Sitio Royalties Corp.

for 2023 earnings call my name is chat and i'll be the coordinator for this call today after the presentation there'll be a q a session where you'll have the opportunity to ask questions by pressing star 4x1 on your telephone keypad if you change your mind please press star 4x2 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 Citio 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.citio.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 Conocenti, our Chief Executive Officer, Kerry Osika, our Chief Financial Officer, and Dr. David 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 CTO'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 EMP 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 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 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 of the 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 Civitoq, 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 multi-year caps and OGDPs, which contain 26% of remaining inventory and represent a total of approximately 2,700 NRAs and 2.5 net remaining locations as of December 31st. 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 nine in our earnings presentation, The DJ Basin acquisition acreage is in the core of the play and expands our DJ Basin NRAs 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 Codel, both of which are being co-developed 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 D.J. Basin, commenting that their acreage has high cash flow margin, low grade given barrels, and has permits that extend through the late 2029. OSSE recently highlighted several positive aspects about the D.J. Basin's 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 segments based on the midpoint of their 2024 guidance. Civitas recently disclosed that their 2024 DJ Basin development plan is focused in 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 productivity in the Watkins area in 2023 relative to 2022, resulting in a 10% higher EURs and 40% higher returns. As of February 19th, 75% of the rigs running the entire DJ Basin were on our pro forma position. an increase of 3x relative to the rigs on Cydia's legacy asset. The rigs on our proforma acreage are exposed to 100% of CVX, Oxy, and Verdad's 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 longstanding 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 differentiate CITIO from many of our peers. I'll now turn the call over to Kerry Osika, our CFO, to discuss fourth quarter 2023 results.

Thank you, Dax. 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 and December Permian acquisitions and excluding production from the divested assets. Horizontal grid 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 floods as a percent of total net line-of-sight wells shifted from 59% at the end of third quarter to 64% at the 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 acquisitions 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 stocks 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 day cash flow from the DJ Basin Acquisition in our calculation of first quarter 2024 DCF. We ended 2023 with an $850 million borrowing-based 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 CAPS and OGDBs 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.

Thank you, Kerry. If you'd like to ask a question, please press star followed by 1 on your telephone keypad now. If you change your mind, please press star followed by 2. When preparing to ask your question, please ensure your phone is unmuted locally. Our first question today comes from Tim Resvan from KeyBank Capital Markets. Please go ahead.

Good morning, folks. I hope you all got some sleep last night. My first question, I wanted to ask, you know, with the DJ Basin acquisition, you know, when you look at things outside Permian, is there a higher hurdle rate, you know, given sort of less industry activity, or was this a simple sort of arbitrage you saw being able to buy it at four times cash flow?

Thanks, Tim. This is Max. No, there's not. We underwrite to get returns, and we're able to technically underwrite a lot of, in all the the basins out there, there's not... So, no, we forget about that. We do see increase, actually, from the operators I mentioned earlier in the BJA basin. We see an increase in activity, and we do see them dedicating capital to that basin, and we see that basin continue with returns of engaging the other banks so that they have that opportunity to drill in.

Okay. Okay. I understand. I guess visibility and activities is what matters. Okay. Thank you. If I could pivot, I don't know if this is more for Chris as a board member or for Carrie. I was curious, you know, with this pretty significant change in cash return framework, I'm wondering if you could talk about, you know, engagement with shareholders in the last few months as you came to this decision you know as the board did you do you think shareholders kind of wanted this or was this more an idea of the board feeling compelled to to step in with shares you know where they were to support the equity i'm just curious kind of what what eventually got got the board to agree to make this change hey good morning sam it's chris i would tell you this is not a 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, we ask them questions about the capital return framework. So this was an ongoing dialogue with shareholders and at the board level. It's been going on for months and incorporated a lot of thoughts from all constituents. We're excited about it because, you know, when we look at the way the business is coming together for this year, as Kerry mentioned, you look at activity under the CAFs and OGEPs and the DJs. 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 in October onwards, that gives us a lot of comfort leading 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 will be more of those this year as well.

Okay, okay. I appreciate that. If I can sneak one last one in, it's maybe more for Carrie. You know, as we sort of bake this last acquisition in the model, you know, you see net debt, you know, a little shy of $1 billion, leverage still kind of north of one. You know, given that the successful, you know, 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? Thank you.

Sure. Hi, Tim. This is Carrie. You know, we continue to target low leverage. You're right. We're sitting at above, a little bit above one times leverage. But we target that low 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, same as 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 retained that we do to manage the balance sheet through a cycle and protect this company. So other companies can 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 leveraged target? Is it 0.75? Do you just want to be sustainably under one times? I'm trying to think about what a steady state kind of level would be.

Yeah, I mean, Terry's remarks. Yeah, Terry was right. We want to have low leverage so we can be optimistic when opportunities present themselves. And so it's not a fixed number, Tim. It's really just, you know, 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. Okay.

Okay. Appreciate it. Thanks, everybody. Thank you.

The next question on the line is from Neil Dingman from Truist. Please go ahead.

Thanks for the time. My first question is on expected activities. 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 or Dak could just speak to your confidence in the continued solid activity, you know, I would call it well into next year if you're anticipating that.

Sure, Neil. Good morning. I'll make a couple comments and turn it over to Dax. So just at a macro level, we did see the recount decline during the year on our asset and broadly across the U.S. But, you know, that decline for us in the Permian started in June and continued until about October where it started to rebound. So we saw that activity on our asset 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.

No, thank you, Chris. You know, that's why we're excited about our DJ acquisition. I mean, especially in the back of all the recent positive commentary from the media operators in the basin. You know, the activity is driven by a 5.9 net line site wells, running some of the most active operators in that basin, Citipox, Oxy, and Chevron. Again, we have 9.6 inventory wells in that deal, 2.5 of which are located in these caps and OGPs, which give you a better line of sight to activity on those inventory wells. So, no, we're excited about that.

Great update. And then just my second quick one on M&A. Specifically, you know, definitely for you, Chris, just wondering, you know, 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, you know, is the price is still, you know, again, obviously fantastic price on your DJ. So I'm just wondering, are there rational other sort of price habits out there that you potentially see?

That's the key question for 2024, Neil. The optimistic sign we saw in Q4 were broad auction processes failing. And we like to see that because, number one, we're rarely ever 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 auctions fail in the fourth quarter is really emerging for 2024. As I said, we as a company in our history have executed on probably less than 10 out of our 193 plus acquisitions through broad auction processes. Most of what we do is through negotiated transactions like we did with the D.J. Basin transaction that we announced this morning.

We tend to have more success engaging with people directly and finding solutions.

And those conversations take years to evolve, and when those will culminate in a transaction, but we have multiple conversations like that ongoing right now, and we're encouraged for 2024.

Great details. Thank you all. Thank you.

The next question on the line is from Derek Whitfield from CIFL. Please go ahead.

Good morning, all. Congrats on your DJ acquisition and return of capital initiatives.

Thanks, Terry.

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 tills in the second half based on Kerry'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 this conversion to till. What we saw in the fourth quarter, about 7.7 net wells turning line, down a little bit from the third 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 interests that we have. But for the most part, we look at 2024 and it's really, You've heard about all the calls you've been on where operators are really guiding to flat-ish 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 in 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.

Yeah, Chris, the only other thing I'll add to that. Sorry. I was just going to add one other thing. The only other nuance to remember, too, is just net development on our app that can affect annual production rates. While activity can be constant, it just depends on which, you know, NRIs get developed.

Makes sense, guys. 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 six months with Exxon, Oxy, and Diamondback, I wanted to ask for your thoughts on the net impact it could have on your business and pace of development if those transactions were Texas heavy.

Yeah, that'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 years, you would have seen Callen, PDC, Noble, Pioneer, and Darko 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 had 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. We can 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 regards to the $200 million share repurchase program, how would you compare the value of buying your stock today versus the value of any opportunities that are available or are available in the foreseeable future?

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 say it's a 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 of purchases and buy our own stock, effectively buying our own minerals. Because the return of capital program is set up such that the buyback is happening within the framework of the 65% return of capital to our shareholders.

Very helpful, Chris. Thanks for your time. Thank you.

As a reminder, to ask any further questions, please press star 4 by 1 on your telephone keypad now. Our next question is from Noel Parks from TUI Brothers Investment. Please go ahead.

Hi, good morning.

Good morning, all.

I just had a couple things. You know, one thing I was wondering about, since there is, you know, oil prices haven't been too bad lately, 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, are you seeing any oil hedging trends among your operators, either kind of uniformly across the operators, or is one of you seeing any divergences, you know, different folks kind of take a different bite at the apples, trying to figure out what it is? protect against downside or try to open themselves up more to potential upside?

We've seen this from different 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. important nuance to remember is that the hedging program that the operators engage in has no impact on the realized prices for CITIO. 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 on our account.

Right, absolutely. I guess I'm just you know, being, as you've discussed, we've had consolidation going on in the Permian, you know, 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, you know, 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 to the degree 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 trends we're seeing, one is just continued march towards higher efficiencies for the operators. They continue to get better and more cost efficient at what they do. And so I think even if you see operators announce a slight decrease and rig counts post-acquisition, oftentimes that's compensated for and even potentially increased by efficiencies gained and applied throughout a larger program. And I could make a comparison back to history. There's good M&A and bad M&A for CFIA when we look at our operator base. The bad M&A for us is where two of our large operators get together and slash the combined rig program to a fraction of what it was for either one of those companies standalone. And that's what happened with, 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, healthier, more efficient, and more capital efficient. So for us as the mineral owner, we like to see the type of consolidation we're seeing today, and we're encouraged by it for our business.

Great, thanks a lot.

Thank you.

As a final reminder, to ask any further questions, please press star four by one on your telephone keypad now. 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.