Sitio Royalties Corp
NYSE:STR
Earnings Call Analysis
Q4-2023 Analysis
Sitio Royalties Corp
Sitio Royalties enters 2024 with cautious optimism, addressing investor concerns in a landscape where market volatility and cyclical downturns pose significant risks. The company has exhibited resilience by making strategic adjustments to its return of capital framework which now includes a balanced approach of dividends and a newly authorized $200 million share buyback program. By prioritizing a flexible structure, Sitio ensures shareholders receive a consistent minimum cash dividend pegged at 35% of discretionary cash flow, averting the common traps of rigid fixed-dollar dividends in an inherently fluctuating market. This strategic foresight is evidenced by the planned minimum dividend of $0.27 per share for the fourth quarter of 2023, translating to an estimated 5% dividend yield—remarkably higher than both E&P companies and S&P 500 averages.
The company keenly focused on growth through acquisition, leading to a noteworthy expansion in the DJ Basin. This $150 million acquisition added over 13,000 net royalty acres, bolstering Sitio's footprint in an area buzzing with activity and characterized by higher productivity compared to legacy assets. Meticulous capital reallocation enabled the company to divest less lucrative assets at a 6x cash flow multiple, showcasing a shrewd approach to portfolio management.
The acquisition's accretion is evident in both near-term cash flow and net asset value (NAV), with high-quality operators like Chevron, Oxy, and Civitas signaling strong and continued commitment to the region. Notably, Sitio reports an 89% increase in monthly production over the past year on the acquired assets, in stark contrast to a 7% decline on recently divested properties. Detailed plans with the Colorado Energy and Carbon Management Commission underpin future activity, offering Sitio an enhanced degree of operational predictability.
For 2024, Sitio's guidance reflects confidence, undergirded by a record number of line-of-sight wells bolstered by the recent DJ Basin acquisition and sanctioned development plans. The management displays an optimistic stance on the mineral M&A market and signals a potential uptick in transactions, marking favorable conditions for strategic growth initiatives.
With a macro perspective, Sitio observed a decline in the rig count that began in June, reaching a trough in October before showing signs of recovery. The rebound in rig activity through the end of the year sets a positive tone for 2024, recognizing the transitory nature of industry setbacks and positioning the company to capitalize on rebounding activity.
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Hello, everyone, and welcome to the Sitio Royalties' Q4 2023 Earnings Call. My name is [ Chat ], and I'll be the coordinator for this call today. [Operator Instructions] I'd now like to hand over to Ross Wong, Vice President of Finance and Investor Relations, to begin. Ross, please go ahead.
Good morning, everyone. Welcome to the Sitio Royalties' 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.sitio.com, or you will find them in our Investor Relations section.
With me today to discuss fourth quarter and full year 2023 financial and operating results is Chris Conoscenti, our Chief Executive Officer; Carrie Osicka, our Chief Financial Officer; and Dax Mcdavid, 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.
Thanks, Ross. Good morning, everyone, and thank you for joining Sitio'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 acquisitions.
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 is 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 turn out to be variable in a commodity price down cycle 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 cyclical upturns.
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 yields 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. The 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 the Anadarko Basin at a nearly 6x next 12 months' cash flow multiple, and acquiring higher growth DJ Basin assets at a 4x 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 Dax Mcdavid, our EVP of Corporate Development, to discuss the highlights of the DJ Basin acquisition and provide an update on other acquisition activities.
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 NAV 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 Civitas, who 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 on 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 of comprehensive area plans or CAPs, and oil and gas development plans or OGDPs, 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 multiyear CAPs and OGDPs, which contain 26% of remaining inventory and represent a total of approximately 2,700 NRA and 2.5 net remaining locations as of December 31. These CAPs and OGDPs don't guarantee operator 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, the DJ Basin acquisition acreage is in the core of the play and expands our DJ Basin NRA by 52% from approximately 25,000 NRAs to over 38,000 NRAs. On a pro forma combined basis, our assets cover approximately 810,000 gross acres or 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 codeveloped across most of the acreage.
Recent public commentary from Chevron, Oxy, and Civitas regarding the DJ Basin has been quite positive, indicating that their assets are highly economic. They have also emphasized commitments to deploy capital and grow production in 2024 and beyond with CAPs and OGDPs. Chevron has underscored their dedication to the DJ Basin, commenting that their acreage has high cash flow margin, low breakeven barrels, and has permits that extend through late 2029.
Oxy recently highlighted several positive aspects about the DJ Basin assets as well, including a 32% improvement in well productivity from 2022 to 2023, and an 11% implied annual production growth for the Rockies and Other segment based on the midpoint of their 2024 guidance. Civitas recently disclosed that their 2024 DJ Basin development plan is focused on the highly-prolific Watkins area, a region that contains Box Elder, one of the larger CAPs on the DJ Basin acquisition acreage. Civitas highlighted much improved growth productivity in the Watkins 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 in the entire DJ Basin were on our pro forma position, an increase of 3x relative to the rigs on Sitio's legacy asset. The rigs on our pro forma acreage are exposed to 100% of CVX, Oxy and [indiscernible] total rig activity in the basin.
In addition to the DJ Basin acquisition, we acquired over 500 Permian Basin NRAs in New Mexico in exchange for Class C shares of our stock in December. This transaction was with one of our long-standing relationships and is 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 Sitio from many of our peers.
I'll now turn the call over to Carrie Osicka, our CFO, to discuss fourth quarter 2023 results.
Thank you, Dax. Our assets continue to perform consistently with production from our royalty interest 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 22. . 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 and December Permian acquisitions and excluding the production from the divested assets.
Horizontal rig count in the Permian Basin and the overall U.S. during the fourth quarter was down by 4.2% and 3.8%, respectively. We estimate that 7.7 net wells were turned in line on our acreage during the fourth quarter, down from the estimated 9.5 net wells turned in line 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. The number of net spuds as a percent of total net line-of-sight wells shifted from 59% at the end of third quarter to 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 1st effective date cash flows from the DJ Basin and Permian acquisition and benefited from a 21% decrease 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 for 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 2024 DCF. 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 property. Contribution from the DJ Basin acquisition properties and the CAPs and OGDPs that Dax mentioned 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 questions.
[Operator Instructions] Our first question today comes from Tim Rezvan from KeyBanc Capital Markets.
I hope you all got some sleep last night. My first question I want to ask about the DJ Basin acquisition. When you look at things outside Permian, is there a higher hurdle rate given sort of less industry activity? Or is this a simple sort of arbitrage you saw being able to buy it at 4x cash flow?
Thanks, Tim. This is Dax. No, there's not. We underwrite the returns, and we're able to technically underwrite a lot of -- in all the basins out there, there's not -- sorry, we forget about that we do see increase -- actually, from the operations I mentioned earlier in the DJ Basin, we see an increase in activity, and we do see them benefiting capital to that basin. And we see that basin continue with returns, not engaging the other basins that they have that opportunity to go on.
Okay. Okay. I understand. I guess, visibility on activities is what matters. If I could tip it, I don't know if this is more for Chris as a Board member, or for Carrie. I was curious, with this pretty significant change in your cash return framework, I was wondering if you could talk about engagement with shareholders in the last few months as you came to this decision, as the Board did. Do you think shareholders kind of wanted this? Or was this more an idea of the Board feeling compelled to step in with shares where they were to support the equity? I'm just curious kind of what eventually got the Board to agree to make this change?
Tim, it's Chris. I would say this is not a trade we're trying to make just 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 meet with shareholders, they asked some questions about the capital return framework. So this was an ongoing dialogue with shareholders and at the Board level. It has been going on for months and incorporated a lot of thought more from the business. We're excited about it because when we look at the way the business is coming together for this year, as Carrie mentioned, if you look at activity under the CAPs and OGDPs in the DJ, if you look at our record level of line-of-sight wells overall, and then recovering trends in activity in the Permian in the fourth quarter, particularly October onwards, that gives us a lot of comfort being into 2024.
The other thing that we like about 2024, too, unlike 2023, is we're seeing some fundamental shifts in the acquisition market and you can see that evidenced by the acquisition we announced this morning. So we're hopeful that there'll be more of those this year as well.
Okay. Okay. I appreciate that color. If I could sneak one last one in, just maybe more for Carrie. As we sort of baked this last acquisition in the model, you see net debt a little shy of $1 billion, leverage still kind of north of 1x. Given the successful refinancing of your debt, what are your updated thoughts on target debt, target leverage, and how do you think about that 65% payout and maybe closing the gap with public peers that pay a higher rate?
Sure. Tim, this is Carrie. We continue to target low leverage. You're right, we're sitting a little bit above 1x leverage, but we target the above leverage to preserve our financial flexibility and our ability to be opportunistic on cash acquisitions. 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, I'll let Chris speak a little bit more about this, but we don't intend to change 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.
Yes. Tim, it's Chris. 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, it's appropriate to have the amount of cash repayment we do to manage the balance sheet through cycle and to protect this company instead of -- other companies are going to make their 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 to call that time right now.
Okay. Okay. And then do you have a leverage target? Is it 0.75x? Do you just want to be sustainably under 1x? Trying to think about what a steady state kind of level would be?
Yes, Carrie is right. We want to have low leverage, so we can be opportunistic when opportunities present themselves. And so it's not a fixed number, Tim. It's really just, we'll take on a little bit of leverage on the balance sheet and the revolver for cash acquisitions and then we'll pay it down after those acquisitions and we'll build it back up and pay it down and repeat.
The next question on the line is from Neal Dingmann from Truist.
Chris, my first question is on 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 all are having with your operators, I'm just wondering if you, maybe in broad terms, you, Dax, could just speak to your confidence in the continued solid activity, I would call it, well into next year, if you're anticipating that.
Sure, Neal. I'll make a couple of comments and turn it over to Dax. So just 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 itself about in October, where it started to rebound. So we saw the activity on our assets continue to rebound through the end of the year. And that's how we entered 2024. I'll turn it over to Dax for any more specific comments.
Thank you, Chris. That's why we're excited about our DJ acquisition. I mean, especially on the back of all the recent positive talk here from the DJ operation, as the activity is driven by 5.9 net line-of-sight wells from some of the most active operators in that basin, Civitas, Oxy, and Chevron. So again, we have 9.6 inventory wells and that yields were 2.5, of which [indiscernible] fees, which gives you -- you have better line of sight to actually all those inventory wells. So no, we were excited about that.
Great update. And then just my second quick one on M&A. Specifically, Dax, maybe for you, or Chris, just wondering, we don't see near like you all do, the deal flow. Just wondering, based on what you're seeing out there, is mineral deal flow still as active as ever? And is that the prices still -- again, obviously, fantastic price on your DJ, so I'm just wondering, are there rational other sort of priced assets out there that you potentially see?
That's the key question for 2024, Neal. The optimistic sign we saw in Q4 were broad auction processes fail, and we like to see that because, number one, we're really never successful at broad auction processes. But number two, what it does is it tends to reset expectations from sellers. And so to see multiple broad actions fail in the fourth quarter is really encouraging for 2024.
Now as I said, we, as a company, in our history, have executed on probably less than 10 of our 193-plus acquisitions through broad auction processes. 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 success in engagement with people directly and finding solutions, and those conversations take years to evolve. And [Audio Gap] exactly when those will culminate in a transaction, but we have multiple conversations like that ongoing right now, and we're encouraged for 2024.
The next question on the line is from Derrick Whitfield from Stifel.
Congrats on your DJ acquisition and return of capital initiatives. 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? Are you guys expecting heavier tails in the second half based on Carrie's commentary?
Sure. So I'll take that first, and Carrie, feel free to supplement with any comments you have. So when we look at the line-of-sight wells, as I said, clearly, it's at record levels for the company. But the key is going to be just conversion to fill [indiscernible] what we saw in the fourth quarter about 7.7 net wells turned in line, down a little bit from the same quarter last year. As I said, activity on our asset rebounded through the fourth quarter, and we expect that to start to roll through the first part of this year. We have a line of sight on 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 for the most part, we look at 2024, and it's really [Audio Gap] you've heard on the calls you've been on, we're operationally 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 sustainable production and in some cases some modest growth, and that's what we expect ours to do as well.
Yes, the only other thing I'll add to that. I would just add one other thing. The only other nuance to remember to you is just net development on our asset can affect annual production rates. While activity can be constant, it just depends on which NRAs get developed.
Makes sense. And maybe looking at it a little bit longer term in perspective, given the considerable M&A we've witnessed across the Permian over the last 6 months with Exxon, Oxy, and Diamondback, wanted to ask for your thoughts on the net impact you could have on your business and pace of development as those transactions were Texas heavy?
Yes, it's a good question. The operator mix for our business has really changed over the last several years. If you just rewind the clock a couple of years, you would have seen Callon, PDC, Noble, Pioneer, Anadarko in our top 10, and now it's building with Exxon, Chevron, Oxy, Apache, Diamondback, and others who have been active in the consolidation business. And really what it's done is it's the effect of putting our minerals being operated in the hands of bigger, better-capitalized operators who have more sustainable programs through cycle. So I think impact number one is slightly less volatility in activity over time. And what we hope too is in terms of engagement with operators, hopefully changing the conversation between operator and mineral owner over time as we have fewer operators to manage those relationships with would hopefully just have a more direct relationship with them and get better information as we grow.
Chris, if I could ask one more. Just with regard 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 or available in the foreseeable future?
Yes. It's an exercise we go through with every single acquisition evaluation we do. We look at the sensitivities of the potential returns of the acquisitions we're evaluating and compare it against our stock. And so should we make the acquisition we're contemplating or should we make the acquisition of our own minerals and buy our own stock?
And so it's an analysis we've done throughout time on our business and we look at it now and see the 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 share repurchases and buy our own stock, effectively buy our own minerals, because the return of capital part instead of share buyback is happening within the framework of the 65% return of capital to our shareholders.
[Operator Instructions] Our next question is from Noel Parks from Tuohy Brothers Investment.
Hi, good morning. I just had a couple of things. One thing I was wondering about, since there is -- oil prices haven't been too bad lately, but there does seem to be some macro uncertainty, indecision out there about what the year is going to look like. I just wondered, in terms of visibility on activity levels, are you seeing any oil hedging trends among your operators either kind of uniformly across the operators? Or I was wondering if you're seeing any divergences? Different folks kind of take a different pie at the apple, you're trying to figure out whether to protect against downside or try to open themselves up more to a potential upside?
[Audio Gap] operators. Typically, it's driven by company size and leverage. Just broadly speaking, you'll see smaller companies and companies with more leverage and larger capital programs to protect being more active with hedging. And the important nuance to remember is that the hedging program that the operators engage in has no impact on the realized prices for Sitio. So we get the prices at the delivery point that the operator gets. Any sort of financial hedging they do on their side is for their account. And we have the ability to hedge or not hedge [indiscernible].
Right, absolutely. I guess I'm just being -- as you've discussed, we've had consolidation going on in the Permian, different assets heading into different hands. And I guess I'm in the process of trying to sort of picture just what the basin looks like in terms of just operator behavior going forward. And I guess I'm thinking about the cost side and capital discipline. We certainly haven't seen anybody really going crazy with reactivity, either with an established footprint or the companies that have been consolidating. And so I guess I'm curious [indiscernible], you get a feeling from operators about what they think about the inflation outlook. Just also curious if there's any trends you're hearing and whether that's affecting folks' aggressiveness at all?
Sure. The couple of trends we're seeing. One is just continued march towards higher efficiencies for the operators. They continue to get better and more cost efficient of what they do. And so I think even if you see operators announce a slight decrease in rig counts post-acquisition, oftentimes that's compensated for and even potentially increased by efficiency and gain and applied throughout a larger program. And I make a comparison back to history, there's good M&A and bad M&A for Sitio when we look at our operator base.
The bad M&A for us is where two of our larger operators got together and slashed the combined rig program to a fraction, but what it was for either one of those companies stand-alone. And that's what happened, for example, with Oxy and Anadarko several years ago. The type of M&A that's happening today is quite good for us, where you have healthy companies getting together, just becoming bigger, more efficient, and more capital efficient. So for us as a mineral owner, we like to see the type of consolidation we're seeing today, and we're encouraged by it for our business.
[Operator Instructions] It appears we have no further questions. So we will conclude the call now. Thank you for your time today. You may now disconnect your lines, and enjoy the rest of your day.