other production milestones were also achieved with an all time oil production high of 19,747 barrels per day and record Delaware Basin and Eagle Ford production of 20,991 BOEs per day and 4,061 BOEs per day respectively.

Speaker 2

These impressive operational results benefited from the flush production from 14.3 pro form a net wells turned in line in the first quarter and 8.5 net wells that commenced production in the 2nd quarter, which was 6% above our 2023 quarterly average. The majority of 2nd quarter operator activity came from the Permian and DJ Basins, which accounted for approximately 94% of all net turn in line wells. As of June 30, we had 44.1 net line of sight wells on our acreage, which included 25 net spuds and 19.1 net permits. During the Q2, we evaluated dozens of acquisition opportunities totaling more than 150,000 NRAs in aggregate. The minerals A and D market remains competitive and we're still seeing many minerals deals of all sizes transact at prices that don't meet our underwriting criteria.

Speaker 2

Despite that market dynamic, we continue to identify and successfully close multiple transactions each quarter, which demonstrates the benefit of our ability to invest capital in assets that are in different basins and are operated by a diverse set of E and P companies. After closing the previously announced DJ Basin acquisition in early April, we closed another 6 acquisitions during the quarter for an aggregate purchase price of $38,500,000 These 6 acquisitions added over 2,100 NRAs to our portfolio, of which approximately 61% are in the Permian Basin and the remainder are in the DJ Basin. As you can see from the maps in our earnings presentation, the acquisitions we closed in the Q2 materially enhanced our position in the DJ Basin and expanded our footprint on the New Mexico side of the Delaware Basin, an area that has seen robust operator activity in recent years. While we have generally focused on larger acquisition opportunities since becoming publicly traded in June of 2022, ultimately our M and A decisions are driven by risk adjusted returns regardless of deal size. In addition to our strong production volumes and continued success on the acquisitions front, we are raising our full year 2024 pro form a average daily production guidance range to 36,000 to 38,000 BOEs per day, which represents an increase of 500 BOEs per day at the midpoint.

Speaker 2

Approximately 200 BOEs per day of this increase is from the 6 small acquisitions we completed in 2Q and the remaining 300 BOE per day is due to an increase in organic activity relative to our previous guidance. Now I'll turn the call over to Carrie to provide an update on quarterly financial results, return of capital and cash tax guidance.

Speaker 3

Thanks, Chris, and good morning, everyone. Vidyo generated record high adjusted EBITDA of $151,600,000 and discretionary cash flow of $129,300,000 in the Q2, driven by historic high production and hedged realized oil prices of $80.21 per barrel, an increase of 3% over Q1 prices. Our Board approved our return of capital of $0.71 per share for the 2nd quarter, comprised of $0.30 per share cash dividend and stock repurchases equating to $0.41 per share. This represents a payout ratio of 85% of DCF and is higher than our minimum 65% of DCF due to the previously disclosed privately negotiated repurchase of 2,000,000 shares for approximately $50,000,000 In addition to this privately negotiated repurchase, we also bought back over 500,000 shares in the open market during the quarter. Since we started our buyback program in March, we repurchased 3,100,000 shares as of June 30, or 2% of shares outstanding prior to starting the repurchase program.

Speaker 3

At the end of the second quarter, we had approximately $124,000,000 remaining of our $200,000,000 share repurchase program. In addition to raising our guidance for full year 2024 pro form a production volumes, we are also decreasing our guidance for cash taxes to a range of $9,000,000 to $15,000,000 which is a $21,500,000 decrease at the midpoint to reflect our latest analysis from our tax experts. That concludes our prepared remarks. Operator, please open up the call for questions.

Operator

Thank you. Our first question today comes from Leo Dingmann with Tuohy Securities. Please go ahead.

Speaker 4

Good morning, guys. Thanks for the time. My first question, Chris, is on your activity specifically. I'm just wondering, and I think I know the answer, but I'm just wondering, given the increased commodity volatility we've seen in the last month or so, have you all seen anything different from operators, notably just on activity? And I guess another one to ask that is your line of sight well still as strong as ever?

Speaker 5

Good morning, Neil. Thanks for the question. Short answer is no. We haven't seen any meaningful change in activity. We continue to see operators achieving greater and greater efficiency.

Speaker 5

So what we're seeing is operators doing more with less. So the migration of assets into larger operators' hands has led to better operational efficiencies. It's led to better footprint configuration so that there's more contiguous acreage and operators are able to draw longer laterals and enhance completion design. So we are seeing sort of a flattish rig count, flattish downish frac crew count, but it isn't really meaningfully impacting the number of wells getting turned in line, which tells us that operators are continuing to achieve the efficiencies that we like to see. In terms of the line of sight wells, yes, we do see a decrease in the net line of sight wells, but gross activity has remained relatively constant.

Speaker 4

Great details. And my second question is just on M and A. Just wondering what when you look at deals out there right now, is there any one area that's more active right now than others? Thank you.

Speaker 5

The most active areas for us continue to be the Permian Basin and the DJ Basin. From a rate of return standpoint, we're seeing attractive opportunities in both. I would say that the Permian Basin is still very, very competitive, and there's still a large number mineral companies pursuing the same opportunities. So you have to have a differentiated approach, relationship driven approach. And in the DJ Basin, there's some really good collections of assets there that we've been able to acquire.

Speaker 5

And we're still seeing a lot of success on the ground there too.

Operator

Our next question comes from Noel Parks with Tuohy Brothers Investment. Please go ahead.

Speaker 6

Hi, good morning. Just had a couple. Just wondering, general terms as you look at what is available out there for deal flow, what's your current thinking on valuation of gas optionality? And I'm thinking in particular in the Permian, sort of heading further south in the Delaware for instance, where well the prolific tend to be gassier and the sort of pro LNG narrative seems a little distant right now compared to just the tough time that the gas markets have had. So I'm just curious what your current thoughts?

Speaker 5

Yes. Thanks for the question. We remain commodity agnostic and really returns driven. So we're not opposed to acquiring more gas assets if we can do it at the right price. And as you noted, our assets have a fair amount of embedded gas within them.

Speaker 5

So it's not like we have to go to a pure gas basin to have gas exposure. We do have it by virtue of the associated gas with our existing assets. So we are not opposed to picking up more assets in the areas where we already have exposure like the Southern Delaware Basin or in the DJ Basin. We're also not opposed to going to other places like Haynesville if the opportunity presented itself at the appropriate rate of return for us.

Speaker 6

Great. Fair enough. And also, as you mentioned a little bit earlier, just operators doing more with less and that general tend of greater sort of capital efficiency. And just wondering if you had if there was that trend hasn't gone on as long as it has. Do you feel like operators pretty uniformly in your basin are sort of headed in the right direction with that?

Speaker 6

Or I wondered if, for instance, you're seeing much in the way of private operators being more aggressive, ramping up production potentially within an eye to a sale. We've seen some very long held on the operated side, some very long held PE based assets that have or appear to finally be transacting. And I was just wondering if you sort of see the ripple effects of that in terms of what's on the market, what people might be thinking of paying and so forth?

Speaker 5

Yes. The trend that we see is that with these assets moving to larger operator hands, we're seeing just less volatility in the capital programs. The larger operators tend to be less influenced by a $5 or $10 move in the price of oil. They tend to set their capital plans with a lower long range price deck in mind, and they don't get rattled by some volatility that can be short term. So we like that stability in the operator base.

Speaker 5

As our assets evolve over time, you've seen our operator mix shift from a lot of private, a lot of Smith cap names to really the largest of large from Chevron, Exxon, Oxy, ConocoPhillips, Diamondback, etcetera. So those are folks that don't with saw around their capital plans with the commodity. To address your question about the mix of private versus public or large operators, The phenomenon you described still exists where you have some of these small private equity backed companies that are ramping up production to build a production profile so that they are capable of selling to the public independent. There's just far fewer of those left. So while we do still see that, it's just a very, very small fraction of our portfolio today.

Speaker 7

Great. Thanks a lot. Thank you.

Operator

The next question comes from Tim Rezvan with KeyBanc. Please go ahead.

Speaker 7

Hi, this is John on for Tim. Thanks for taking our questions. So in the absence of large scale M and A, do you think this pattern of small acquisitions you've done in the quarter is repeatable? So just trying to understand whether you have line of sight on more acquisitions of this size?

Speaker 5

Good morning, John. Thanks for the question. We do still see a number of opportunities of all sizes. And so we're evaluating a lot of small acquisitions every day. And then we're working to make progress on some of these larger acquisitions all the time.

Speaker 5

And we just know that these larger acquisitions are going to be more episodic and they tend to be years in the making instead of quick 1 or 2 week turnaround as we see the smaller deals. So our visibility on the smaller deals is candidly better and we're still working on a number of those. So I do expect to continue to make a number of those, but the predictive capability on the larger acquisitions is just not as good because they take longer to develop. But we're working on transactions of all sizes. And really, it's just going to depend on where we can allocate the capital to get the best rate of return.

Speaker 7

Okay. That makes sense. Just to follow-up with that, these acquisitions in the quarter, they pushed net debt over $1,000,000,000 and leverage has picked higher.

Speaker 6

You've

Speaker 7

talked before about wanting to have leverage of 1x. Do you think that's still reasonable? And we just want to see how the Board is currently thinking about this?

Speaker 5

Yes. The thinking around debt has not changed one bit. We still have the objective of having a very strong balance sheet using our retained cash flow to pay down prepayable debt and to preserve maximum balance sheet flexibility so that we can take advantage of cash acquisitions. So we do retain more of our discretionary cash flows than our peers, and we use that to make accretive cash acquisitions and to pay down our pre payable debt. So you'll see like we did this quarter where we borrowed money to make some accretive cash acquisitions and then we'll continue to work towards our goal of getting that closer to one time so that we have the balance sheet flexibility to make a large cash acquisition on the future.

Speaker 7

Okay. That's great. That's all we had. Appreciate the time.

Speaker 5

Thank you.

Operator

Our next question comes from Betty Jiang with Barclays. Please go ahead.

Speaker 8

Good morning. Thanks for taking my questions. Maybe I'll start with buyback and that's a good follow-up from the last question. Just given second quarter, we're actually seeing pretty outsized buyback and including some in the open market, wondering your thoughts around that buyback against debt reduction for our uses of cash going forward? Thanks.

Speaker 6

Yes. Thanks for

Speaker 5

the question, Betty. I'm glad you asked. We just we actually got an e mail from Sheryl asking the same question about the thought process on the allocation between dividends and buybacks and debt pay down. So glad to address that here. As we think about it, we don't have to make a trade off between buying back stock or paying down debt because we are focused on returning at least 65% of our discretionary cash flow to shareholders.

Speaker 5

So our decision becomes how do we allocate that 65% between dividends and buybacks. And when we see opportunities like we saw this past quarter and in the Q1 to repurchase stock well below what we believe is net asset value and to make NAV accretive buybacks, we want to take advantage of that. So you saw in the second quarter, we paid out the minimum cash dividend of 35% of discretionary cash flow. And then we use the rest of the return of capital in the form of buybacks to take advantage of the NAV accretive opportunity. So we don't look at it as a trade off between do we make the buyback or do we pay down debt.

Speaker 8

Got it. That makes sense. And then follow-up, perhaps just on the line of site activity line of site backlog. I understand that the second quarter line of sight is down from 1Q and that is reflecting the very high number of pills in 1Q. So looking forward, just wondering how your thoughts about the net line of sight activity across the portfolio against the historical trends that you haven't seen?

Speaker 8

And I really appreciate the additional disclosure on tail counts as well. Thanks.

Speaker 5

Sure. I'll make a quick comment and then I'll turn it over to Jared to add his thoughts. But the comment I'd make on the Q2 was very much in line with the 2023 historical average. In fact, it was slightly above the 2023 historical average. Where the 2nd quarter, we had about 8.5 net sales in the quarter.

Speaker 5

And I think you're referring to the Q1, which was a bit of an anomaly. So I'll let Jared cover the rest.

Speaker 9

Sure. Hi, Betty. Couple of comments here. Our rig count is obviously what's feeding these line of sight wells. And if we look back at the last year, our rig count as a percentage of North America has always run between roughly 18% 20% and that hasn't materially changed in recent history.

Speaker 9

So when you look at our asset given the gross footprint we have, we're really the overall rig count that we see from Baker Hughes or the other reporting agencies is really a proxy for line of

Speaker 1

sight

Speaker 9

wells are down quarter over quarter sequentially. We do line of sight wells are down quarter over quarter sequentially. We do track this metric monthly. And what I can tell you is, it is already partially recovered as of this month. So on a go forward basis, we're not modeling anything that is materially lower than the historical averages we have had.

Speaker 9

But obviously, the recent activity we have had has been very high relative to the our historical averages.

Operator

As we have no further questions registered, this concludes today's call. Thank you everyone for joining us today. You may now disconnect your lines.

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