STR - Sitio Royalties: New Notes Reduce Interest Costs By Around $15 Million Per Year

2023-10-23 10:59:55 ET

Summary

• Sitio's new 7.875% unsecured notes due November 2028 have a lower interest rate than its other debt.
• Sitio's variable interest rate notes due September 2026 have an effective interest rate of over 11%.
• Sitio's interest costs should be reduced by around $15 million per year.
• Sitio's free cash flow in 2024 should exceed $3 per share at current strip.

Sitio Royalties ( STR ) recently completed a $600 million offering of 7.875% unsecured notes due November 2028. The proceeds from these notes will help it repay its variable rate (currently over 11%) unsecured notes due September 2026 as well as some of its credit facility borrowings.

These moves help Sitio by saving it around $15 million per year in interest costs along with extending its nearest note maturity by a couple years.

I now estimate Sitio's value at approximately $28 per share with long-term (after 2024) $75 WTI oil and $3.75 Henry Hub natural gas. Sitio's projected free cash flow has improved compared to August due to higher commodity prices and the reduced interest costs from its new notes.

Significant Permian Basin Exposure

Sitio has a large amount of exposure to the Permian Basin. It mentioned that it has exposure to nearly 40% of all wells drilled in the Permian, while wells in which it owns an interest in produced 36% of Permian production volumes in Q1 2023.

Sitio's average NRI for horizontal wells is 1.1% in the Delaware Basin and 0.5% in the Midland Basin.

New Notes And Refinancing

Sitio recently issued $600 million in 7.875% unsecured notes due November 2028. It is using the net proceeds from the note offering to repay its variable rate unsecured notes due September 2026 and part of its credit facility debt. Sitio had $416 million in variable rate unsecured notes due 2026 outstanding at the end of Q2 2023.

I view this as a positive move given that Sitio's variable rate notes have quite a high interest rate currently (estimated at 11.2%). As well, Sitio's credit facility had an 8.2% interest rate at the end of Q2 2023. Thus the note refinancing should reduce Sitio's interest costs going forward. I estimate that Sitio's annual interest costs will be reduced by approximately $15 million by these moves.

Potential 2024 Outlook

The current strip for 2024 is now around $82 WTI oil and $3.40 Henry Hub gas. At those commodity prices, I expect Sitio to generate $671 million in revenues after hedges. This is based on my expectations for Sitio to end up with 36,500 BOEPD (50% oil) in production during 2024.

Sitio's hedges have around $3 million in positive value based on strip prices. It has 3,300 barrels per day in WTI swaps at $82.66 per barrel, as well as 11,400 MMBtu per day in natural gas collars with a floor of $4.

Sitio's cash interest is now projected at $75 million for 2024 after its new notes have lowered its interest costs. Sitio may end up with $25 million in cash income taxes if its 2024 tax rate ends up at 12% of pre-tax net income.

Sitio is now projected to generate $481 million ($3.06 per share) in free cash flow during 2024. This would allow for a $1.99 per share in total dividends related to 2024 at a 65% payout ratio, which is very close to $0.50 per share per quarter.

Notes On Debt And Valuation

Sitio still has a significant amount of debt, as it is projected to end 2024 with over $800 million in net debt with a 65% payout ratio. I can envision Sitio increasing its payout ratio later though, with its credit facility debt potentially being reduced below $100 million in 2025, and its new unsecured notes not being due until late 2028.

An increased payout ratio will likely depend on whether Sitio makes more acquisitions (utilizing debt) in the next year and a bit. If it doesn't increase its leverage from new acquisitions, I can see its payout ratio increasing to around 75% or 80% in 2025.

I now estimate Sitio's value at $28 per share at my long-term (after 2024) commodity price estimates of $75 WTI oil and $3.75 Henry Hub gas. Sitio's reduced interest costs help increase its pre-tax free cash flow per share by nearly 10 cents per year. This also assumes low-$80s WTI oil in 2024, which would help Sitio deleverage a bit, while also paying out nearly $0.50 per share in quarterly dividends.

Conclusion

Sitio is saving itself approximately $15 million per year in interest costs by refinancing its variable rate notes, which have a current interest rate of above 11%. Sitio's new unsecured notes due November 2028 have a 7.875% interest rate, which is decent in the current environment.

At current 2024 strip prices, Sitio may be able to put $168 million towards debt reduction with a 65% payout ratio, while also paying out very close to $0.50 per share in quarterly dividends.

Sitio's lowered interest costs and strong near-term free cash flow expectations results in its estimated value reaching around $28 per share at my long-term (after 2024) expectations for $75 WTI oil and $3.75 NYMEX gas.

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