Kimbell Royalty Partners, LP (NYSE:KRP) Q2 2022 Earnings Conference Call August 4, 2022 11:00 AM ET
Company Participants
Rick Black – Investor Relations
Bob Ravnaas – Chairman and Chief Executive Officer
Davis Ravnaas – President and Chief Financial Officer
Matt Daly – Chief Operating Officer
Blayne Rhynsburger – Controller
Conference Call Participants
Trafford Lamar – Raymond James
Chris Baker – Credit Suisse
Derrick Whitfield – Stifel
Cameron Lochridge – Stephens
Operator
Greetings and welcome to the Kimbell Royalty Partners’ Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Rick Black, Investor Relations for Kimbell Royalty Partners. Thank you, Mr. Black, you may begin.
Rick Black
Thank you, operator and good morning everyone. Welcome to the Kimbell Royalty Partners conference call to review financial and operational results for the second quarter ended June 30, 2022. This call is also being webcast and can be accessed through the audio link on the Events and Presentations page of the IR section of kimbellrp.com. Information recorded on this call speaks only as of today, August 4, 2022. So please be advised that any time-sensitive information may no longer be accurate as of the date of the new listening or transcript reading.
I would also like 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, which, 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.
And with that, I would now like to turn the call over to Bob Ravnaas, Kimbell Royalty Partners’ Chairman and Chief Executive Officer. Bob?
Bob Ravnaas
Thank you, Rick, and good morning, everyone. We appreciate you joining us on the call this morning. With me today are several members of our senior management team, including Davis Ravnaas, our President and Chief Financial Officer; Matt Daly, our Chief Operating Officer; and Blayne Rhynsburger, our Controller. I will start the call today by commenting on the quarter and the current operating environment before turning the call over to Davis to walk you through our financials in more detail.
We are very pleased to have sustained the momentum we had last quarter into this quarter. The strong commodity prices during the quarter, coupled with organic production growth, resulted in several new records for Kimbell. In addition, net DUCs and permits reached record levels at the end of Q2 2022, reflecting increased activity and line of sight on our acreage. I’m particularly pleased with the 4% organic growth – organic production growth in the quarter, which drove record run rate production in Q2 2022, driven mainly by significant new production from multiple high interest wells in the Haynesville.
Reflecting these strong quarterly results, we are pleased to announce today that our second quarter distribution is $0.55 per common unit. This marks yet another record for the company. Recessionary fears have now permeated across the economy and U.S. gasoline demand has decreased, resulting in a steep drop in oil prices from the March 2022 highs. However, upstream operators across the United States have generally kept production growth constrained, which should provide a sturdy backstop for potential downside in oil prices from current levels. In fact, overall U.S. Oil production has grown only approximately 2% this year, even with multiyear highs in commodity prices.
As of June 30, 2022 and we had 74 rigs actively drilling on our acreage, up 1% from last quarter and representing over 10% market share of all rigs drilling in the Continental U.S. After a significant correction in natural gas prices from June highs, these prices are again trending higher, reflecting record power demand and tepid production growth. This price increase is happening, notwithstanding approximately 2 Bcf per day of demand temporarily lost due to a major LNG export facility being offline. These higher oil and natural gas prices are supporting activity increases across all major basins, which we are seeing through increased lease bonus activity as well as record net DUCs and permits. And we continue to see operators maintaining discipline even in the face of these higher prices and expect only modest production growth as we finish out 2022. As we have mentioned before, at Kimbell, we only need approximately 4.5 net wells completed each year to keep production flat, and our net DUCs and permits currently exceed this level, providing the potential for continued organic production growth as we finish out 2022.
As we look forward in 2022 and beyond, we remain very bullish about the industry overall. We remain extremely excited about our role as a leading consolidator in the oil and natural gas royalty sector, and we believe there are substantial opportunities for Kimbell to generate long-term unitholder value for years to come.
And with that, I will now turn the call over to Davis.
Davis Ravnaas
Thanks, Bob and good morning everyone. We are very pleased to report record performance during the quarter, and we are affirming our full year 2022 guidance that was previously disclosed in our fourth quarter 2021 press release.
I will start by reviewing our financial results from the second quarter, beginning with record oil, natural gas and NGL revenues of $78.6 million, an increase of 21% from Q1 2022, reflecting improved realized commodity prices, coupled with growth of organic production. Kimbell’s second quarter 2022 average realized price per BBL of oil was $107.96, per Mcf of natural gas was $6.93 and per barrel of NGLs was $46.10 and per BOE combined was $57.78. Our second quarter average daily production was 14,948 barrels of oil equivalent per day on a 6:1 basis, an increase of 4% from Q1 2022. This daily production was composed of approximately 63% from natural gas and approximately 37% from liquids or 24% from oil and 13% from NGLs.
On the expense side, general and administrative expenses for Kimbell were $7.9 million in the quarter, $4.9 million of which was cash G&A expense or $3.61 per BOE. Second quarter net income was approximately $43.3 million, a new record. Total second quarter consolidated adjusted EBITDA was $53.5 million, an increase of 22% compared to last quarter and also a new record. Today, we announced a record high cash distribution of $0.55 per common unit for the second quarter. This represents a cash distribution payment to common unitholders of 75% of cash available for distribution and the remaining 25% will be used to pay down a portion of the outstanding borrowings under Kimbell’s secured revolving credit facility. Since May 2020, excluding this upcoming Q2 payment, Kimbell has paid down approximately $63 million of outstanding borrowings under its secured revolving credit facility by allocating a portion of its cash available for distribution for debt pay-down.
Commenting further on the balance sheet and liquidity. As of June 30, Kimbell had approximately $216.1 million in debt outstanding on our secured revolving credit facility. It also had net debt to second quarter 2022 trailing 12-month consolidated adjusted EBITDA of approximately 1.2x and was in compliance with all financial covenants under its secured revolving credit facility. Kimbell had approximately $83.9 million in undrawn capacity under its secured revolving credit facility.
We are extremely proud of the strength of our business model that continues to perform very well in the highly cyclical energy industry. And we are also very pleased with our record performance, which is largely the result of seeds planted many years ago when we completed several acquisitions when commodity prices were much lower. We remain highly focused on our goal of generating long-term unitholder value for years to come.
With that, operator, we are now ready for questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from Trafford Lamar with Raymond James. Please proceed with your question.
Trafford Lamar
Hey, guys. Congrats on a great quarter, record quarter all around. I guess first question kind of centers around share buybacks. I see some of your peers have kind of shifted more from just a straight dividend distribution to incorporating buybacks as a percentage of that total distribution. I know you mentioned it a little bit last quarter with regards to potentially rolling out buybacks or increasing the distribution later this year as a percentage of distributable cash flow, but I just want to get your thoughts on that?
Davis Ravnaas
Yes, great question. I appreciate it. This is Davis. I think from our perspective, as we have discussions with the Board, we are increasingly encouraged to state the obvious by the cash flow profile and outlook for the business, particularly in the context of our balance sheet which continues to get stronger, and stronger, and stronger with every passing quarter. As I mentioned before, we will look at all possible options to maximize shareholder value. And so that can take the form of increasing our payout ratio at some point in the future when our leverage ratio gets to be so low that it’s effectively de minimis. That could mean share buybacks or we can continue to pay down even more debt. I think as it currently stands, we don’t have a firm target on exactly what that bright line of leverage is, but for general purposes, I think it’s fair to say around that – we’d like to be at less than 1x debt-to-EBITDA, which, as you can tell, is not too far away. So the stock is obviously trading at a very attractive level. Free cash flow yield is – we’ll see the dividend yield annualized is 12.5% at the current price. Free cash flow yield is obviously significantly higher than that. So it’s a compelling value proposition. It’s something that we think about. And in the not too distant future, we’ll be in a position vis-à-vis the balance sheet where we can really push down the gas pedal on hopefully buying back some stock or increasing dividends to our shareholders. Matt or Bob, anything you want to add?
Matt Daly
No, I think that’s right, David. I mean – this is Matt. I mean, looking at the three options you mentioned there in terms of increasing the payout ratio, paying down debt or buyback stock. As I alluded to, the free cash flow yield, you are looking at a 17% free cash flow yield on the stock right now. It’s an incredible value. And so to the extent you have a marginal dollar that would be likely a place where you consider very strongly on buybacks.
Trafford Lamar
Great. Okay. Appreciate the color guys on that. And then second question, just kind of like a quarterly check up on kind of ground floor game and you all increased production pretty materially sort of organically from first quarter, second quarter. So not that you would need to make an acquisition, but just given the recent volatility, especially on the oil side, I guess what have you all seen kind of in the bid-ask spread with sellers at the ground floor level?
Davis Ravnaas
Yes, good question. It continues to be challenging. I think you see that not only with us but also with our peers. Sellers want credit for $100 oil. And I think in some cases, I don’t want to admit that the curve is in such deep backwardation. So for us, volatility always hurts. And I think that’s true for any industry. In this particular case, kind of going back to your first question, we’d be better off buying back our own stock, to Matt’s point, at a 17% free cash flow yield. We know our own assets, of course, better than we would know any third-party assets. So I think for now, as we think about the use of cash and the business generates, we’d like to continue to delever. And if we continue to trade like this, I think buybacks become the most appealing option.
Bob Ravnaas
This is Bob. What I’d like to just add to that is we did – obviously, we saw a number of publicly announced acquisitions this last quarter that were significant and pretty large, that was pretty aggressive pricing that I think companies did strategically and we did look at all those, and we’re not the high bidder, obviously. What I’m excited about through the years and going through the cycles, I don’t like the volatility right now, but it’s been my experience with us buying high-quality royalties that as prices keep on going up like they did earlier this year, that people tend to hold on to them saying that we think prices are going to go up even further. It’s been my experience that when prices kind of come down a little bit and people are concerned on whether or not they are going to go back up again, that sort of loosens the thought of sellers saying, maybe $90 a barrel is not a bad price. And so I’m cautiously optimistic about that in the next couple of quarters. But to Davis’ point, the volatility does hurt.
Trafford Lamar
Great. Well, appreciate the color from both you and Davis.
Operator
Thank you. Our next question comes from the line of Chris Baker with Credit Suisse. Please proceed with your question.
Chris Baker
Hi, guys. Congrats on some solid organic growth this quarter.
Davis Ravnaas
Thanks, Chris. [indiscernible] the pipeline.
Chris Baker
I was hoping you can maybe just talk a bit about how you’re thinking about the second half? I think it was reiterated, but obviously, the top end of the range gives you a little bit of wiggle room there. And just longer-term, I know a while back, we had talked about maybe a low single-digit organic growth target over time. Any updated thoughts just based on where you’re seeing the macro shake out today in terms of that organic growth story in the second half and beyond?
Davis Ravnaas
Yes. Great question. So reaffirmed guidance. Your point is well taken that perhaps, well, implicit in that comment might be that we’re being a little bit conservative, which we always try to be. Looking at the second half of the year, we feel very good about that. We had a long discussion on that topic yesterday in terms of line of sight that we’re seeing on development activity in the second half of the year. That’s supported and evidenced by just the amount of DUC and permit inventory that we have right now as it currently stands. We – frankly, it took us – it took a little bit longer, at least that I expected personally, just start to see some of these high interest DUC conversions that we had in the Haynesville. We knew that a lot of these wells were out there and it just took a little bit longer than we expected to – for that to materialize. So that could accelerate in the second half of the year. We don’t want to count on it. That’s why we’re not enhancing guidance at this time. But Chris, your point is well taken. I feel very confident about the back half of the year, certainly given what’s going on with natural gas prices. Matt, Bob, anything you want to add?
Matt Daly
Yes. Yes, that’s exactly right. I mean, 14,948 BOE per day, that’s 4% above the midpoint of guidance. And any time you have sort of this low single-digit organic growth in this market, especially when you have oil production growing at 2% at Lower 48 and gas production growing 1%. Anytime you have sort of low to mid-single-digit organic growth, it’s certainly very positive. And as Davis said, we have a fair amount of activity that we see coming up here. The timing is always a little bit difficult to pinpoint, but certainly, a lot of these DUCs and the rigs you guys have been seeing over the last several quarters are starting to materialize now, especially as Davis said, in the Haynesville and other areas. You obviously saw the lease bonus activity as well. That was relatively sizable, and that was very broad-based among multiple basins. And so we’re certainly benefiting right now and see the momentum.
Chris Baker
Yes. So – go ahead, Bob. Sorry.
Bob Ravnaas
Yes, I’d like to add, too. I’m really proud of our property base. Yes, I don’t know of any company that only requires 4.5 net wells to maintain production flat. And if you recall, our last significant acquisition last year had a very, very low PDP decline, which would even tend to even lower that. Plus as wells get more mature, they tend to flatten out. We haven’t updated our work on that yet this year, but I’m optimistic that the amount of wells right now with our current property set to maintain production flat would be less than 4.5%. I don’t know how much less, but if anything, directionally, I would anticipate it to be lower. And so that just really that just really makes it so much easier to grow organically. I’m very proud of that. We don’t have to do an acquisition financed by debt to make it accretive to maintain production or to increase production that our property set just continues to show growth every year organically. So I’m very happy about that.
Chris Baker
Appreciate the comments, Bob. And then just longer-term, fair to think as we kind of look out to ‘23 and beyond that in a moderate growth sort of scenario, Lower 48 onshore, that Kimbell’s portfolio would keep pace, just directionally speaking?
Davis Ravnaas
Yes, Chris, this is Davis again. Yes, I would have to agree with that statement. Just looking at kind of our historical track record and what we’re seeing more recently particularly on the natural gas development front, I mean, Matt, yes, I think we’d have to conclude that we would at least match Lower 48, if not exceed it. I think what’s been surprising, I think, is just – and perhaps not surprising. I mean, I don’t think anybody really predicted that natural gas prices were going to increase so rapidly here in the not-too-distant past. And that’s just really highlighting the position we have in the Haynesville, right? And that was an acquisition that we made, we were fortunate to pull off that acquisition when natural gas prices were much lower, and there just wasn’t a whole lot of development on that asset over the last few years. But now with prices increasing dramatically, yes, Chris, I’d have to logically conclude that we would expect development activity to at least match, if not exceed, Lower 48 average.
Chris Baker
That’s great. And if I could just squeeze one more in. I’d be remiss if I didn’t kind of touch on it. The headlines yesterday, I guess the question for you guys, to the extent that you continue to see valuation sort of disconnected, certainly agree the stock looks like it’s trading well above peers on a cash flow yield basis, any consideration for a strategic review or some sort of strategic alternative process if you kind of continue to see shares trading at what looks like unreasonable levels?
Davis Ravnaas
I think that we have the ability to enhance value through buybacks. I think that – we’ve touched on that a number of times on this phone call. I think that would be kind of the first [indiscernible] to maximize value to kind of take control of our own destiny by buying back our own stock in what we feel is a very attractive valuation. But yes, always thinking about ways to maximize value, Chris, but don’t have any comments specifically on some of the reports for yesterday.
Chris Baker
Fair enough. Thank you, guys.
Operator
Thank you. Our next question comes from the line of Derrick Whitfield with Stifel. Please proceed with your question.
Derrick Whitfield
Thanks and good morning, all.
Bob Ravnaas
Good morning.
Davis Ravnaas
Good morning.
Derrick Whitfield
With my first question, I wanted to focus on your hedging strategy. In light of the higher commodity price environment and your improving the balance sheet, could you speak to your views on hedging at present? And if you’re – those views are evolving as the landscape evolving.
Davis Ravnaas
We have always felt that the most important thing about hedging is to have a consistent hedging policy. We are not in the business predicting oil and gas price movements. So we continue at the Board level to invoke a strategy where we effectively protect the debt or the leverage in our business relative to the overall enterprise. And so we will continue to hedge on a go-forward basis, our debt divided – the percentage of our production that’s reflected in debt divided by total enterprise value. We’re not an operating company. So we don’t have a CapEx program to protect, we don’t have operating expenses, etcetera. But what we do have is a modest amount of financial leverage. And so in our view, hedging some modest amount through these cycles just allows us to better protect all of the stakeholders in our business. Matt, anything you’d like to add? I wouldn’t say that we’re – because of the elevated prices, I wouldn’t say that we’re considering some sort of change in our hedging strategy. I think that’s entering to time those movements can be really tough. And when you start making inconsistent hedging decisions and start changing your strategy from quarter-to-quarter, it can obviously be less than ideal. So, Matt…
Matt Daly
Yes, yes. Based on the formula Davis said earlier, the debt enterprise value, the amount we’re hedging, we’re putting on, we just put on the Q2 ‘24 hedges. It’s in our press release. We hedged about 17% of our midpoint of 2022 production. So 17%, we got oil swaps at $82 a barrel. We’re not hedging too much, but hedging some at, we think, good prices. So I think the strategy has worked very well, especially proved softer in the pandemic, but we’ve never really gone much more than third of our production hedged. And right now, we’re laying on hedges are around 17% 2 years out.
Derrick Whitfield
Great. That makes sense. And as my follow-up, shifting over to Tiger Acquisition Corp. Could you help kind of size up the opportunities you’re seeing in the market at present to affect a direct drive operating strategy?
Davis Ravnaas
We continue to evaluate a number of opportunities. We feel very confident in Tiger and in our ability to be successful there. But no comments beyond that we can report.
Derrick Whitfield
Alright. Terrific, thanks for you time, guys. It’s very helpful.
Bob Ravnaas
Thank you.
Operator
Thank you. Our next question comes from the line of Cameron Lochridge with Stephens. Please proceed with your question.
Cameron Lochridge
Hi, good morning, guys. Thanks for taking my questions.
Bob Ravnaas
Hi, Cameron.
Davis Ravnaas
Hi, good morning.
Cameron Lochridge
I wanted to start going back to the topic of M&A. You mentioned, obviously, the bid-ask spread is not conducive to doing deals at this time. But just generally, if you can kind of maybe give us a sense for – I mean, you have a great footprint across the Lower 48. Any particular basins you’re particularly keen on at this point? Anything you’d share there would be helpful.
Davis Ravnaas
Bob, I’ll turn this over to you. Maybe I’ll make one or two comments. So Cameron, we’ve always been opportunistic on M&A. And what we really pride ourselves on doing is deploying capital in as efficient of a way as possible on behalf of our investors. So for example, over the last 5, 6 years, we didn’t really make a whole lot of acquisitions in the Delaware Basin, the phenomenal basin. But it’s been very pricey. I think development expectations or the reality of development pace just hasn’t matched, I think, when a lot of folks underwrote over the last, let’s call it, 6 years. So for us, we really are agnostic to basin. If we can make more money and deploy capital more efficiently buying something in the Haynesville or the Eagle Ford or the Bakken, we’re more than happy to do that, and we will do that over spending money in the Permian just because the Permian is the sexiest Basin. So that’s a consistent theme that we’ve had going on over the last 25 years of our business model. We’re also agnostic between oil and natural gas. Again, we don’t try to make – we don’t try to take a position on relative outperformance of one commodity relative to another. And we’re just very selective.
I mean, so the last year, we had one acquisition that we made that frankly has already turned out to be a home run with Cornerstone. We – I’d say, on average per year, we’ve done about one or two M&A events. So we just try to look at everything. We try to be very patient and conservative with what we bid. And we’re very rarely successful. But when we are, it tends to be a good outcome for everyone involved. So still very interested in M&A. I think that what’s particularly exciting for us though, just to kind of repeat this again, is we’re at a pretty exciting inflection point for the business in terms of there being a catalyst here with debt pay-down, whereby we’re going to have debt at a pretty de minimis level very soon. And at that point, frankly, we on a risk-adjusted basis, much better off buying back our own stock, assets that we’ve underwritten historically assets that we currently manage that we understand, that we like. So that’s going to be kind of the competition for external M&A is going to be getting better off just buying back our own stock. So that’s where we are. That’s where we continue to kind of evaluate. But Matt or Bob, anything you want to add in, Bob?
Bob Ravnaas
Yes. We’re really proud of our position, as you said, all over the Lower 48. We’ve always looked at total returns when we look at an acquisition. And our first acquisition was in the Permian Basin over 20 years ago. And so I obviously and our team are obviously very familiar with the Permian. When we aren’t able to get an acquisition because of being so pricing in the Permian, and we get it, I think sometimes people spend all their time looking at operating working interest companies and they say the Delaware and the Midland Basin are superior just because of the amount of oil in place per acre. And we get that, and I agree with that. But I think a lot of times, people forget about being a mineral company where you don’t have the CapEx to drill, all you’re doing is buying basically a sophisticated financial instrument that if you can buy another basin at a 20% return compared to a 10% return in the Permian, a lot of times, it makes sense. Now we do shy away obviously from – and I’ve heard people wonder about us. We do shy away from areas where there is no activity. We don’t want to be just a PDP deplete – look at a PDP depletion acquisition. There has to be activity in that basin. But if we can buy it at a very attractive return to our shareholders, we’re going to do it in a good basin that has a very long life.
Unfortunately, earlier in my career, we bought very attractive acquisitions, somewhat, in California. And there are some world-class oil reservoirs in California. And unfortunately, just because of the political climate there, we probably – in effect, we probably won’t entertain an acquisition there. The other area that we’ve kind of shied away from is the DJ Basin. And we get why some people get excited about the DJ Basin acquisition that has a lot of DUCs on the property, because you might have a short-term – a tremendous short-term pop over the 3 to 6 months after the acquisition. But in the DJ Basin, if you don’t have control over operations, which outpass DUCs and permits, as a royalty owner, you don’t. As you’re aware, it’s very significant declines. So we are also very cautious on doing any acquisitions there. But anyway, I think in summary, Matt, any other comments?
Matt Daly
No, I think you nailed it guys. Thanks.
Davis Ravnaas
I’ll add one more thing there, Cameron, beat this to that. I think one thing that’s a little bit different about us that might be surprising to folks that don’t follow our story as much we’d love to do a big acquisition in the Central Basin platform, a more mature basin that still has a really significant reserve life remaining that’s on an effectively flat trajectory? I mean, we will take that all day long. So I think we’re a little bit unique in the sense that we’re not only looking at unconventional assets. I think a lot of folks forget that there is a very significant percentage of Lower 48 production that is not horizontal in nature. And that market, in our opinion, attracts less competition and could be a really wonderful foundation and stable production base for a business like ours.
Cameron Lochridge
That’s very helpful. Thank you all for the color. I appreciate it. Maybe switching gears here to the financials. I thought you guys have a great chart in your slide deck showing the decline in cash G&A per BOE really going back to 2017. It does look like as of late been has started to pick up just modestly over the past few quarters. And I just wondered if you could comment on maybe some of the drivers there and where you think that ultimately settles down or settles out over the long run?
Davis Ravnaas
Great question. Matt, you want to take that one?
Matt Daly
Yes. So yes, the increase Q1 cash G&A per BOE was $3.39, Q2 was $3.61. The increase was almost entirely due to professional fees related to the proxy preparation and solicitation related to our extraordinary general meeting that we held back in June. It was our first annual meeting since our IPO. It involved a lot of new document drafting. So we don’t expect those costs the rest of the year. G&A, the cash G&A, should fall back down within the range that we gave for guidance, which is between $3.20 and $3.40.
Cameron Lochridge
Got it. Thanks, Matt. I appreciate that and thank you, all. I will turn it back.
Davis Ravnaas
Thank you very much.
Operator
Thank you. This does conclude our Q&A session for today. I’d like to turn the floor back over to management for closing comments.
Bob Ravnaas
We thank you all for joining us this morning, and look forward to speaking with you again when we report third quarter results. This completes today’s call. Thank you everyone.
Operator
Ladies and gentlemen, thank you for your participation. This does conclude today’s teleconference. You may disconnect your lines, and have a wonderful day.
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