Riley Exploration Permian, Inc. (REPX) Earnings Call Transcript & Summary

Today, it's a pleasure to host a fireside chat with Riley Exploration Permian. Joining us from the company today, we have Bobby Riley, Chairman and CEO; and Philip Riley, the company's Chief Financial Officer. Before we begin, I would like to remind participants that today's discussion could include forward-looking statements as of today, April 10, 2024. Disclosures regarding such statements can be found under the Investor Relations tab of Riley's corporate home page. Bobby, with a little bit of housekeeping out of the way, and Philip, thank you, and welcome.

Thank you, Jeff.

For those who may not be as familiar, Riley is a growth-oriented independent oil and gas company. They're focused on the acquisition, exploration, development and production of oil, natural gas and NGLs, primarily in the Permian Basin. Management strategy is to build long-term shareholder value by developing Riley's existing assets and investing to grow the base, while at the same time maintaining a conservative financial posture to return cash to shareholders through a sustainable dividend. As I said, the company's asset base has concentrated in the Permian Basin, primarily in Yoakum County, Texas on the Northwest Shelf and in Eddy County, New Mexico. I think one thing as we look at the stocks today, the dividend on the dividend yield this morning was about 4.8%. Most of the assets that the company has are conventional assets and are developed with modern drilling and horizontal drilling and modern completion techniques.

So Bobby and Philip, I'd like to start just with the capital allocation model. Bobby, can you talk about how the Board structures the capital program to optimize returns for shareholders?

Yes. Sure. I'll give a shot at that. Thank you for having us on today. We enjoy these types of things, share some information. I think one of the best basic principles that appears -- appeals to our Board is our ability to develop assets with a moderate year-over-year growth, while spending around 50% to 60% of our cash flow. That further allocation allows us to pay our fixed dividend that we like to set with a moderate growth profile year-over-year and then the balance to debt pay down.

You talked about the dividend, and as I said in my outset that the sustainable dividend has been a fixture of the company's business strategy since you came public. Does the dividend allocate -- or just what role does the dividend play in your capital allocation process?

We paid dividends now for 20 quarters in a row, dating back to before we became a public companies. Ideally, we would like to modestly grow our dividend year-over-year. Mindful, however, of not wanting to ever have to cut the dividend. Return of capital through our quarterly dividends is one of the primary goals and is well received from our Board and our shareholders.

Bobby, it's for that commitment to the dividend and outgrowth of your history with other private companies and working with private investors.

Well, I think building a profitable company with a healthy balance sheet appeals to both public and private investors paying a sustainable dividend as a milestone that we achieved at Riley Permian early in our history. We were fortunate to have quality assets in our portfolio that enable us to execute on this corporate objective.

Philip, can you talk a little bit about how the balance sheet factors into capital allocation decisions, obviously, to reinvest 50% of cash flow for growth and pay a sustainable dividend, you also have to focus on maintaining low leverage.

Yes, sure. It might be helpful to back up to this time last year, almost exactly a year ago, we just closed on an acquisition about 15x the size of this -- the smaller one we're just announcing now. And we financed it solely with debt. We entered that deal largely unlevered, so we had more debt capacity. And the plan was to pay that down organically, and we've executed on that plan. An example is the $30 million of debt we paid down in the fourth quarter of 2023 alone. So when we look at something like the small acquisition now, we could have funded it in a number of ways. We have debt capacity, but we're also mindful of maintaining some flexibility for other opportunities we see out there. So the small primary issuance we just did made sense to us. I guess I'd add that we don't have an explicit quantified threshold for leverage targets, but for reference, at the current pace and absent something new, we forecast landing around 1x debt to EBITDA at year-end '24 based on $75 WTI for the remainder of the year. And at the current market value, that would be just over 30% debt to enterprise value, which feels reasonable.

The issuance you mentioned last week, Riley, priced a 2.1 million share offering, which included 700,000 primary shares and 1.4 million shares that were sold by selling shareholders, and the proceeds were used or will be used to fund an acquisition of about 12,500 net acres in Eddy County, New Mexico. The selling shareholders in the offering still, I think, own about 33%. That's before the [indiscernible] exercise number. Philip, can you provide any color around their thought process and what you see is how that enhances the liquidity of Riley's trading?

Sure. Yes, both the selling shareholders and we, the company and the Board, rationalized it a few ways. First, the selling shareholders are referencing they've never done a stock sale. Yorktown had done a couple of small direct distributions, while Bluescape had never sold a share or done any distribution. So this is only a small 13% reduction in each of those party's holdings, and they still own a combined 43%, not 33%, of the combined company after the deal. Second, it's important to the company to increase our shareholder base and trading liquidity. We're fortunate to hear from quality long-only investors that they'd like to build a position in our stock, but express a desire for increased float. The selling shareholders recognize that too. And we hope the small sale benefits the remaining 87% that they still own of their positions.

As I said earlier, Riley's asset base is concentrated in conventional reservoirs in the Permian Basin. The approach is to use horizontal drilling and modern completion techniques to extract more value from those fields. How does the production profile and the capital intensity of conventional assets support your strategy to invest roughly half of cash flow depending on prices and pay the dividend and maintain the balance sheet?

Bobby, you want to take that?

Yes. Well, why don't you go ahead, Phil? You were asking about maintaining the balance sheet.

Yes. I'd say it's a mixture of -- it's a few things. As we look at our capital program this year, we're looking to cut that a few ways. We're excited about that. And obviously, that has positive impacts on the balance sheet. We've been able to cut the outlook for spending this year is a few ways. It's both the market dynamics and then what we're doing internally. I guess to start with the latter, it's pretty exciting, the type of efficiencies, our teams have been able to generate this year. We're setting records for drilling wells amazingly fast. We're doing [ zipper ] fracs to save money on development there. So those are all exciting. At the same time, we're seeing a more competitive landscape on the service suppliers. The consolidations we see in the upstream mergers and so forth, every time you've got one of those, it takes a customer out of the landscape, and that's led to the service companies to be competitive because they're wanting to maintain market share. So we're trying to lock in some of those services. We also see some fantastic reductions in steel costs based on what you see coming out of China and so forth.

The guidance for this year reflects about a 10% reduction in capital costs that you alluded to, Philip, and about a 10% increase in oil production. When you think about the conventional asset base and owning assets across 2 core areas, some of the flexibility and the profile of those assets, is that what underpins the ability to grow at a pretty nice oil production rate and yet still grow at a lower capital spending rate?

Yes, potentially. I mean, we certainly appreciate having more flexibility now. We're constantly assessing a host of variables anytime we're looking at development plans. But we look at the variables across both regions, including preferred location focused by our geosciences team, development cost dynamics, infrastructure and so forth. Fortunately, with 100% held by production status and our land across both assets, nearly 100% HBP, we have no land-based pressures, nearly 0 drilling obligations. So that creates a very valuable option for us.

We touched on Eddy County acquisition, the acreage acquisition, which is essentially a bolt-on to the assets that Philip, you mentioned acquiring in April of 2023. Is the desire to get bigger there? Is that really driven by just the success you all have had so far on the assets acquired last year?

Yes, Jeff, I think it will, for sure. It allows us to capitalize on infrastructure build-out for assets that are contiguous that we can get more economies of scale and spread that expenditure out over a larger asset base. So I think it will help improve our overall economics.

I think these assets add 20 to 25 net undeveloped horizontal locations. How does -- how do those fit into the 2024, kind of 2025 capital program? Or are they kind of fungible with what you have on the existing footprint?

Yes, you're right. It's a fungible thing. It just allows us flexibility in our drilling schedule. We want to bring wells online at the same time that we have our gas takeaway and our water takeaway infrastructure and service. So we just plug and play.

Philip, you mentioned that most of your acreage across the company's asset base is held by production. I think the New Mexico acreage is about 99% HBP. Bobby, are there any permitting issues that you have to contend with for New Mexico wells between how the land is set up?

It is. It's sometimes challenging is a process, though, that you just have to get your hands around and understand. We have a number of approved permits in hand now, and the process has started for additional drilling permits. So knowing and understand the process is key and manageable.

Philip, this is obviously a bolt-on. Are there incremental opportunities to either add working interest in the assets you are -- have acquired and are acquiring, or is there other acreage in the area that you might be able to continue to expand this footprint?

Yes, absolutely. And frankly, in all sizes. We like these small bolt-ons as they allow for easy execution and integration. They lead to immediate synergies and increased optionality, as I was discussing before. Though we're also seeing midsized and larger-sized opportunities percolating, which we're watching. There's certainly been no shortage of M&A discussion in the market over the past 6 months. We're always looking at opportunities ourselves, and we certainly appreciate the benefits of scale. But we're not going to grow just for the sake of it. Asset quality still matters and that, of course, directly translates into return on capital metrics that are important to us.

I think I did a quick tally, not long ago, and there have been more than $200 billion of announced E&P transactions. And I'm sure that missed quite a few as well. Bobby, in your experience, when you see consolidation, especially among bigger companies, how long does it take? Or how long could it take for some of those assets to filter down into the market as people try to rationalize their portfolios?

No, I think it's pretty quick. I think they've got those on a -- in a bucket that tells them where that is. So I would expect within the next several months that we'll start seeing assets put out in packages from some of the majors.

One of the things that Riley really stresses is adding value through efficient operations. Bobby, you mentioned some of the things you think you can do in Eddy County. Are there -- do those synergies factor into how you think about acquisitions and pricing acquisitions? Or are those synergies that you really think that you look to, to be able to add value once you've acquired an asset?

We look for the synergies right off the bat, especially from infrastructure. This small asset that we're building -- or we're closing on here in the near future is bringing in, for example, to service water disposal wells that will integrate into our gathering system across the field. So it will blend in nicely and gives us immediate capacity increase. So a lot of things there will bring synergies as we move forward.

Bobby, is that saltwater disposal infrastructure allowed you to put more water on pipe and eliminate trucking costs?

We don't truck any water. That would just -- it would just be too expensive to do that. So it will give us excess injection capacity, which -- the more capacity we have, the slower we can pump it, less pressures, more efficient. So it helps us tremendously to add on to that water infrastructure system.

One of the value-add business ventures that Riley undertook took last year actually could have been a little bit overshadowed by the original Eddy County acquisition, which was announced, I think, around the first part of March was a power joint venture to generate baseload electricity to serve the Champions area in Yoakum County. That power facility became operational in the fourth quarter of '23, and I think now is supplying 35% to 40% of the electricity that Riley consumes in Yoakum County. Bobby, along the lines of adding value, how did the power generation idea kind of come into play and percolated into the joint venture that you formed?

Yes, Jeff. As you know, gas prices in the Permian are extremely weak. We were looking for ways to take a dislocated asset, basically our residue gas and create a more valuable outcome for us.

So essentially add value to something that you were giving away or in some quarters paying someone to take?

Yes, that's true. So the power deal, it's going to create a lot more reliability for us as far as our operations are concerned. We run a number of electric submersible pumps, and when you have power outages, sometimes those -- that equipment doesn't come back on, and it's a very expensive workover to go and replace that. So we feel like being in control of our baseload power consumption is going to create a lot more increased run times on our Downhole equipment and ultimately reducing our leasehold operating expenses.

Philip, in terms of value and LOE and things like that, is it possible to quantify the economic benefit of lowering costs and extracting more value from to produce natural gas instead of giving it away?

Yes. Jeff, at the moment, we haven't guided to a material change in our OpEx. Electricity is just one small part of the overall operating expense we incur managing the business. What we hope, as Bobby said, is it leads to more reliability, anytime you're producing more oil. In general, that's your numerator when you're looking at per BOE stats and so that should help. Another way to think about it is we're pretty confident that we're locking in a price here. And so you've got -- if you're buying off the grid, those are always subject to escalation, pretty standard escalations we're seeing here. And so we're hopeful that we're at least locking that in. And then you had another way, this is more on the capital side, not the OpEx. But we're seeing more opportunities just like a lot of the industry to electrify the field. An example is running our drilling rig. The most recent rig campaign we had out here, we powered that with electricity, using that versus diesel is typically less expensive. I think people are more and more seeing that. You're seeing that trend continue. So we're pretty excited about that.

How much of your residue gas is going to be consumed by this initial power facility. And is there the opportunity to grow that over time?

Yes. So in Texas, our midstream partner is nearly completing a material expansion at their plant. That should lead to significant increase in our process gas sales, the residue that Bobby referenced. So accounting for that expansion, I'd estimate the power consumes a bit less than 20% of total net residue sales. And then I guess the second part of your question, are there -- is there room for expansion? Definitely, and we're focused on it. We view this self-generation project really as a proof-of-concept phase with hopefully more to come. Broadly, most industry analysts forecast the gas midstream egress constraints to persist corresponding with sustained large negative basin [ diffs ], like Bobby mentioned and like you see at Waha. So we're certainly seeing scenarios with excess low-cost gas that we could use as a feedstock to create additional value.

Bobby, is this an issue that could also offer an opportunity into Mexico?

Yes. We do see opportunities to provide our base load eventually in New Mexico as well. The first step in that is installing primary meters so that we can take power from one point and then self-distribute to all our wells. So we're in the process of kind of laying out that grid work now. So that as we start more aggressively developing that New Mexico asset, we'll have that at our fingertips to be able to provide our own self-generated power.

Bobby, I guess if we bring this to a close, we've talked about the life cycle approach to managing production assets and adding value through enhanced operations, all in support of growing production, reinvesting less than cash flow, using the balance to pay a sustainable dividend. Can you just summarize maybe for people how are -- your thoughts on how Riley's model supports the Board's drive -- or the Board's goals to drive value?

Yes. I think we've talked about several of those points on today's call. But -- here at Riley, we continue to focus on opportunities to extend development of underdeveloped conventional reservoirs through modern horizontal drilling and completion methods. In other words, when we look at a project, a key step is to look at what we feel was the original oil in place, determine what has been produced and what resource -- recoverable resource looks like. So sometimes lower quality reservoirs, i.e., lower porosities and permeabilities that were marginal vertical wells perform nicely with horizontal development. So we were able to connect more of the rock to the wellbore to get a much more -- much larger and efficient drainage system. So by focusing on finding quality assets and through our subsurface evaluation and applying a disciplined capital approach, we feel like we can continue to drive long-term value for a long time.

Bobby, is it safe to say, based on your comments about conventional assets and Riley's approach that the horizontal drilling shale revolution, which essentially commercialized noncommercial formations or significantly enhance their value has similar applications in underdeveloped conventional assets across the Permian, and that creates the opportunity for Riley?

Absolutely. I mean, that's the key is the reservoir has already been discovered and pretty much outlined and then we look at, is it underdeveloped and what can we do to optimize recoveries through horizontal drilling.

Very good. I think we'll leave it there for today. We look forward to hosting another fireside chat with you, Bobby and Philip in the near future. And I want to thank you so much for your time today.

Yes. Thank you, Jeff.

Thank you.

Thank you.