Viper Energy

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Viper Energy Partners LP is a publicly traded partnership focused on owning and acquiring mineral and royalty interests in oil and natural gas properties, primarily in the Permian Basin of West Texas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Viper Energy (VNOM) operates in the oil and gas industry, a notoriously cyclical and competitive space. Its long-term success hinges on its ability to acquire high-quality assets at reasonable prices and effectively manage production costs, a feat that is far from guaranteed.

Business Overview

Viper Energy Partners LP (VNOM) operates as a pure-play royalty company in the oil and gas sector, specializing in acquiring and owning mineral and royalty interests, predominately in the Permian Basin of Texas, United States. Unlike exploration and production (E&P) companies, VNOM does not participate directly in drilling or operating wells. Its business model is straightforward: it acquires the rights to a portion of oil and gas production from existing wells and collects royalties from these properties.

  • Revenue Distribution: VNOM’s revenue is primarily derived from oil, natural gas, and natural gas liquids production from its acreage. These revenues are based on prices that can be volatile due to various factors. These revenue streams are also affected by production volumes.
    • The largest contributing revenue components are Oil royalties at $143.9M, and then comes Natural gas at $96.3 million, and finally Natural Gas Liquids income at $81.1m for the nine months ended September 30th, 2023.
  • Industry Trends: The oil and gas sector is highly cyclical and influenced by global demand, geopolitical factors, and regulations. Commodity prices can fluctuate dramatically, affecting VNOM’s revenues. In recent times, there has been a rise in demand for alternative and renewable energy sources, which has added another layer of complexity to the long-term prospects for businesses in this sector.
    • Also, with inflation being high, service costs may increase which would affect the operating profits.
  • Margins: VNOM’s business has no production costs, it has pretty impressive operating margins with a operating profit margin at 72.4% at the end of 2022 and 74% for the nine months of 2023. The margins are very high because royalty agreements have very little cost of goods sold. These margins are also highly dependent on crude oil prices.
  • Competitive Landscape: VNOM’s competitive advantage comes down to its skill in acquiring high-quality oil and gas acreage at attractive prices in competitive auctions and then using their capital efficiently.
    • The industry has a lot of players involved and competition is high. Also companies like Diamondback Energy, Inc. have a large capital pool and an extensive team of analysts that can outbid smaller companies like VNOM, making acquiring acreage difficult. Also, larger companies, such as Pioneer Natural Resources, are usually much more proficient and faster in developing their assets.
  • What Makes VNOM Different: What sets VNOM apart is its status as a pure royalty company, meaning it doesn’t operate wells, so it has no operational costs. This is a double-edged sword because while it gives VNOM very high operating margins, it also takes away from control over the profitability of its assets.
  • Other relevant info: The management has significant experience in the Oil and gas sector, and have a long track record of successful operations. The partnership has significant relations with Diamondback Energy as well. The partnership’s revenue is mainly from the Permian Basin and it operates with a very low overhead costs.

Financials in Depth

Viper Energy’s financial health is a mixed bag. The partnership generates strong revenue due to its focus on royalty interests, but its profits and cash flows depend heavily on unpredictable oil and gas prices. Here is a more detailed look:

  • Income Statement Analysis: VNOM has shown great revenue growth in the last 3 years, as revenues went from $345M in 2020 to $667M in 2021, and $976M in 2022. For the nine months ended September 30th, 2023, VNOM generated a revenue of 775M.
    • This also translated to a increase in net income, which went from $131M in 2020 to $258M in 2021 and then again to 547M in 2022. In 2023 YTD, net income amounted to 330M. This increase in net income is attributed to the price surges that happened in 2021 and 2022.
    • While the revenue figures are impressive, they are highly volatile. A small decrease in oil prices would cause a similar decrease in both the revenues and profits of the company.
    • The operating margins are stable and high, meaning the cost of goods sold is very low, as VNOM doesn’t operate any wells themselves.
  • Balance Sheet Analysis:
    • At the end of September 30th 2023, VNOM had approximately $141 million in cash and equivalents, a good indicator of liquidity. Also, the debt was $1.07 billion at September 30th 2023, which is considerable, but is manageable given the company’s consistent income.
    • Goodwill and other intangibles comprise around $3.1billion on the asset side. The rest comes from Oil and Gas properties. Goodwill and intangibles represents a larger part of assets than I personally like. However, it’s not a concern as long as the assets are properly recorded.
    • On the liabilities and Equity side, Limited Partners equity is around $2.2 Billion and the remainder of liabilities consists of operating liabilities, debt, and deferred taxes.
  • Cash Flows: VNOM has been consistently generating positive cashflows, which also translates to higher shareholder distributions, as can be seen in the latest quarterly earnings report for Q3 2023.
    • Operating cashflows were $492M for the nine months of 2023. There is high profitability and positive cashflows. However, this depends on oil and gas prices, which can be volatile.

Moat Analysis: 2 / 5

VNOM’s economic moat is considered relatively weak due to limited control and competitive pressures in the Oil and Gas sector.

  • Intangible Assets: The company benefits from its brand name among the financial community for a pure-play royalty company in the permian basin. Also the management team’s experience and track record helps the credibility. However, those are not tangible competitive advantages. (Low Moat Score: 1 / 5).

  • Switching Costs: Since they are a royalty player that doesn’t actually operate any wells, there is no or negligible switching costs. Their customers are basically other E&P companies, who would be able to very easily switch to other royalty players if they feel the cost-to-profit ratio doesn’t add up. (No Moat Score: 1 / 5).

  • Network Effects: Network effects are not relevant to VNOM as their business doesn’t revolve around the network or any user base of their product or services. (No Moat Score: 0 / 5).

  • Cost Advantages: Their focus on Permian Basin, which is rich with oil and gas reserves, does give them some benefit, but it’s not an exclusive asset since the other E&P companies, such as Diamondback, also have operations in the region. The fact that VNOM does not operate wells does reduce some costs and give them very high operating margins. (Narrow Moat Score: 3 / 5).

Overall, VNOM has no clear structural moat, so I will rate it a 2/5, with that rating being justified mostly by the high operating margins stemming from the royalty model of the company.

Risks and Resilience

  • Commodity Price Volatility: The most significant risk to VNOM is its sensitivity to fluctuations in oil and gas prices. Since their revenues directly relate to commodity prices, a downturn in the market could dramatically affect their financial performance. They do not have the ability to change the prices of these commodities either.
  • Interest Rate Hikes: With the company using Debt to make acquisitions, the rising interest rates would make the debt more expensive.
  • Geopolitical Factors: Global events, such as supply disruptions, conflict zones, and trade wars could affect oil prices and therefore VNOM’s operations.

  • Competition: Even though they operate in the prolific permian basin, they are always competing with other large E&P companies. Other players could try to acquire the land that VNOM is targeting. This competition could raise the acquisition prices.

  • Regulatory Changes: Any new regulations can hurt the oil and gas sector and can reduce production. Government support for green and clean energy could also shift the market.

  • Technological Disruptions: A better technology for production or other methods of alternative energy could quickly change the supply and demand of oil and natural gas, potentially disrupting the sector.
  • High Debt: With VNOM’s significant acquisitions, there is also a substantial level of debt, which may bring risks to the operations.
  • Dependence on Permian Basin: Over reliance on the Permian Basin might mean if anything happens there, VNOM has no way to protect the downside.

Despite these risks, VNOM does have some elements of resilience:

  • Experienced Management: Their management has good experience in the space and have navigated similar situations before.
  • Solid Relationships: VNOM has deep connections with a larger company Diamondback, which helps them in acquisitions.

However, the lack of control over actual production, the high reliance on oil and gas prices, and high debt levels still make VNOM a risky company.

Understandability Rating: 3 / 5

VNOM’s business model is quite simple to understand, they essentially collect royalties from production of oil and natural gas resources. They have no operating costs but are dependent on the overall sector performance, and how well the company is able to select and acquire high-performing royalty interests. However, analyzing the company’s financials requires familiarity with tax accounting for partnerships, and some understanding of the volatile energy sector.

Balance Sheet Health: 4 / 5

  • VNOM’s cash is healthy, with almost $141 million of cash and equivalents.
  • Debt levels are high at $1.07 billion but are manageable given the recurring high operating profits and cash flows.
  • The overall balance sheet is slightly skewed with goodwill and intangible assets making up a good part of total assets.
  • VNOM has been doing a good job in managing its credit and debt and has been comfortably making interest payments.

Recent Concerns/Controversies/Problems and Management Response

  • Lower Production: In the latest quarterly report, while the company beat revenue expectations, they lagged in production. However, the CEO mentioned this is due to several maintenance activities, which will improve production in the future.
  • Decline in Commodity Prices: With decline in commodity prices recently, the management has mentioned they will be focused on increasing free cash flows and are not too worried about fluctuations in commodity prices, as they have a low breakeven price.
  • General market concerns: With the markets being volatile, the management has mentioned that they will be focusing on disciplined capital allocation, instead of chasing growth opportunities. This shows that they are prudent and willing to operate under any circumstances.

Overall, VNOM’s business is relatively simple to understand but has some nuances. Its balance sheet is solid but the high debt levels are always something to keep in mind. The company has some risks due to the nature of its business in a very competitive and cyclical industry, with the price of oil and gas having a big impact on revenues. The moat is narrow and needs constant monitoring. All in all, it’s a good company to invest in as long as you understand its structure and limitations.