Kimbell Royalty Partners: Yield May Reach 13% In 2024 With 75% Payout Ratio (NYSE:KRP)

Kimbell Royalty Partners (NYSE:KRP) just announced a large $455 million acquisition that should further boost (at least in the near-term) its distributable cash flow. I project that it can now generate $2.51 per unit in distributable cash flow in 2024 at current strip, which would result in a 13.1% yield at its current unit price with a 75% payout ratio.

Longer-term, the effect of this latest acquisition on its distributable cash flow per unit is more uncertain. This is because Kimbell is also issuing Series A Preferred Units that can be eventually converted into common units at a conversion price of $15.07.

I am maintaining my estimated value for Kimbell’s common units at $19 per unit, reflecting the positive impact from its acquisition, offset by the negative impact of the dilution.

Q2 2023 Results

Kimbell reported Q2 2023 production of 18,145 BOEPD. This included 45 days of production from its MB Minerals acquisition as well as 572 BOEPD related to prior period production that was recognized in Q2 2023.

Kimbell had previously expected 17,500 to 19,300 BOEPD in Q2 2023 production (including 45 days of production from MB Minerals), so production was under the midpoint of its guidance for the quarter.

Kimbell maintained its guidance for the second half of 2023, but then subsequently announced the LongPoint acquisition, which I will go into in more detail below.

LongPoint Acquisition

Kimbell is paying $455 million in cash to acquire mineral and royalty interests from LongPoint Minerals II. These assets are located in the Permian (64% of reserve value) and Mid-Continent (36% of reserve value). The Permian assets are mostly in the Delaware Basin.

The acquired assets have next 12 month production (from Q3 2023 to Q2 2024) projected at 4,765 BOEPD (33% oil, 26% NGLs and 41% natural gas). The current production (as of June 1) is approximately 4,840 BOEPD (33% oil, 25% NGLs and 41% natural gas).

For 2024, the acquired assets are projected to average 5,049 BOEPD (33% oil, 26% NGLs and 41% natural gas), indicating expectations for some production growth in the second half of 2024.

Kimbell estimates that the LongPoint assets will generate $64.3 million in cash flow (from Q3 2023 to Q2 2024) at strip prices from July 26. It bases the cash flow calculations on realized prices of $76.61 oil, $2.89 natural gas and $28.40 for NGLs. The $455 million purchase price is thus a 7.1x multiple to the $64.3 million in projected NTM cash flow.

The transaction multiple is higher than Kimbell’s other acquisitions from the past couple years since it appears to include a significant amount of additional locations. The LongPoint acquisition is expected to add 2.56 net DUCs and net permitted locations to Kimbell’s line of site inventory, plus another 16.63 net upside locations. Kimbell also expects that it can maintain flat production now with 5.8 net wells per year, compared to 4.9 net wells per year prior to this transaction.

Acquisition Financing

Kimbell is financing the acquisition via a combination of common and preferred units. It announced an offering of 7.25 million common units at $14 per unit, bringing in $101.5 million in gross proceeds. Kimbell is also planning on issuing up to $400 million in 6.0% Series A Preferred Units to Apollo.

Kimbell mentions that of that $400 million total, $325 million “is provided as a firm commitment”, while the other $75 million is issuable at Kimbell’s option. For the purposes of this report, I will assume that Kimbell issues the full $400 million.

These units will be convertible into common units (under certain circumstances) at a conversion price of $15.07 per unit. Full conversion of the Series A Preferred Units would add 26.54 million common units.

These offerings will bring in $501.5 million in gross proceeds, with the potential for more if the underwriters exercise their option for another 1.0875 million common units. With those additional common units, Kimbell will have close to 95 million common units outstanding.

After commissions and other expenses, this should still be enough to fully cover the purchase price of the acquisition as well as pay down a bit of Kimbell’s credit facility debt.

2024 Outlook With LongPoint

I am modeling Kimbell’s production at slightly over 24,000 BOEPD in 2024 now. This assumes 5,049 BOEPD from the LongPoint acquisition and 19,000 BOEPD from Kimbell’s existing assets, which is in-line with its 2H 2023 production expectations before this acquisition. Kimbell’s oil percentage remains at approximately 34%.

At current 2024 strip prices (including roughly $76 WTI oil), Kimbell is expected to generate $345 million in revenues inclusive of $3 million in positive hedge value.

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Kimbell is projected to generate $238 million in distributable cash flow for 2024 now, or approximately $2.51 per unit with Kimbell’s common unit count at approximately 95 million.

This is a 12% increase from the projected $2.25 per unit in distributable cash flow that Kimbell would generate in 2024 at current strip without the LongPoint acquisition (and associated preferred and common unit offerings).

However, if the Series A Preferred Units were fully converted into common units, then Kimbell would end up with $2.16 per unit in distributable cash flow at 2024 strip prices and slightly over 24,000 BOEPD in average production. This would be a 4% decrease per unit compared to the projections without the LongPoint acquisition.

The Series A Preferred Units are generally not convertible into common units for at least two years and also requires Kimbell’s common unit price to be at least $19.59 per unit. Thus, Kimbell’s distributable cash flow per unit should be boosted by the deal for at least two years, but after that the effect is more uncertain.

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At a 75% payout ratio, Kimbell would be able to pay a quarterly distribution of approximately $0.47 per common unit during 2024.

Valuation

I am maintaining my estimate of Kimbell’s value at $19.00 per common unit at my long-term commodity prices of $75 WTI oil and $3.75 NYMEX gas. I believe that Kimbell paid a fairly good price for its LongPoint acquisition. However, the additional dilution (including the potential Series A Preferred Unit conversion to common units) at an average price of under $15 per unit offsets that impact on Kimbell’s value.

The LongPoint acquisition should boost Kimbell’s distribution for the next two years, although its effects are more uncertain after that due to the potential Series A Preferred Unit conversion.

Conclusion

Kimbell’s LongPoint acquisition should result in a near-term boost to its distributable cash flow, and I now project that it can generate $2.51 per unit in distributable cash flow in 2024. At a 75% payout ratio, this would result in $1.88 per unit in distributions, or a 13.1% yield based on Kimbell’s current unit price.

The conversion of Kimbell’s Series A Preferred Units could result in it having 121 million to 122 million outstanding common units, and would likely decrease its distributable cash flow per unit. Conversion cannot typically happen for at least two years though.

I estimate the value of Kimbell’s common units at $19 per unit based on long-term $75 WTI oil and $3.75 NYMEX natural gas.