BSM - Black Stone Minerals: The 11% Yield Appears Sustainable In Current Environment

2023-08-02 11:10:39 ET

Summary

• Black Stone Minerals, L.P. has a $0.475 per unit quarterly distribution.
• Distribution coverage is projected at 1.1x at current strip for 2H 2023.
• Distribution coverage may fall slightly below 1.0x at current 2024 strip, partly due to weaker hedges.
• Black Stone has no long-term debt and $47 million in cash on hand, allowing it to cover minor shortfalls in distribution coverage.
• I expect Black Stone to maintain its distribution at $0.475 per unit for the foreseeable future in the current commodity pricing environment.

Black Stone Minerals, L.P. (BSM) is expecting slightly higher production levels in 2H 2023, including higher oil cuts. This should allow it to achieve 1.1x distribution coverage during the second half of the year at current strip prices.

Due to weaker hedges in 2024, there is a good chance that Black Stone's distribution coverage falls slightly below 1.0x in 2024 based on current strip prices ($77 WTI oil and $3.50 NYMEX gas).

However, I'd expect Black Stone to maintain its quarterly distribution at $0.475 per unit in that scenario since it has a good amount of positive working capital and no long-term debt.

I am maintaining my estimate of Black Stone's value at $18.50 to $19.00 per unit at long-term prices of $75 WTI oil and $3.75 NYMEX gas. This allows for a bit of capital gain potential for Black Stone's units, while it also can deliver an 11% yield at its current unit price.

Q2 2023 Production

Black Stone reported approximately 36,200 BOEPD (74% natural gas) in total production for Q2 2023, with 93% of that production being mineral and royalty production and 7% being working interest production.

This was an 8% decrease from the approximately 39,300 BOEPD (78% natural gas) in average production that it reported in Q1 2023. During that quarter, 94% of Black Stone's production was from its mineral and royalty interests.

Black Stone's production declined sequentially mainly due to lower Haynesville volumes as NYMEX natural gas prices only averaged a bit over $2 during Q2 2023, while the breakeven price for many Haynesville operators is estimated at around $3. This has resulted in a slowdown in development activity there, while Black Stone noted that it also had naturally declining production from several high-interest (and high initial production) Haynesville wells that went online in 2H 2022.

Due to the change in mix, the value (independent of commodity prices) of Black Stone's production only decreased by approximately 2% quarter-over-quarter despite total volumes decreasing by 8%.

Distribution

Black Stone maintained its quarterly distribution at $0.475 per unit. Despite lower commodity prices and lower total production volumes, Black Stone's distributable cash flow was nearly the same in Q2 2023 as its was in Q1 2023. Black Stone reported $0.496 per unit in distributable cash flow in Q1 2023 and $0.493 per unit in distributable cash flow in Q2 2023, resulting in distribution coverage of approximately 1.04x in both quarters.

Black Stone's increased oil production helped offset lower oil prices during the quarter, so its oil revenues were still up 1% quarter-over-quarter. Revenues for natural gas and NGLs were down 28% quarter-over-quarter due to the combination of lower prices and lower production volumes. However, Black Stone had hedges covering 56% of its natural gas production and 64% of its oil production in Q2 2023. Black Stone had a realized gain of $28.2 million from its hedge settlements in Q2 2023, compared to a $13.3 million realized gain in Q1 2023.

2023 Outlook At Current Strip

Black Stone continues to expect to average 37,000 to 39,000 BOEPD in production for 2023. It expects slightly more gas in its full-year production though, and has thus increased its guidance around the natural gas percentage from 72% to 74%.

To get to the midpoint of Black Stone's full-year guidance, it would need to average approximately 38,300 BOEPD (72% natural gas) in production during the second half of the year. Production during 2H 2023 would be 2% higher than the first half, with oil making up 28% of total production (compared to 24% in 1H 2023).

Black Stone believes that volumes coming online from various Permian wells (along with recent high-interest Bakken wells) will help drive the increased oil percentage in the second half of the year.

Based on the current strip for the second half of 2023, Black Stone is projected to generate $288 million in revenues after hedges. Black Stone's 2H 2023 hedges have approximately $38 million in value at current strip.

Black Stone is thus projected to generate $220 million in distributable cash flow in 2H 2023, or $1.05 per unit.

This would be 1.1x distribution coverage if Black Stone maintains its quarterly distribution at $0.475 per unit. The increased distribution coverage is driven by the expectation of higher production volumes and oil cuts during the second half of the year.

One thing to note is that Black Stone's preferred units currently have a 7% annual distribution rate. This will be repriced in November 2023 based on the 10-year Treasury Rate + 5.5%, which would be approximately 9.5% at this time. That would add $7.5 million per year to Black Stone's preferred distributions.

Potential 2024 Outlook And Valuation

I have taken a look at Black Stone's potential 2024 results if its production averages 38,300 BOEPD (72% natural gas), which is similar to 2H 2023 expectations.

At current 2024 strip of approximately $77 WTI oil and $3.50 Henry Hub gas, Black Stone would be projected to generate $510 million in revenues after hedges.

Black Stone's 2024 hedges are at a lower price than its 2023 hedges. Black Stone's 2023 hedges were mostly at $80.80 oil and $5.15 gas. The 2024 hedges are at $68.98 oil and $3.57 gas.

The weaker hedges and increased preferred distributions result in Black Stone's distributable cash flow ending up at $1.78 per unit for 2024 if it averages 38,300 BOEPD production at current strip. This results in 0.94x distribution coverage.

At current 2024 strip and a 5% increase in production (to approximately 40,200 BOEPD with 72% natural gas), Black Stone's distribution coverage would end up at around 0.99x with a $0.475 per unit quarterly distribution.

Black Stone's 2024 hedges have a negative 0.03x impact on distribution coverage, so without its hedges distribution coverage would be 0.97x and 1.02x in the two scenarios mentioned above.

I believe that Black Stone is likely going to maintain its quarterly distribution at $0.475 per unit in the current environment.

I continue to value Black Stone at $18.50 to $19.00 per unit based on my long-term commodity prices of $75 WTI oil and $3.75 NYMEX gas.

At its current $17.35 unit price, Black Stone currently offers an 11% yield, and that distribution appears to be sustainable, albeit with distribution coverage hovering around 1.0x at strip.

Conclusion

Black Stone Minerals should see improved distributable cash flow in 2H 2023, due to increased production expectations (particularly for oil). However, its hedges for 2024 are noticeably worse than its 2023 hedges, so it may end up with 2024 distribution coverage slightly under 1.0x at current strip.

I expect Black Stone to maintain its quarterly distribution at $0.475 per unit, as its distribution coverage should be very close to 1.0x during the next year and a half at current strip and 38,300 BOEPD in average production.

This would give it a roughly 11% yield at its current unit price, along with the potential for a modest amount of capital appreciation.

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