VNOM - Viper Energy Partners: Good Growth And Fair Valuation Make This A Choice For Dividend Investors

2023-04-28 10:55:05 ET

Summary

• Viper Energy Partners LP's good positioning in the industry lends itself to high operating margins.
• A history of recent growth is likely to continue.
• The Viper Energy Partners base dividend giving a yield of 3.5% is safe, with variable additional returns being very likely.

Company Overview

Viper Energy Partners LP (VNOM) was formed by Diamondback Energy, Inc. (FANG) to own and acquire mineral and royalty interests in oil and natural gas properties primarily in the Permian Basin. The company's primary business objective is to provide an attractive return to unitholders by focusing on business results, generating robust free cash flow, reducing debt while protecting the balance sheet , and maintaining a best-in-class cost structure.

Initial assets for Viper Energy Partners consisted of mineral interests contributed by Diamondback Energy in oil and natural gas properties across West Texas in the Permian Basin, almost all of which are leased to working-interest owners who bear the costs of operation and development. The company currently has 26,315 net royalty acres located entirely in the Permian Basin and 44 rigs currently operating on Viper's acreage. The company estimates that less than 30% of the Permian assets have currently been developed.

Diamondback Energy, responsible for forming Viper Energy, is an independent oil and natural gas company headquartered in the heart of the Permian Basin in Midland, Texas. Diamondback's activities are primarily focused on the acquisition, development, exploration, and exploitation of unconventional, onshore oil and natural gas reserves across the Permian Basin.

Permian Basin Exposure

Viper Energy Partners' interests lie entirely in the Permian Basin, one of the oldest and most well-known oil and gas producing areas in the world. It is located primarily in West Texas, with parts also in Southeast New Mexico. Since the first well was drilled in 1920, over 30 billion barrels of crude have been recovered, with experts predicting at least 20 billion barrels are remaining. The Permian Basin covers an area approximately 250 miles wide and 300 miles long and is composed of more than 7,000 fields.

The company boasts West Texas Permian Basin proved reserves of 148.9 million barrels of oil equivalent and has a current liquidity of $366 million, an unmatched size and scale. Oil production for Viper Energy was up 9% year-over-year. In 2023, there are expected to be 477 gross horizontal wells in the process of active development, with an additional 501 gross horizontal wells with line-of-sight to future development. The average production guidance for 2023 for Viper is 20,000-22,000 barrels of oil per day. This kind of steady 8% - 9% year-over-year growth continues to show the company is dedicated to long-term organic growth.

Revenue

We can see that, over time, the company's strategy of expansion and continued drilling on their Permian Basic reserves has continued to generate increasing revenue for the company. Looking at their segment data, oil makes up the lion's share of their revenue but they also have small amounts of income from natural gas (around 27% of their total revenue).

Now they've certainly benefited from recent hikes in commodity pricing, so will likely see a decrease in revenue in FY 2023, but it should still remain increased from pre-covid levels. Current estimates have them making $710M in FY 2023, and $776M in FY 2024.

Valuation

VNOM's closest comp is probably PR (Permian Resources Corp) which focuses on the Permian Basin as well. VNOM is definitely coming in as a higher valuation than its comp, but compared to its historical levels it's at a great place.

Looking through PR's metrics, the reasons why are clear. PR has lower margins, higher leverage, and a worse dividend than VNOM. VNOM is objectively better in many categories, so its higher valuation from investors is clearly warranted.

Looking back to pre-covid VNOM had a much higher EV/Sales valuation, and it's steadily dropped since then, even while raising revenues. That makes me think it was probably overvalued previously, and now has reached a fair valuation.

Debt

VNOM carries some total debt at $576M as of their FY 2022 10-K, but with a paltry $21M in current liabilities. They're adept at keeping their current liabilities low, and keeping that debt very serviceable. Looking at their latest 10-K , I also find interest payments at $59M versus a reported EBIT of $680M, giving them a fantastic interest coverage ratio of 11.5x.

Looking at their utilization of the debt, they could be doing better. Their ROE coming in just fine at a current 20%, beating PR at 18%. Their ROA however coming in a bit lower. Overall PR's debt situation and serviceability is worse however.

Looking at their overall view with debt, they could probably be utilizing the leverage better but it's perfectly serviceable.

Dividend

VNOM doesn't pay only a typical base dividend, but they pay a base of $0.25 and an additional variable dividend based off of the profitability of the company. Their base of $0.25/share implies a 3.5% annual yield, and according to their latest investor presentation, represents approximately 50% of estimated cash for distribution given a price for WTI of $50/bbl.

Their committed return of capital however is 75% of cash available for distribution, which is represented in the difference between the base and variable dividends.

If we look at only the base distribution of $0.25 we can find a payout ratio of right about 50%, and not the 264% as reported in the charts. This number is very safe and sustainable, and I wouldn't be concerned about them being able to pay the current dividend at that 3.5% yield.

If you believe they'll continue to be profitable and continue growing, then it's likely to assume they'll continue to pay that additional variable dividend - but unfortunately we have no way of forecasting what those amounts will be beyond educated guesswork.

Industry Positioning

Viper Energy Partners is well-positioned for continued incremental growth and investors should be pleased with the direction of the company. Additionally, Diamondback Energy forecasts a 16% rise in oil production for 2023, boding well for shareholders of Viper Energy. With less than 30% of the total Permian asset having been developed, the company looks on track to make shareholders happy for years to come.

The undeveloped inventory on Viper's acreage supports durable free cash flow for the company. High cash margins, no capital requirements, and minimal operating costs drive continuous free cash flow and provide significant upside to increases in commodity prices. Continued global unrest and prolonged OPEC + supply cuts will likely continue to push crude prices higher, boding well for investors. Additionally, natural gas prices are expected to continue to double by the end of the year and continue to rise over the next 3 to 4 years, making Viper Energy just that much more attractive to investors.

Overall, VNOM should see steady and organic growth in the coming years. The company's relationship with the Primary Operator, Diamondback Energy, reduces uncertainty around the pace of development. Investors are insulated from inflationary cost pressures because there are zero capital requirements. Viper is uniquely positioned in the market by having a higher upside to commodity price increases. It is a substantial fact that they work primarily with working interest owners who bear the cost of operation and development. This means the only real exposure the company has is to a downturn in commodity prices. And with the state of the world we're living in and global market manipulation, oil and gas prices are almost sure to remain high.

Trading in the crude oil market is being dominated by short-term strategies right now while longer-term investors are waiting for more clarity around China and US recession. While there will certainly be artificial price corrections along the way, those with working knowledge of the oil and gas market would agree that prices should continue to push higher long-term for crude oil, natural gas, and LNG. At the very least, price floors for crude oil and natural gas are going to remain higher with the current state of global affairs.

Conclusion

The direction of growth in Viper Energy Partners LP as evidenced by their revenue stream is certainly a big positive, and as long as they can hit their estimates then investors should be pleased with that continued trajectory.

Their debt level is serviceable and completely manageable, despite perhaps not being the most well utilized when looking at their Return On Assets. Their valuation is one that suggests they're fairly valued at present, and a better overall value than PR which is their closest comp that this author could find.

Their dividends are variable, which has ups and downs. The upside is that we can see outsized returns (and likely will) above the base yield of 3.5% at the time of writing. The downside is that those returns are not as "set in stone" and we can't predict a yield with any sort of certainty beyond the base.

Potential Risks

The biggest risk here for VNOM is the price of oil collapsing. I think this is unlikely given the current state of geopolitical tensions, but it's there nonetheless. We saw prices collapse in COVID and a resurgence of it in China, for example, could cause significant downfalls in oil pricing. A strong US recession, which again I feel is unlikely, could cause the same situation. Thankfully VNOM has done the calculations for their base dividend with a WTI price of $50/bbl, so that's somewhat mitigated.

Buy Rating

Overall, I think investors should buy this stock with the confidence of a steady return and shareholders can continue to expect steady year-over-year growth as has been reported in recent years. But they should do their due diligence when calculating yield, and not use TTM numbers. Personally I'd use only the base dividend plus a small premium, perhaps arriving at 4% at this time. That way I'm likely to be pleasantly surprised.

About this article: When I research stocks I start with a "bird's eye view" of the target company. Many of the things I went through in this article are what I'll look at first.

When this bird's eye view is complete, I'll decide if I want to avoid the company for the time being or if it's a potential candidate for investment. This article that you are reading is the result of my bird's eye view examination. It is designed to be an overall high level view of the company that you can read to determine if this company is something that you might consider as a candidate for investment. You should not take my final conclusion on the company as your sole recommendation for investment, and you should conduct further in-depth research on your own to come to your final conclusions.

As a result of this, my "buy" recommendations come with an asterisk. And that asterisk is that this is only a high-level examination, and in-depth research that can take many hours, or days, of your time is still required. This is why my articles are short and to the point, with no fluff or filler. Just the facts that you need to know to move forward.

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