Q4 2023 Sitio Royalties Corp Earnings Call

Participants

Ross Wong; Vice President of Finance and Investor Relations; Sitio Royalties Corp

Christopher Conoscenti; Chief Executive Officer; Sitio Royalties Corp

Dax McDavid; Executive Vice President of Corporate Development; Sitio Royalties Corp

Carrie Osicka; Chief Financial Officer; Sitio Royalties Corp

Tim Rezvan; Analyst; KeyBanc Capital Markets Inc.

Neal Dingmann; Analyst; Truist Securities

Derrick Whitfield; Analyst; Stifel Nicolaus and Company, Incorporated

Noel Parks; Analyst; Tuohy Brothers Investment

Presentation

Operator

Hhello, everyone, and welcome to the CTA royalties.Key for 2023 earnings call. My name is chat, and I'll be the coordinator for this call today. After the presentation, there will be a Q&A session where you'll have the opportunity to ask questions by pressing star, followed by one on your telephone keypad. If you change your mind, please press star followed by two. I'd now like to hand over to Russ Wong, Vice President of Finance and Investor Relations to begin. Thus, please go ahead.

Ross Wong

Good morning, everyone. Welcome to the Federal Realty's Fourth Quarter and Full Year 2023 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.SEDAR.com, or you will find them at our Investor Relations section.
With me today to discuss fourth quarter and full year 2023 financial and operating results as Christmas on a Sunday, our Chief Executive Officer, carrier speaker, our Chief Financial Officer, and Dr. David <unk>, our EVP of Corporate Development 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 and non-GAAP measures.
Please refer to our earnings press release, investor presentation and publicly filed documents for additional information regarding such forward-looking statements.
And non-GAAP measures. And with that, I'll turn the call over to Chris.

Christopher Conoscenti

Thanks, Ross. Good morning, everyone, and thank you for joining Citi's Fourth Quarter and Full Year 2023 earnings call before discussing fourth quarter results, I want to provide an update on our return of capital framework, which going forward will include dividends and the ability to layer in share repurchases, and I would like to share some exciting news regarding our first acquisition of 2024.
Regarding repurchases, our Board has authorized a $200 million share buyback program which provides an additional avenue to maximize long-term value for our shareholders. We remain confident in the outlook for our business and believe there is a compelling opportunity to repurchase our shares given this outlook under this updated framework, which is effective immediately and applies starting with the first quarter of 2024, we still plan to return at least 65% of discretionary cash flow to our shareholders and to retain up to 35% of discretionary cash flow for balance sheet management and opportunistic cash acquisition. However, instead of allocating the full 65% of discretionary cash flow exclusively to cash dividends. Like we've done historically, we intend to pay a minimum dividend equal to 35% of discretionary cash flow and allocate at least 30% of discretionary cash flow to additional cash dividends, share repurchases or a mix of both committing to a minimum dividend equal to 35% of discretionary cash flow provides our shareholders with the certainty of a minimum cash dividend that has a compelling size while avoiding the pitfalls of setting a minimum dollar amount of dividends. History has shown that fixed minimum dividends expressed in a set dollar amount for a cyclical commodity-exposed business turned out to be variable in a commodity price downcycle when companies inevitably cut their so-called fixed dividend. This introduces the risk of the Company buying back more stock when it has more discretionary cash flow above the fixed dollar dividend, which is when commodity prices and stock prices are high. Our strategy is designed to avoid having to cut a minimum dollar amount of dividends during cyclical downturns and to avoid the pro-cyclical and potentially value destructive behavior of allocating additional capital to repurchases during a cyclical upturn. If our new return of capital framework had been applied to the fourth quarter of 2023, our minimum dividend would have been $0.27 per share, which implies an approximate 5% dividend yield. This would have been roughly 300 basis points higher than the dividend yield for E&P companies and approximately 350 basis points higher than the S&P 500 yield over the last 12 months.
Turning to the acquisition, I mentioned earlier in January we signed a definitive agreement to acquire over 13,000 net royalty acres in the DJ Basin for$150 million, which enhances our overall dj footprint and exposure to areas with higher levels of activity relative to our legacy assets in the area. As with most of our acquisitions, this deal originated through a relationship with a seller we've known for a while seller did an outstanding job of piecing together a differentiated asset base concentrated in the best parts of the DJ Basin. This transaction highlights our proactive approach to portfolio management and prudent capital allocation by selling smaller scale, declining assets in Appalachia and in the Anadarko Basin, it had nearly six times next 12 months cash flow multiple and acquiring higher growth. Dj Basin assets at a four times next 12 months cash flow multiple. We continue to focus on optimizing capital allocation and generating strong shareholder returns.
I'd now like to turn the call over to Doug Schmick David, our EVP of Corporate Development, to discuss the highlights of the DJ Basin acquisition and provide an update on other acquisition activities.

Dax McDavid

Thanks, Chris, and good morning, everyone. We're thrilled to kick off 2024 with a compelling acquisition, which we hope is a sign of a more transactable middle market. This deal is highly accretive on both a near-term cash flow and NAB basis and checks all the boxes for what we look for in an attractive acquisition. The acreage has terrific geology, competitive, well economics and is under well-capitalized operators with great line of sight for future development. The primary operators are Chevron, Oxy, and so the talk through in aggregate were responsible for more than 95% of the production on these assets in 2023. In the fourth quarter, these assets produced approximately 2,600 BOE a day with 41% oil and generated $8.6 million of asset-level cash flow. As Chris mentioned earlier, this acquisition has a more growth oriented production profile relative to our recently divested assets from December 2022 to December 2023. Monthly production on these assets grew by 89%, a stark contrast to the approximate 7% decline over the same period of these assets we divested in December 2023. At year end, there were approximately 5.1 net line-of-sight wells and 9.6 net remaining locations, 73% of which were in the Greater Wattenberg field, providing visibility and running room for future development. We were able to underwrite future DJ Basin activity with more certainty relative to other areas in the United States because the comprehensive area plans, forecasts and oil and gas development plans, or LGDP.s, which are filed with the Colorado energy and carbon management commission and must be approved before development can take place.
The DJ Basin acquisition acreage has exposure to several multi-year caps and AGPs, which contain 26% of remaining inventories and represent a total of approximately 27 hundred arrays and 2.5 net remaining locations as of December 31st. These Castaños GDPs don't guarantee operate activity, but administratively, it is challenging for operators to deviate from these plans once they are approved.
As you can see on slide 9 in our earnings presentation for DJ Basin acquisition acreage is in the core of the play and expands our DJ Basin and arrays by 52% from approximately 25,000 arrays to over 38,000 on arrays. On a pro forma combined basis, our assets cover approximately 810,000 gross acres for 49% of the entire DJ Basin and 57% of the greater Wattenberg Field, which contains the best rock and is under the most active operators in the basin. These assets are prospective for the Niobrara and Codell, both of which are being co-developed across most of the acreage. Recent public commentary from Chevron, Oxy and so the talk regarding the DJ Basin has been quite positive, indicating that our assets are highly economic. They have also emphasize commitments to deploy capital and grow production in 2024 and beyond. With caps and GDPs, Chevron has underscored their dedication to the DJ Basin comedy that their acreage has high cash flow margin, low breakeven barrels and have permits that extend through into late 2029. Obviously, recently recently highlighted several positive aspects about the DJ Basin assets as well, including a 32% improvement in well productivity from 2022 to 2023 and 11% implied annual production growth for the Rockies and other segment based on the midpoint of our 2024 guidance. So the past recently disclosed with our 2024 DJ Basin development plan is focused on the highly prolific Watkins area or region that contains Box Elder. One of the larger caps on the DJ Basin acquisition acreage silicon highlighted much improved productivity in the walk-ins area in 2023 relative to 2022, resulting in a 10% higher EURs and 40% higher returns as of February 19, 75% of the rigs running the entire DJ Basin or on our pro forma position, an increase of three times relative to the rates on City as legacy assets. The rates on our pro forma acreage are exposed to 100% of CDX Oxy and Merdad total rig activity in the basin. In addition to the DJ Basin acquisition, we acquired over 500 Permian Basin generated from New Mexico in exchange for Class C shares of our stock in December. This transaction was with one of our long-standing relationships and as someone from whom we've acquired assets in the past, our consolidation strategy continues to be focused on executing relationship-driven deals versus broad auction processes, which we believe differentiates video from many of our peers.
I'll now turn the call over to Carrie Osaka, our CFO, to discuss fourth quarter 2020 results.

Carrie Osicka

Thank you that our assets continue to perform consistently with production from our royalty interests, producing an average of 35,776 BOE a day in the fourth quarter and 36,338 BOE a day for the second half of 2023, which is just above the midpoint of our second half 2023 guidance range. Our reported results included 82 days of contribution from our Appalachia and Anadarko assets. Because the divestiture closed on December 22nd, reported fourth quarter production was 47% oil. However, when excluding prior period adjustments, fourth quarter production was 49% oil. On a pro forma basis, our fourth quarter production was 36,623 BOE a day, including a full quarter of production from the DJ Basin in December, Permian acquisitions and excluding the production from the divested assets, horizontal rig count in the Permian Basin in the overall U.S. during the fourth quarter was down by 4.2% and 3.8% respectively. We estimate that 7.7 net wells for turn-in-line on our acreage during the fourth quarter, down from the estimated 9.5 net wells turned in mind during the third quarter. We ended the year with an all-time Company high of 53.4 pro forma net line-of-sight wells, including approximately 5.1 net wells from the DJ Basin acquisition number of net spuds as a percent of total net line-of-sight wells shifted from 59% at the end third quarter, 64% at year end, which is usually an indicator of increased near-term activity. We reported pro forma fourth quarter discretionary cash flow of $124 million, which included $8.7 million of incremental post October first, effective date, cash flows from the DJ Basin and Permian acquisitions and benefited from a 21% increase in interest expense versus the third quarter in 2023, our Board declared a fourth quarter cash dividend of $0.51 per share of Class A. common stock based on 65% payout ratio of pro forma DCF, which included an uplift of approximately $0.04 per share from DJ Basin acquisition and Permian acquisition cash flow in the fourth quarter. Similar to the dividend calculation for the fourth quarter of 2023, we expect to include post effective date cash flow from the DJ Basin acquisition in our calculation of first quarter 2024DCF, we ended 2023 with an $850 million borrowing base revolver and liquidity of $588 million. As a result of the enhancements to our capital structure made during 2023. We have better access to capital and are much better positioned to finance acquisitions going forward.
Included in yesterday's earnings press release, we released our full year 2024 guidance. Our 2024 outlook is underpinned by the record number of line-of-sight wells on our properties contribution from the DJ Basin acquisition properties and the cap in OGDC. that the expansion and some higher interest wells are in process of being completed, we're off to a fantastic start to the year with the announced highly accretive DJ Basin acquisition, and I'm optimistic about improving trends in the minerals M&A market for 2024. That concludes our prepared remarks. Operator, please open up the call for.

Question and Answer Session

Operator

Yes. Thank you, Carrie. If you'd like to ask a question, please press star followed by one on your telephone keypad. Now if you change your mind, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted.
Likely. Our first question today comes from Tim was then from KeyBanc Capital Markets. Please go ahead.

Tim Rezvan

The motor folks who are beyond that. So the question I had my first question, I want to ask with the DJ Basin acquisition. When you look at things outside the Permian, is there a higher hurdle rate on given sort of less industry activity? It was just a simple sort of arbitrage, you saw being able to buy it at four times cash flow,

Dax McDavid

Fiserv, which backs on? No, there's not a we underwrite to the returns and we're able to bundle 10 fleets underwrite a lot of it all in all the basins out there and there's not. So we feel good about that, that we we do see an increase actually from the operators I mentioned earlier. And in the DJ Basin, we see an increase in activity and we do see them dedicate capital to that basin. And we'll see that Basin continue with returns. Our intentions are basins that they are at a cheap drilling.

Tim Rezvan

Okay. Okay. I understand. I guess visibility of activities was what matters affect. Thank you. And if I could pivot. I don't know if this is more for Chris as a Board member or for Carrie. I'm curious with this pretty significant change in cash returns framework. But if you could talk about, you know, engagement with shareholders in the last few months as you came to this decision, the more did you do you think shareholders kind of wanted this? Or is this more an idea of the board feeling compelled to step in with shares where they were going to support the equity. I'm just curious kind of what what eventually got the board to agree to make this change?

Christopher Conoscenti

Hey, good morning. And Chris. I would say that's not a a freight refined makes us because we think the stock is cheap. It's really fundamentally underpinned by our outlook for the business going forward. We did engage with several shareholders every time we make a short of asking questions about the capital return framework. So this was an ongoing dialogue with shareholders and at the Board level going on for months and incorporate a lot of thought multiphysics. We're excited about it because when we look at the way the business is coming together this year. I'm curious, as you look at activity out of the castles OG is in the DJ, you look at our record level of 1.8 wells overall and in a recovering trend in activity in the Permian in the fourth quarter, particularly in October onwards, that give us a lot of comfort going into 2024 the thing that we like about 2024 to unlike 0.3, we're seeing some fundamental shift in the acquisition market. And you can see that evidenced by the acquisition we announced this morning. So we're hopeful that there will be more of those this year as well.

Tim Rezvan

Okay. Okay. Appreciate that color. If I could sneak one last one in is maybe more for Carrie as we sort of bake this last acquisition in the model, you see net debt in a little shy of $1 billion leverage still kind of north of one. And given the successful refinancing of your debt, what are your updated thoughts on target debt target leverage? And how do you think about that 55% payout and maybe closing the gap with public peers that pay a higher rate? Thank you.

Carrie Osicka

Sure. Hi, Tim. This is Gary. We continue to target low leverage. You're right, we're sitting at above a little bit above 1 times leverage, but we target that low leverage to preserve our financial flexibility and our ability to be opportunistic on cash acquisitions and after cash acquisitions we're going to continue to pay down that prepayable debt to maintain that flexibility.
As far as the 65% payout goes on, I'll let Chris speak a little bit more about this, but we don't intend to change that that payout, right.
This second other than the way our capital return is going to work. We're going to continue to pay down that debt and keep that opportunistic flexibility on the debt?

Dax McDavid

It's Brett. I'll just add that I'll leave it to our peers to comment on their payout philosophies for us. We just felt at our company size is appropriate to have the non-cash, retain that we do to manage the balance sheet through Sitel and protect the company instead of other companies going to make your own decisions. But at our size, we feel that 65% is an appropriate amount of cash flow to return to shareholders as we grow that number may grow but we're still far too small. We call that mine right now.

Tim Rezvan

Okay. And then do you have a leverage target is at 0.75? You just want to be sustainably under one times trying to think about what a steady state at a level would be?

Dax McDavid

Yes.

Carrie Osicka

I mean, we're going to remain there.

Dax McDavid

As Mark said, there's right, and we want to have low investment. So we can be opportunistic when opportunities present themselves. And so it's not a big number, and that's really just an album. We'll take on a little bit of leverage on the balance sheet and the revolver for cash position, and then we'll pay it down after those acquisitions and we'll go to back up and pay down debt and repeat as you can appreciate it.

Tim Rezvan

Thanks, everyone.

Carrie Osicka

Thank you.

Operator

Next question on the line is from Neal Dingmann from Truist. Please go ahead.

Neal Dingmann

Someone else. Thanks for the time on twist. My first question is on the expected activity specifically. I'm just wondering, given your great line of sight, you talked about all the line of sight wells. And then if you look at sort of the current rig count out there and maybe conversations you're having with your operators. I'm just wondering if you maybe in broad terms your debt could just speak to your confidence in the continued solid activity, I would call it well into next year if you're anticipating that.

Christopher Conoscenti

Sure, Neal, good morning. I'll make a couple of comments and turn it over to Dax. So just kind of at a macro level, we did see the rig count decline during the year on our asset and broadly across the U.S., but that decline for us in the Permian started in June and continued until about October where it started to rebound. So we thought equity interest that continues to rebound and through the end of the year, and that's how we enter 2024 alternative index for more specific comments.

Dax McDavid

And now Thank you, Chris. And that's why I'm excited about our DTA acquisition. I mean, especially in the back while the recent positive top carry from the media coverage Novation. So the activity has grown by 5.9 net lines of sight wells running sort of most active operators in that basin sort of pause, Oxy and Chevron. So again, we have 9.6 inventory wells, not below that 2.5 of which are located with the cancellation fees, which is a new line until you have better line of sight to activity on those inventory. Well.So now that we're working very excited about that, he's a

Neal Dingmann

great update. And then just my second quick one on the M&A physically that maybe for you, Chris, just wondering, we don't see near like you all do the deal flow just wondered based on what you're seeing out there as mineral deal flow still is as active as ever, and you know, is that prices still get obviously a fantastic price under DJ. So I'm just wondering, are you are there rational other sort of priced assets out there that you potentially see?

Christopher Conoscenti

That's the key question for 2024. And you know the optimistic I think plus up in Q4 were brought auction properties fail, and we like to see that because number one, we're rarely ever successful at our auction phosphates, but number two. What it does is it tends to reset expectations with those. And those the multiple broad auction sale in Q4 is really encouraging for us for 2020 for now as I said, we as a company in our history have executed on probably less than in all of our 193 plus acquisition through broad auction process. Most of what we do is through negotiated transactions like we did with the DJ Basin transaction that we announced this morning. We tend to have more sense engagement people directly and fund solutions and those conversations take years to evolve and that would when Bill will culminate in a transaction. But we have multiple trends, multiple conversations that are going right now and we're encouraged for 24.

Neal Dingmann

Great details. Thank you all.

Christopher Conoscenti

Thank you.

Operator

The next question on the line is from Derrick Whitfield from Stifel. Please go ahead.

Derrick Whitfield

Good morning and congrats on your DJ acquisition and return of capital initiatives.

Christopher Conoscenti

Thank you.

Derrick Whitfield

For my first question, I wanted to focus on your 2024 guidance. As outlined, your guidance implies maintenance level activity versus Q4, while a lot of site activity implies growth, how would you frame your production trajectory for 2024 for you guys expecting heavier tails in the second half based on Gary's commentary?

Christopher Conoscenti

Sure. I'll take that first and Gary feel free to supplement with any comments you have. So when we look at the line-of-sight wells ahead of the Fed, clearly at record levels for the company. The key is going to be this conversion to sale. What we saw in the fourth quarter, about 7.7 net wells turned in line and down a little bit from last year. As I said, activity on our asset rebounded through the fourth quarter. We expect that to start to roll through that first part of this year. And we have line of sight on and multiple wells, for example, coming in line just in March here. So there are specific instances where we have some ability to model in specific timing on specific interest that we have. But then for the most part, we look at 2024 and it's really being current on all the calls you've been on for operators really guiding to flattish to low single-digit type of growth in the Permian. And because our asset covers about 35% of the Permian Basin, you should expect our asset to mirror pretty closely what the Texas side of the Permian Basin does, and that is not growing at double digits, but it's still showing good and stable production in some cases, some modest growth, and that's what we expect ours to do.

Carrie Osicka

Well, we're taking that and that's the only other thing I'll add to that. Sorry, I'll just add one other thing on the only other nuance to remember too, it's just that development on our assets can affect the annual production rates. And while activity can be constant, it just depends on what yes, our NRIs get developed.

Derrick Whitfield

Makes sense guys. And maybe looking at it a little bit longer-term perspective, given the considerable M&A we've witnessed across the Permian over the last six months with Exxon Oxy and Alan back, wanted to ask for your thoughts and the net impact it could have on your business and pace of development as those transactions were Texas Heavy?

Christopher Conoscenti

Yes, good question be the operator mix for our business has really changed over the last several years. You rewind the clock a couple of years. You would have seen Callon, PTC, Noble, Pioneer and Arco and our top 10. And now it's a building with the Exxon, Chevron and Oxy, Apache, Diamondback and others who have been active in the consolidation business. And really what it's done is it's had the effect of putting our minerals being operating in the hands of bigger, better capitalized operators who have more sustainable program through a cycle. So I think impact number one is slightly less volatility in activity over time. And the and what we hope to see in terms of a treatment with operators, hopefully changing the conversation between operators and mineral owner over time as we have fewer operators to manage those relationships with hopefully just have a more direct relationship with them and they get better information as we grow.

Derrick Whitfield

Chris, if I could ask one more, just with regards to the $200 million share repurchase program, how would you compare the value of buying your stock today versus the value of M&A opportunities that are available are available in the foreseeable future.

Christopher Conoscenti

And it's an exercise we go through in every single acquisition evaluation we do. We look at the sensitivities of the potential returns of the acquisitions were evaluated and compared against our stock. And so should we make the acquisition we're contemplating or should we make the acquisition of our own minerals environment stock. And so it's an analysis we've done throughout time on our business and we look at it now and they have really compelling opportunity based on the dynamics in the market today and also with the outlook we have going forward.
The other nuance here is that this is not an either or decision we can have compelling acquisition opportunities in front of us and we can execute on the share repurchase and Byron thought effectively buyer on minerals because the return of capital program has been such that the buyback is happening within the framework of the 65% returning capital to our shareholders.

Derrick Whitfield

Very helpful, Chris, thanks for your time.

Christopher Conoscenti

Thank you.

Operator

As a reminder to ask any further questions, please star followed by one on your telephone keypad now. Our next question is from Noel Parks from Tuohy Brothers Investments. Please go ahead.

Noel Parks

Hi, good morning. Why now I just had a couple of things on your one thing. I was wondering about there is oil prices, everything and too badly, but there does seem to be some macro uncertainty and decision out there about what the year is going to look like. I just wondered in terms of visibility on activity levels and are you seeing any oil hedging trends among your operators on either kind of uniformly across across the operators? Or is wondering if you're seeing any divergences different flows kind of take a different buyer at the apples you're trying to figure out what it is protected by patents against downside or tried to open themselves up modest potential upside

Christopher Conoscenti

just from the operators. Typically, it's driven by company size and leverage just broadly speaking, you'll see smaller companies and companies with more leverage and markets that are organic, the proportion being more active with hedging. And the important nuance to remember is that the hedging program that the operators have engaged and has no impact on realized prices for Sydney. So we get the prices at the delivery point that the operator gets any sort of financial hedging they do on their side as they are now and we have the ability to hedge or not based on Libya.

Noel Parks

Right. Absolutely. I'm just saying I'm just you've been as you've discussed, we've had consolidation going on in the Permian different assets heading into different hands. And I'm I guess I'm in the process of trying to sort of picture just what what the basin looks like in terms of just operator behavior going forward and done? And I guess I'm looking thinking about the cost side and capital discipline.
We certainly haven't haven't seen anybody really going crazy with reactivity on either with an established footprint or are the companies that have been consolidating and done? And so I am I guess I'm curious to do you get a feeling from and the operators about some what they think about the inflation outlook? I'm just also curious if you're seeing any trends you're hearing and whether that attacking folks' aggressiveness at all

Christopher Conoscenti

sort of the a couple of trends we're seeing. One is just continued march towards higher efficiencies for the operators that continue to get better and more cost-efficient what they do. And so I think even you see operators announce a slight decrease and rig counts post acquisition, oftentimes the best compensated for and that and even potentially increase by efficiency gain and applied throughout a larger program. And yes, I could make a comparison back to history. There's good M&A and that M&A for Citi. When we look at our operator base. The bad M&A for us is where two of our larger operators get together and flash the bind rate program, a fraction of what it was, but it was for either one of those companies standalone. And that's what happened with that. For example, with documented Darko, several years ago, the type of M&A that's happening today, quite good for us. Really have healthy companies getting together just becoming bigger, more efficient and more capital efficient. So for us, instead of the mineral owner, we like to see this type of consolidation. The same today and we're encouraged by for our business.

Noel Parks

Great. Thanks a lot.

Christopher Conoscenti

Thank you.

Operator

As a final reminder that asked any further questions, please press star for my one on your telephone keypad. Now it appears we have no further questions, so I will conclude the call now. Thank you for your time today. You may now disconnect your lines and enjoy the rest.