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Fitch Affirms Viper Energy Partners at 'BB-'; Outlook Stable; Removes UCO

05/25/2022 | 04:01am

Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) of Viper Energy Partners LP and Viper Energy Partners LLC at 'BB-'.

Fitch also affirmed Viper Energy Partners LLC's senior secured revolving credit facility at 'BB+'/'RR1' and Viper Energy Partners LP's senior unsecured notes at

'BB-'/'RR4'. The Rating Outlook is Stable.

The ratings were placed Under Criteria Observation (UCO) on Dec. 2, 2021 following the conversion of Fitch's exposure draft: 'Parent and Subsidiary Linkage Rating Criteria' to final. Fitch has removed all of the ratings from UCO.

Viper's ratings reflect its non-operated status, high-margin cost structure, through-the-cycle positive FCF after dividends, and strong credit metrics with sub-1.5x debt/EBITDA throughout the base case. Offsetting factors include the company's relatively small asset base and volumetric risks from third-party operators.

Key Rating Drivers

Uplift from Linkage with Parent: Under Fitch's new parent-subsidiary linkage criteria, Viper's IDR receives a one-notch uplift (same as prior criteria) due to the moderate linkage between the company and its higher rated parent, Diamondback. The linkage reflects the lack of strong legal ties (debt guarantees, cross defaults), weaker strategic ties given Viper's low overall financial contribution and moderate operational ties since the companies have integrated management personnel and Diamondback generates stronger unit economics on Viper acreage.

Unique Asset Base: Viper's asset base is unique relative to growth-oriented independent E&Ps; the company is the leading public consolidator of royalty mineral ownership across the Permian. Viper's net royalty acreage is highly contiguous and largely undeveloped (less than 30% developed in the Midland and less than 20% developed in the Delaware). Given the royalty structure, the asset requires no operating expenses and provides organic growth opportunities without capital costs, resulting in higher margins than operating peers in the Permian.

Distribution Policy Provides Flexibility: Management's variable distribution rate of 70% of free cash flow rewards shareholders, while the remaining 30% provides Viper additional financial flexibility and capital optionality. The company's high margin profile and lack of capital costs supports robust FCF generation at Fitch's price deck.

Fitch expects post-dividend FCF to be allocated toward repayment of the revolver in the near term, and believes a portion could be used for M&A funding in the medium term, reducing the company's dependency on capital markets. Fitch does not expect the distribution rate to reach its previous level of 100%, but recognizes a payout increase could have negative implications for future M&A growth and funding.

FANG-Linked Production: Viper's net royalty production attributed to Diamondback operating activity is forecast to be maintained at approximately 60%-65%. FANG's highest return wells are on Viper's net royalty acres in the Northern Midland Basin, and management expects FANG will continue to target this acreage in the near and medium term. Additionally, approximately 65% of FANG's drilled uncompleted wells (DUCs) are on Viper royalty acres, which should provide near-term production tailwinds.

Fitch believes this linkage provides a production floor and drives Viper's production growth through the forecast. Fitch expects Viper's production growth from third party operators to remain in the low to midsingle-digit range.

In general, Viper has strong insight into Diamondback's volumes and drilling plans, reducing volumetric and cash flow risks, and considerably less visibility and certainty around volumes from third party non-operated interests. Consolidation of mineral interests on third party acreage could result in additional cash flow risk in the longer term. Viper attempts to offset this risk by targeting royalty interests on acreage that is highly contiguous and core to targeted third party operators.

Equity Weighted M&A: Viper has conservatively funded its M&A activity, approximately 75% equity-linked since its IPO in 2014. Fitch believes Viper will continue to fund M&A, over the longer term, through revolver borrowings, positive free cash flow and equity issuances. Near-to-medium term M&A will likely focus on Diamondback acreage; however, Fitch recognizes the number of sizeable transactions could be limited given increased basin consolidation since 2020. Fitch believes continued equity offerings could potentially reduce Diamondback's ownership stake, which may weaken the Diamondback/Viper linkage.

Sub-1.5x Leverage Metrics: Fitch forecasts Viper's debt/EBITDA ratio to reach 1.0x in 2022 at Fitch's $95 WTI price. Fitch expects leverage will remain below 1.5x in the outer years of the forecast following continued repayment of the revolver borrowings and low to midsingle-digit production growth.

Near-Term Hedging Program: Fitch expects Viper to maintain a near-term focused hedge program, which provides protection from sudden downward price movements. Currently, the company has collars for 8,000 boepd at a weighted average floor of $47.5.00/bbl, and a ceiling of $110/bbl for 2H22, in addition to deferred premium put options with an average strike price of approximately $50 for downside protection. Management also has 20,000 mmbtu/d of natural gas hedges for fiscal 2022 through costless collars (average floor of $2.50/mmbtu and ceiling of $4.62/mmbtu), given strong natural gas pricing.

As leverage continues to improve, Fitch believes management will reduce overall hedge coverage, but will continue to retain extreme downside protection through puts in order to maintain liquidity, fund distributions and repay debt.

Derivation Summary

Viper is an independent E&P focused on owning the mineral interests of the liquids-oriented Delaware and Midland basins with 1Q22 net production of 31.6 mboe/d. Production size, due to the nature of the royalties business, is substantially smaller than its 'BB' category E&P peers, Murphy Oil Corporation (BB+/Stable), CrownRock, L.P. (BB-/Stable) and Vermilion Energy Inc. (BB-/Stable), all of whom produce at least 80 mboe/d.

As a minerals owner, Viper has minimal operating costs, which results in a Fitch calculated unhedged cash netback of $59.1/boe (87% margin) for 1Q22, better than the entire peer group. Viper's parent FANG had daily production of 381 mboepd with a cash netback of $56.2/boe (81% margin) in 1Q22.

Viper's high unhedged cash netbacks and no capital expenditures result in a best in class FFO margin, albeit at a much smaller amount. Viper's MLP-linked distributions historically resulted in a neutral FCF profile, but the current 70% distribution rate should facilitate positive FCF going forward.

On a debt/EBITDA basis, Fitch forecasts Viper's pro forma leverage at 1.0x in 2022, which trends below 1.5x in the outer years of the base case at mid-cycle prices, as revolver borrowings are reduced. Debt/EBITDA metrics are in line with the 'BB' category thresholds and Permian-focused E&P peer group.

Key Assumptions

Fitch's Key Assumptions Within The Rating Case for the Issuer include:

WTI oil price of $95 in 2022, $76 in 2023, $57 in 2024, and $50 in 2025 and longer term;

Henry Hub natural gas (USD/mcf) of $4.25 in 2021, $3.25 in 2023, $2.75 in 2024, and $2.50 in 2024 and longer term;

Double-digit production growth in 2022, followed by single digit thereafter;

Distribution rate of 70% in 2022 and thereafter;

Free cash flow after dividends used to repay revolver borrowings;

No material M&A activity through the forecast.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Increased size and scale resulting in mid-cycle FFO at or above $500 million while maintaining strong relationship with Diamondback;

Mid-cycle debt/EBITDA maintained below 2.0x on a sustained basis;

Leverage sensitivities are consistent with higher-rated peers and are unlikely to change upon future rating upgrades.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Production trending below 15-20 mboe/d and/or increased volumetric risk;

Erosion in Diamondback's credit profile, or material reduction in parent support for Viper (on an ownership, acreage and/or production basis);

Change in financial policy, particularly publicly stated leverage targets and M&A funding appetite;

Mid-cycle debt/EBITDA above 3.0x on a sustained basis;

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: At 1Q22, Viper had cash on hand of $33 million and $252 million of availability under the revolving credit facility of ($248 million outstanding; $500 million of elected commitments under the $580 million borrowing base). Viper continues to retain 30% of distributable free cash flow to strengthen the balance sheet by repaying revolver borrowings. Fitch believes management's financial policy decisions will continue to reward shareholders through distributions and buybacks in the near-term, but will also allow for repayment of the revolver given the currently strong commodity price environment.

Simple Debt Structure: Viper's senior secured revolver matures in June 2025, and the company's 5.375% senior unsecured notes are due in November 2027.

Distribution Limitations: Viper's distributions are limited by the indenture under the company's 5.375% senior unsecured notes due 2027. Outside of the builder basket, Viper is able to make restricted payments as long as leverage is under 3.0x. Additionally, to the extent the company is above 3.0x, Viper has a general basket up to the greater of $50 million or 4% of ACNTA.

Issuer Profile

Viper owns the oil and gas mineral, royalty, overriding royalty, and similar interests operated by its parent company Diamondback Energy, Inc. and third parties in the Permian and Eagle Ford basins.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Viper has an ESG Relevance Score of '4' for Group Structure, as the company has a complex group structure. This has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

(C) 2022 Electronic News Publishing, source ENP Newswire

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