Sitio Royalties Corp. (NYSE:STR) Q2 2022 Earnings Conference Call August 9, 2022 8:30 AM ET
Company Participants
Ross Wong – Senior Director of Corporate Finance & Investor Relations
Chris Conoscenti – Chief Executive Officer
Conference Call Participants
Jeanine Wai – Barclays
Derrick Whitfield – Stifel
Operator
Good morning. My name is Samantha and I will be your conference operator today. At this time, I would like to welcome everyone to the Sitio Royalties Second Quarter 2022 Earnings Conference Call. [Operator Instructions]
I will now turn the call over to Ross Wong, Senior Director of Corporate Finance and Investor Relations. Ross, you may begin your conference.
Ross Wong
Thanks, operator and good morning, everyone. Welcome to Sitio Royalties second quarter 2022 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.sitio.com where you will find them in our Investor Relations section. With me today to discuss second quarter 2022 financial and operating results is Chris Conoscenti, our Chief Executive Officer; and Carrie Osicka, 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. These statements may include but are not limited to, estimates of future volumes, operating expenses and other financial metrics. They may also include statements concerning anticipated cash flow, liquidity, business strategy and other plans and objectives for the company. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can provide no assurance that such expectations will prove to be correct. Please see our Form 10-Q which was filed with the SEC on August 8, 2022, the company’s proxy statement on Schedule 14A filed with the SEC on May 5, 2022, our annual report on Form 10-K for the fiscal year ended December 31, 2021, as well as other SEC filings for a list of factors that could cause actual results to differ materially from expected results. Please also note it on this call, we may use the terms EBITDA, adjusted EBITDA, discretionary cash flow and cash G&A. These are financial measures that are not presented in accordance with U.S., Generally Accepted Accounting Principles. Sitio believes such non-GAAP measures are useful for investors, they are not measures of financial performance under GAAP and should not be considered in isolation or as an alternative to any measure of such performance derived in accordance with GAAP. These non-GAAP measures have limitations with analytical tools and you should not consider them in isolation or a substitute for analysis of results which reported under GAAP. These non-GAAP measures may not be comparable to similarly titled measures used by other companies in our industry or across different industries. These are non-GAAP financial measures and we have provided reconciliations the most directly comparable GAAP measures in our most recent earnings release.
And with that, I’ll turn the call over to Chris.
Chris Conoscenti
Thanks, Ross. Good morning, everyone and thank you for joining Sitio’s inaugural quarterly earnings call. Overall, second quarter 2022 financial and operational results exceeded our internal expectations and we made significant progress on execution of our large-scale minerals consolidation strategy with the completion of the reverse merger with Falcon Minerals on June 7, the signing and closing of the Foundation Minerals acquisition in late June and the announcement of the Momentum Minerals acquisition which closed in late July. In aggregate, all transactions resulted in the acquisition of more than 68,000 net royalty acres and increased our total NRAs by approximately 65% to more than 173,000.
Completing the Foundation and Momentum acquisitions further weighted our asset portfolio towards the Permian Basin which comprises approximately 80% of our NRAs. In June, we also changed the name of our company from Desert Peak Minerals to Sitio Royalties and listed our Class A common stock on the New York Stock Exchange which trades under the stock ticker STR. Since there were several large transactions that occurred during the quarter, I want to explain our second quarter 2022 financial reporting methodology, so there is a clear understanding of the metrics we’ll be referring to later on the call.
Our reported second quarter 2022 financials include a full quarter contribution from legacy Desert Peak Minerals’ assets in the Permian Basin and contributions from the acquired assets based on transaction closing dates which include 24 days from legacy stuff and Minerals assets in 7 days from legacy Foundation Minerals assets.
In our reported financials, there is no contribution from the assets acquired from Momentum Minerals since that transaction closed subsequent to the second quarter. In January 2022, when the reverse merger with Falcon Minerals was publicly announced, we issued first half 2022 financial and operational guidance for the combined company. Therefore, for comparability to the first half 2022 guidance, I will sometimes refer to pro forma combined second quarter 2022. This refers to metrics as its legacy Desert Peak Minerals and legacy Falcon Minerals assets have been combined for the entire quarter.
Now, let’s briefly review our pro forma combined first half 2022 results relative to the combined company guidance that was provided in January 2022. In summary, we met or exceeded all production-related guidance metrics, including average daily production on a BOE basis, average daily oil production in barrels, percent oil production and percent production from the Permian Basin.
Second quarter 2022 pro forma combined production was 15,149 BOE’s per day which exceeded expectations and was primarily driven by the timing and performance of wells turned in line on our Permian assets. This continued strong production output in the second quarter resulted in first half 2022 pro forma combined production of 15,317 BOE’s per day which is 9.4% above the midpoint of our first half 2022 guidance range and 5.6% above the high end of that range.
Pro forma combined first half 2022 oil production of 50.4% was on the lower end of our 50% to 53% guidance range. However, looking at percent oil production alone is a bit misleading because pro forma combined first half 2022 oil volumes of 7,720 barrels per day exceeded the high end of the implied guidance range for barrels of oil production which was 7,685 barrels per day. Furthermore, approximately 75% of pro forma combined first half 2022 production volumes came from the Permian assets which exceeded guidance by nearly 2%.
Second quarter cash G&A of $3.7 million which excludes share-based compensation and onetime transaction costs, was slightly below the midpoint of our full year 2022 quarterly run rate of $3.9 million that was disclosed in our most recent guidance issued on June 27.
Now, turning to second quarter actual reported results. Production volumes were 12,402 BOE’s per day. Adjusted EBITDA was $76.7 million and discretionary cash flow was $75.5 million, all record highs for Sitio which were driven primarily by a 20% increase in quarter-over-quarter realized pricing, inclusive of hedging impact to $76.28 per BOE and the integration of assets from Falcon and Foundation during the quarter.
Consistent with our publicly disclosed capital allocation framework, the Board utilized a 65% payout ratio to determine the dividend per share declared for the second quarter. However, instead of applying the payout ratio to reported second quarter discretionary cash flow which would have resulted in a $0.58 per share dividend, the Board approved a second quarter dividend of $0.71 per share based on $91.4 million of pro forma discretionary cash flow which is inclusive of Falcon Minerals cash flow for the entire quarter and excludes transaction fees related to the reverse merger.
We believe that the dividend of $0.71 per share for the second quarter returns, the intended amount of capital to shareholders and does not penalize investors for the closing timing of the Falcon Minerals merger. We are particularly pleased that the dividend came in only $0.01 lower for the combined enterprise as compared to Falcon’s first quarter split-adjusted dividend while we moved from Falcon’s historical 100% payout framework to our 65% dividend payout methodology.
For the second half of 2022, we are reiterating our average daily production range of 18,000 to 19,000 BOE’s per day and slightly lowering the ranges for gathering and transportation per BOE and cash taxes after reviewing completed second quarter results.
On assets currently owned and as of the end of the second quarter, there were 26.8 net line-of-sight wells versus only 58 net wells that have been turned in line since the beginning of 2019, implying strong visible growth which gives us confidence in this production range. As I touched on briefly earlier, we had a very active quarter on the mergers and acquisitions front and continue to execute on our large-scale Permian-weighted consolidation strategy. Including the Momentum acquisition which closed in July, we have completed 5 transactions of at least 10,000 NRAs since June of 2021. Since the beginning of 2019, we’ve grown our NRA position by more than 365% which is over 4.5x that of our nearest public peer. Additionally, I’d like to remind you that the Foundation acquisition was effective April 1 and the Momentum acquisition was effective on March 1.
Through the end of July, we had received approximately $15 million in the form of post-effective date of pre-closing cash receipts from these assets. Given the effective date and the time required to collect cash on royalties owed to us, we expect to receive more post-effective date by preclosing date cash receipts over the coming months which will be utilized to accelerate debt repayment. In addition to having no lease operating expenses and 100% of our capital expenditures being discretionary, one of the key differences between our business model versus a traditional E&P operator is how scalable our cost structure is.
Our cash margin per BOE improves with each acquisition since we don’t operate assets and don’t need to grow headcount linearly as we increase our mineral and royalty cash flow. For context, in 2020, our cash G&A per BOE was $4.45 and we had 24 employees in less than 50,000 NRA. This metric falls to $2.31 per BOE at the midpoint of our second half guidance. This represents a decrease of $2.14 per BOE or 48% since 2020 and we are now approaching $2 per boe.
That concludes my prepared remarks. I’d like to open up the call for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Jeanine Wai with Barclays.
Jeanine Wai
Our first question maybe just on leverage and A&D. Post the Foundation and Momentum deal leverage is about 1.5x and your target is to improve that to 1x. You put hedges in place for protection. We forecast really strong free cash flow or cash flow. Can you talk about how your current leverage impacts Sitio on the A&D front, specifically in terms of timing, size and structure of future deals?
Chris Conoscenti
So our focus on acquisitions is still on large-scale consolidation. I would say that near term, our focus is going to be more weighted towards deleveraging and getting back below 1x leverage. So I think you should expect us to look at transactions or prioritize transactions that have a stock component that would allow us to continue deleveraging, bringing assets and cash flow into the enterprise but not adding to that leverage.
Jeanine Wai
And then maybe addressing the elephant in the room on your appetite for the larger scale accretive acquisitions. Given the Minerals business model versus, say, the upstream operator model, how are you currently thinking about Sitio scale in terms of your ability to compete versus peers in both deals and how you compete for investor dollars. Do you see a meaningful advantage in Sitio getting larger? Or do you currently think that you’re competitive as is?
Chris Conoscenti
So, I think the scale that we have today allows us to compete for larger transactions. But the question is, do we have the scale and relevancy for public investors as they look at their investment alternatives across the energy landscape. And so I think that’s one area where we can continue to improve. And that’s really the purpose of our large-scale consolidation strategy is building something that’s truly investable and competitive across all acquisitions. So that’s why we focus on the large-scale acquisitions. That’s why we look for ways to grow the enterprise and add more cash flow to the business.
Operator
[Indiscernible] comes from line of Derrick Whitfield with Stifel.
Derrick Whitfield
With my first question, I wanted to focus on your growth trajectory during the second half based on your Q2 results, line-of-site inventory and other transaction closures, how do you see the trajectory of volumes during Q3 and Q4?
Chris Conoscenti
So we don’t have specific individual quarterly guidance. But what I can tell you is you’re going to see a ramp just because the Momentum transaction closed in late July. So you’re going to see — you won’t see a full quarter contribution from Momentum until the fourth quarter. So you’ll see a bit of a ramp just from that. And then when you look at our line-of-sight inventory where we have roughly 27 net normalized line-of-sight wells, that gives us visibility into organic growth on the asset today. So we do see the organic growth continue through the back half of the year.
Derrick Whitfield
And more broadly, just on cycle times. How are you guys thinking about DUC conversions in an environment where operators are continuing to add rigs but we’re not seeing a commensurate increase in frac spreads.
Chris Conoscenti
Well, we have seen, just like everybody else has, the decrease in the DUC inventory. But when we look at pace of development. So for us, the metric that we follow most closely is wells per DSU per year and that’s the number of wells that are turned on line on our assets. To us, that’s the most important metric. It’s not rigs because you can have different net interest than any given well. But when we look at net wells turn in line per year per unit, that metric is continuing to trend up and is becoming competitive with 2019 levels.
Operator
[Operator Instructions] And there are no other questions in queue at this time. And this concludes the Q&A portion for today’s call. Ladies and gentlemen, you may now disconnect.
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