Sitio Royalties Q1 2023 Earnings Report

Sitio Royalties EPS Results

• Actual EPS: $0.28
• Consensus EPS: $0.26
• Beat/Miss: Beat by +$0.02
• One Year Ago EPS: $0.32

Sitio Royalties Revenue Results

• Actual Revenue: $150.80 million
• Expected Revenue: $156.25 million
• Beat/Miss: Missed by -$5.45 million
• YoY Revenue Growth: +127.10%

Sitio Royalties Announcement Details

• Quarter: Q1 2023
• Date: 5/9/2023
• Time: After Market Closes
• Conference Call Date: Wednesday, May 10, 2023
• Conference Call Time: 8:30AM ET

Sitio Royalties (NYSE:STR) operates as oil and gas mineral and royalty company. The company acquires oil-weighted rights in productive and the United States basins. It has approximately 140,000 net royalty acres through the consummation of over 180 acquisitions. The company was founded in 2016 and is headquartered in Denver, Colorado.

Sitio Royalties Q1 2023 Earnings Call Transcript

Key Takeaways

• CTO Royalty completed integration of Brigham assets with an uneventful quarter. Q1 averaged 34,440 BOE/d, and the company reaffirmed full-year 2023 production guidance of 34,000–37,000 BOE/d.
• Despite evaluating ~50,000 net royalty acres, management closed no deals in Q1, emphasizing disciplined underwriting targeting mid-teens unlevered returns and rejecting market prices that would yield mid-single-digit returns.
• Operating efficiencies drove cash G&A per BOE to a record low of $1.97, while absolute cash G&A fell 46% versus the combined pre-merger entities, illustrating scalable cost synergies.
• Financial results aligned with guidance, reporting adjusted EBITDA of $140 million, discretionary cash flow of $120 million, and a hedged realized price of $48.87/BOE.
• The company strengthened its balance sheet by reducing net debt—making $11.25 million note amortization and cutting the credit facility balance to $441 million—resulting in ~$315 million of liquidity, and declared a 65% payout dividend of $0.50/share.

Presentation

[Operator]

Good morning. Thank you for attending Sitio Royalties' Q1 2023 earnings call. My name is Felicia, and I'll be your operator today. All lines will be muted during the presentation portion of the call with an opportunity to questions and answers at the end. I would now like to pass the conference over to your host, Ross Wong, Vice President of Finance and Investor Relations. You may proceed.

[Ross Wong, Vice President of Finance and Investor Relations at Sitio Royalties]

Thanks, operator. Good morning, everyone. Welcome to Sitio Royalties' Q1 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, where you will find them in our investor relations section. With me today to discuss our Q1 2023 financial and operating results is Chris Conoscenti, our Chief Executive Officer, Carrie Osicka, our Chief Financial Officer, 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. With that, I will turn the call over to Chris.

[Chris Conoscenti, CEO at Sitio Royalties]

Thanks, Ross. Good morning, everyone, and thank you for joining Sitio's Q1 2023 earnings call. There is one word that captures the theme from this quarter, uneventful. For the first time in 2 years, we did not announce or close any acquisitions during the quarter. For the first time since becoming public, there are no pro formas or partial period results in our reported financials. Integration of the Brigham assets and personnel is complete with nothing unexpected to note. During the Q1, production associated with Sitio's assets averaged 34,440 barrels of oil equivalent per day, which is comparable to the 34,424 BOEs per day produced from these assets in the Q4 of 2022.

[Chris Conoscenti, CEO at Sitio Royalties]

Q1 production volumes were in line with our expectations. We are reaffirming Sitio's full year 2023 production guidance range of 34,000-37,000 BOEs per day. We estimate that in the Q1, there were 7.3 new net wells that started producing on Sitio's acreage, more than 95% of which are in the Permian Basin. These new net wells represent Sitio's interest in wells publicly known to have come online during the quarter, plus Sitio's interest in net wells still identified as spuds in public data sources, but are estimated to have started producing during the quarter based on market intelligence and our forecasting methodology.

[Chris Conoscenti, CEO at Sitio Royalties]

As of March 31st, we had 42.8 net line of sight wells, which implies steady operator activity over the next 12 to 15 months on our assets, particularly relative to the cumulative total of 141.3 net wells that have come online since the beginning of 2019. The Q1 of 2023 demonstrated quite different M&A dynamics than the past 3 years. During the Q1, we evaluated multiple acquisitions totaling approximately 50,000 net royalty acres in aggregate, were unable to find any opportunities that met our returns criteria. Buyers and sellers are still transacting, at different underwriting assumptions and returns thresholds than Sitio's. We remain focused on achieving a minimum of mid-teen unlevered returns using strip pricing and future development assumptions aligned with actual operator behaviors.

[Chris Conoscenti, CEO at Sitio Royalties]

I will provide you with one recent example of a private buyer and private seller. The market clearing purchase price in this example was approximately 2x the price that Sitio could have paid using our returns parameters. The only way we could have justified paying the same purchase price would have been to either assume a near-term production profile of 4x-5x our base case production assumptions or an average oil price of approximately $140 per barrel in perpetuity using our production assumptions. In this example, paying the market clearing purchase price would have resulted in mid-single-digit returns for our shareholders, which clearly does not meet our hurdle rate. We believe attractive consolidation opportunities exist with mineral owners we know and have been pursuing for years, and we will continue to be disciplined and good stewards of capital.

[Chris Conoscenti, CEO at Sitio Royalties]

Now, turning to some key financial metrics for the quarter. Overall, our financials came in as expected and were within the range of our full year 2023 guidance metrics, with the exception of our implied cash tax rate, which I will describe in more detail later. Our average hedged realized price per BOE for the Q1 was $48.87, which was $8.61 or 15% below the Q4 of 2022. We reported Adjusted EBITDA of $140 million and Discretionary Cash Flow of $120 million. Q1 Cash G&A was $6.1 million, a $2.2 million increase relative to 4Q 2022 since this was the first full quarter with former Brigham employees on the Sitio payroll.

[Chris Conoscenti, CEO at Sitio Royalties]

We achieved a significant milestone with 1Q 2023 Cash G&A of $1.97 per BOE, the lowest ever in Sitio's history and the Q1 in which Cash G&A per BOE has been below $2. Another important point on the G&A topic is the magnitude of the absolute G&A savings that have been achieved through the 2022 combination of Desert Peak and Falcon to form Sitio and Sitio's merger with Brigham. If you add up the Cash G&A from the Q1 of last year when all three of those companies were independent of each other, the total Cash G&A was $11.3 million. Compare that to our Q1 2023 Cash G&A, and you can see that we have reduced the absolute amount of Cash G&A from all three entities by 46%.

[Chris Conoscenti, CEO at Sitio Royalties]

This is a great illustration of the scalability of our business model and of the value to be created for our shareholders by consolidating this highly fragmented industry. Due to timing differences, cash taxes in our financials can be somewhat confusing relative to our guidance. I wanted to go over this in more detail. 1Q/23 cash taxes reported in our financials represent the cash taxes paid in the Q1, not the taxes payable related to taxable income for the Q1. In January, we made a cash tax payment of $550,000 for income taxes related to taxable income in the Q4 of 2022. This was the only cash tax paid during 1Q/23. The implied reported cash tax rate is 1% for the Q1.

[Chris Conoscenti, CEO at Sitio Royalties]

Similarly, in April, we made a cash tax payment of $5.9 million for income taxes related to taxable income in the Q1 of 2023. The Q1 2023 estimated cash tax rate would have been 11% without timing differences. In addition to the $5.9 million of cash taxes that was paid in April, we plan to make another cash tax payment during the Q2 related to income taxes due for 2Q 2023, which we expect to be approximately 11%-13% of Q2 pre-tax income. Our board declared a dividend of $0.50 per share using a payout ratio of 65% for the Q1 of 2023, which will be paid on May 31st to record holders at the close of business on May 19th.

[Chris Conoscenti, CEO at Sitio Royalties]

This dividend is down by $0.10 per share relative to the dividend in the Q4 of 2022. I wanted to provide some details to help explain the variance. Lower commodity prices decreased the dividend by roughly $0.11. Lower production volumes driven by 2 fewer days in the quarter decreased the dividend by another $0.016. The combination of lower lease bonus, higher Cash G&A, and higher cash interest decreased the dividend by $0.018. These decreases were partially offset by an increased dividend of $0.026 due to lower cash taxes and the combination of lower severance and ad valorem taxes, lower gathering and transportation expenses, and higher realized hedging gains, which added another $0.018 to the dividend.

[Chris Conoscenti, CEO at Sitio Royalties]

Our Q1 dividend of $0.50 per share benefited from paying cash taxes related to the Q1 in April. If all income taxes had been paid in the quarters that they were related to, our Q1 dividend would have been approximately $0.47 per share. Moving on to the balance sheet, at the end of March, we made another amortization payment at par of $11.25 million on our unsecured notes, bringing the remaining amount outstanding principal to $427.5 million. We also paid down our credit facility balance by $23 million during the Q1. On April 28th, our lenders reaffirmed our $750 million borrowing base.

[Chris Conoscenti, CEO at Sitio Royalties]

As of May 5th, 2023, we had reduced the outstanding balance on our credit facility to $441 million, which is an additional $46 million reduction since the end of the Q1, providing liquidity of approximately $315 million, including $6 million of cash and $309 million of remaining availability on our credit facility. I want to remind shareholders that we filed our 2023 proxy statement on March 31st and that our virtual annual investor meeting is scheduled for Tuesday, May 16th, 2023 at 11:00 A.M. Central Time. Whether or not you plan to attend the annual meeting, it is important that your shares be represented, so I highly encourage all shareholders to vote.

[Chris Conoscenti, CEO at Sitio Royalties]

I'm proud of the differentiated business that we have built and think the proxy statement does a good job highlighting the accomplishments of the company and our best-in-class governance model, which provides strong alignment between the board, management team, and shareholders to drive long-term value. That concludes my prepared remarks. Operator, please open up the call for questions.

[Operator]

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you'd like to remove that question, please press star followed by two. Again, to ask a question, press star followed by one. We have a first question from Tim Rezvan from KeyBanc Capital Markets. Please go ahead, sir. Your line is now open.

[Tim Rezvan, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Good morning, everybody. Thank you for taking my question. The first question I had is on the payout ratio. You know, you paid out 65% again. I believe that's the sort of the near-term target given work on the balance sheet. I was wondering, Chris, if you could, you know, talk from, you know, your seat as CEO or as a member of the board on kind of how folks are thinking about intensity, the form of repayment. You know, are repurchases being considered? You know, what level of leverage or debt reduction would cause you to reconsider that 65% payout ratio? Thanks.

[Chris Conoscenti, CEO at Sitio Royalties]

Good morning, Tim. Thanks for the questions. As a board, we do talk about repurchases. As I mentioned last quarter, though, unfortunately, we're a bit hamstrung by the unsecured notes that are in place right now that have a limitation on what we can do in terms of return of capital to shareholders. As a team, we've been prioritizing that dividend. We've committed to paying out 65% of Discretionary Cash Flow in the form of a dividend, and we don't want to cannibalize any of that for buybacks right now. I think when the time comes, when it's appropriate to refinance those unsecured notes and we put a different structure in place that allows for buybacks, it'll become a more vibrant conversation, and I think, you'll see us, you know, put something in place at that time.

[Chris Conoscenti, CEO at Sitio Royalties]

In terms of your second question, you know, the sort of metrics that would allow us to do that, I think there's two things. It's one, the company size, and then two is as you mentioned, the leverage. Company size as we think about as we get larger and that 35% retained cash flow becomes a larger number. Second, when the leverage starts to drift down towards that target we have for long-term leverage of 1x or less, that's when we start to get really interested in returning more capital than the 65% we're already committed to returning to shareholders. We'd love to be in a position to do that, unfortunately with the notes we have today, we're just not.

[Tim Rezvan, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Okay. We should look for that potential refinancing as a first step on other changes. Okay.

[Chris Conoscenti, CEO at Sitio Royalties]

Correct.

[Tim Rezvan, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

I appreciate that, the color. Just final one, you know, on the M&A comments. You know, I appreciate them in the, in your prepared statements, and it's pretty clear you're trying to get a message out, you know, in the actual release. You know, are you? I'm trying to get a little more color. Are you sort of frustrated? Do you think the market's gonna kind of normalize as maybe some of this private capital dries up? How do you see the landscape playing out, or how do you hope it kind of plays out over the next year or two to allow you to get more scale?

[Chris Conoscenti, CEO at Sitio Royalties]

Yeah, I wouldn't describe us as frustrated. I think, you know, different people have different underwriting discipline and requirements and different costs of capital, and so there's different drivers for everybody. So I wouldn't describe it as frustrated. You know, we're gonna just focus on what we do. We've seen this before. We saw it in 2020 when we were trying to make a lot of acquisitions and the sellers weren't willing to transact. We just kept at it and kept those relationships warm. When the timing lined up and we were able to act, we did in 2021 and 2022.

[Chris Conoscenti, CEO at Sitio Royalties]

It just feels like this, we're in a period here where it's gonna be a bit more challenging to reach a bid ask that makes sense for our shareholders. We're making some progress, but, you know, clearly nothing in the Q1, and we're pretty deep into the Q2 right now and haven't announced anything yet. I think it's gonna be one of those years where it's gonna be a bit lumpy, relative to the past couple of years.

[Tim Rezvan, Managing Director and Equity Research Analyst at KeyBanc Capital Markets]

Okay. Thanks for the comments.

[Operator]

The next question we have comes from TJ Schultz from RBC Capital Markets. Please go ahead.

[TJ Schultz, Managing Director and Equity Research Analyst at RBC Capital Markets]

Hey, good morning. I guess first on the, on the 50,000 NRAs you looked at, where were you focused? I guess just from a commodity perspective, have lower natural gas prices changed at all the focus for you on where you want to transact or the conversations with sellers? I'll just leave it there.

[Chris Conoscenti, CEO at Sitio Royalties]

Thanks, TJ. Good morning. The bulk of what we looked at in the Q1 was in the Permian Basin. We did look at a couple things in the DJ Basin and then one or two things that were more diversified. We really haven't looked at anything that's just purely gas focused, meaning anything in the Haynesville or anything in Appalachia. But, you know, that day may come, but we found we have just a bit of a, you know, more localized knowledge and skill set in areas where we currently have assets. When we look at things in the Permian and DJ, we feel like we have a better grasp on the underwriting. Candidly, that's where we feel like there's the most remaining inventory that's economic today.

[Chris Conoscenti, CEO at Sitio Royalties]

For us, you know, acquiring these minerals and not having to deploy additional capital for additional production in the future, there's the greatest potential for that in the Permian Basin and the DJ Basin relative to some of these other places. You know, I don't think the gas price softness of the past six months plus has really impacted us in terms of M&A or in terms of seller mindset. The natural gas is a bit of a byproduct in the Permian and people don't get very anchored on gas prices when they think about monetizing assets. Hasn't really played a role there.

[Chris Conoscenti, CEO at Sitio Royalties]

It has played a role, I think, in some of the transactions we've been watching, not evaluating ourselves, but we've seen some transactions that have been pulled or had trouble getting financed in other, you know, purely gas basins.

[TJ Schultz, Managing Director and Equity Research Analyst at RBC Capital Markets]

Okay. Makes sense. We've seen some recent deals get done with a mix of stock and cash. When you're looking at deals, how are you considering the financing mix and how high are you willing to take debt leverage to transact on M&A? Thanks.

[Chris Conoscenti, CEO at Sitio Royalties]

We do consider different consideration mixes. It's, you know, it's really driven by the sellers and what they're open to taking in terms of consideration. It's not really our decision to dictate. We can express a preference, but ultimately if the seller needs or wants one form of consideration, that's gonna drive the conversation. We're open to using the stock, but it has to be accretive, just like it would have to be accretive in a cash situation. You know, we, you know, we've used stock in the past for the Brigham transaction, Falcon, Rock Ridge, Source. You know, the bulk of what we've done in the past has been for stock, and we're willing to do it again, but it just has to meet those accretion metrics that we've used in the past.

[TJ Schultz, Managing Director and Equity Research Analyst at RBC Capital Markets]

Okay. Thank you.

[Operator]

The next question we have comes from John Annis from Seaport. Please go ahead.

[John Annis, Sales/Trading Professional at Seaport Global]

Hey, good morning, all, and thanks for taking my questions. For my first question, I wanted to focus on a bigger picture question for the Permian and activity within the Permian. If we were to assume strip pricing, do you think we've seen peak activity for at least the immediate term, given that privates generally have less quality inventory depth and are more likely exposed to weaker gas pricing?

[Chris Conoscenti, CEO at Sitio Royalties]

I think you're seeing the continued discipline by operators. I think the basin certainly is capable of running at higher activity levels. If we're assuming current commodity prices, current capital discipline, then yeah, I think we're sort of steady state, and I think that's what our guidance suggests in terms of volumes for our company. If you look at our footprint, you know, if you look at just gross DSU acreage within our footprint, it covers about one-third of the entire Permian Basin. When you look at our production volume cadence, it really reflects that of the broader basin. You know, with the guidance we've put out there, it doesn't suggest anything beyond, you know, single-digit growth, which is what we'd expect for operators at this time.

[Chris Conoscenti, CEO at Sitio Royalties]

I do think that there are private operators that do have a lot of tier one remaining inventory. I look at folks like, you know, Endeavor and CrownQuest and Mewbourne and others that have really fantastic assets. You know, I think some of the later stage private equity backed companies that are looking to sell may be had tried to ramp up production ahead of a sale so they could have some better metrics for the buyers and make it a more appealing asset for buyers. That may be what you're referring to, but there are still a lot of privates that do have a lot of remaining tier one inventory.

[John Annis, Sales/Trading Professional at Seaport Global]

Makes sense. For my follow-up, in reference to slide 7, where you highlight the synergies achieved to date from your past transactions, can you comment on whether there's still more runway to achieving further synergies, or have the lion's share of those gains already been realized?

[Chris Conoscenti, CEO at Sitio Royalties]

In terms of the assets we have today, I think there are opportunities for additional synergies. We talked a little bit about it on last quarter's call. We've had some, you know, third-party vendors that we've worked with, data providers that are trying to gouge us on pricing and, you know, they have not been really rational with respect to how they're approaching pricing. We're looking for alternatives, and some things just doing things on a proprietary basis that will eliminate those costs altogether. We're making some modest investments this year as we look to just eliminate those line items.

[Chris Conoscenti, CEO at Sitio Royalties]

I wouldn't look at those as multiple millions of dollars in terms of savings, but they matter, and they're in perpetuity. They're investments we make today and benefit from for the rest of the company's life. We're excited about those. We get excited about, you know, our data and ways to access it and work with it. It's important to us and it's a real focus for this year. In terms of personnel, we're still investing in people. You know, we find ways that, you know, even adding people can add efficiencies. We're looking at some of those alternatives as well. I think there's. The bigger gains to come are from further consolidation, though.

[Chris Conoscenti, CEO at Sitio Royalties]

I think as you see us continue to add assets and not have to scale the head count linearly with the asset growth, that's where you're gonna see additional cost savings on a dollar per BOE basis and on an absolute dollar basis.

[John Annis, Sales/Trading Professional at Seaport Global]

Terrific. Thanks again for taking my questions.

[Chris Conoscenti, CEO at Sitio Royalties]

Thank you.

[Operator]

The next question we have comes from Noel Parks from Tuohy Brothers. Please go ahead.

[Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research]

Hi. Good morning.

[Chris Conoscenti, CEO at Sitio Royalties]

Morning.

[Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research]

Just a couple things. Thinking about the acquisition path that you've gone along with Brigham being the biggest and most recent, what hurdles would a new entrant into the royalties market have to overcome in order to attempt to follow your strategy or mimic your strategy, you know, realistically today?

[Chris Conoscenti, CEO at Sitio Royalties]

One would be, finding high-quality opportunities like we have in the past. Two would be access to sufficient capital to replicate what we've done. I think one of the bigger challenges is candidly the people and systems that we've built, and that's very difficult to replicate. You know, from the outside looking in, it can appear that the minerals business is a very easy one, but to manage it optimally, it requires the right people and the right systems to really extract the most value for shareholders. That's taken us quite a while to build, and we're still investing every day in that. I think that's where we have a real advantage over anybody just starting today.

[Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research]

Great. Thanks. As you look at the different basins, you know, with... We've had this sort of fairly steady oil environment now for, you know, over a year, mostly 70 plus for WTI, and then tremendous volatility in nat gas. I wonder as you look at the various basins, it seems like some of them are at different stages of life cycle, I guess, I don't know if I'd call it consolidation, but like on a land, management basis, there are some basins where there's a lot of trading of interest, non-operated interests, you know, trying to block up acreage and so forth. I assume that situations like that might, you know, the opportunities might jar some things loose.

[Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research]

There seem to be other basins where they are just not in that, in that sort of stage right now. I was wondering if on sort of a land management basis, if you're noticing any particular trends with the different basins.

[Chris Conoscenti, CEO at Sitio Royalties]

We make the same observation you do about the relative maturity of different basins. It feels like places like the Eagle Ford and the Williston have a lot less remaining organic growth, and they may be more of in maintenance mode or in slight decline. That leads to a different opportunity set for operators in terms of, you know, who's gonna be the ultimate holder of those assets, longer term. You know, for the mineral owners, for us, as we look at these opportunities, we like a balance of current production plus remaining development potential.

[Chris Conoscenti, CEO at Sitio Royalties]

When we look at opportunities that were, let's say, just Eagle Ford or just Williston Basin compared to something that's just in the Permian or just in the DJ Basin, it's a harder comparison for us to make the same sort of underwriting assumptions about future growth just because we know that there's less remaining running room in those places. That's why you see us continue to come back to places like the Permian and the DJ.

[Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research]

Sure. Fair enough. Okay. Thanks a lot.

[Chris Conoscenti, CEO at Sitio Royalties]

Thank you.

[Operator]

As a reminder, ladies and gentlemen, to ask any further questions, please press star followed by one on your telephone keypad. Since we have no further questions registered, this concludes today's call. Thank you all for attending. You may now disconnect your lines.

Participants

Executives

• Chris Conoscenti, CEO
• Ross Wong, Vice President of Finance and Investor Relations

Analysts

• John Annis, Sales/Trading Professional at Seaport Global
• Noel Parks, Managing Director and Equity Research Analyst at Tuohy Brothers Investment Research
• TJ Schultz, Managing Director and Equity Research Analyst at RBC Capital Markets
• Tim Rezvan, Managing Director and Equity Research Analyst at KeyBanc Capital Markets