Kimbell Royalty Partners stock: very profitable with a return of more than 10% (NYSE:KRP)
Since last discussing Kimbell Royalty Partners (KRP) in my previous article, oil prices have strengthened further in the second half of 2021 and have seen their payout yield rise in tandem to now reach a high of 9.34 % against its return of 6.78% last time. Looking ahead, it looks like business is business as usual in 2022, albeit very profitable with a very high return of 10%+ all but assured thanks to the very strong oil price outlook as shown in this follow-up article which also reviews them then published the results for the second half of 2021.
Executive summary and ratings
Since many readers are likely short on time, the table below provides a very brief summary and scores for the main criteria assessed. This Google document provides a list of all my equivalent ratings as well as more information about my rating system. The following section provides a detailed analysis for readers wishing to delve deeper into their situation.
*Instead of simply assessing distribution coverage through distributable cash flow, I prefer to use free cash flow as it provides the strictest criteria and also best captures the true impact on their financial position.
Following the continued rise in oil prices during the fourth quarter of 2021, it was not surprising to see their cash performance follow in tandem with their operating cash flow ending the year at 91.4 million. million, thus reaching more than double its result of 44 million dollars during the first half of 2021 and thus pointing to an acceleration. In addition to representing a strong recovery from their previous result of $62.2 million in 2020, it also beats their previous best result of $80.8 million in 2019 and thus marks a new high point. Thanks to their variable distribution policy which ties their distributions to their free cash flow, this has also seen their distribution payouts reach a new record of $47.3 million in 2021 with a strong coverage of 135.30%.
Looking ahead, the current very strong outlook for triple-digit oil prices in 2022 should see their payouts even higher than in 2021, as their free cash flow should increase in parallel, although the magnitude exact cannot necessarily be quantified due to the high level. oil price volatility. Although it is technically possible that oil prices will crash later in 2022, this seems unlikely after the Russian-Ukrainian war, which has further worsened an already very optimistic outlook that had already seen many analysts talk of three-digit oil prices even before the war. Given the new possibility that lost Russian oil production will further tighten an already tight market, it seems reasonable to expect these currently very high prices to persist through 2022 and possibly even into 2023, thus raising their cash performance and therefore their distributions to new heights.
Due to the very low capital intensity of their mining rights operations, the only other variable with respect to their distributions is their capital allocation strategy. Since they operate with a variable payout policy, if they increase the relative share of their free cash flow going to their unitholders, this would also help increase their distributions, although this seems unlikely to happen in 2022. with their capital allocation strategy which should remain unchanged. , according to the management commentary included below.
“I think you’re right that for the duration of this year we’re going to maintain 75%. I think you’re right to point out that the ratio is just going to keep accelerating downward because we have a greater amount of cash flow and therefore 25% of that cash flow is just going to create further decline overtime leverage.”
– Kimbell Royalty Partners Q4 2021 conference call.
We can see that management seems determined to keep its capital allocation strategy and therefore its variable distribution policy unchanged in 2022, with 25% of its free cash flow being retained to help deleverage. It appears that management wants to see its net leverage ratio at 1.00 or less, per the management commentary included below, which will likely take a number of years to achieve, as discussed later.
“I think a few years ago, maybe 5 to 10 years ago, if you had asked us what the appropriate level of debt would be for the royalty business, we would have said less than twice the debt compared to EBITDA. That was kind of a rule of thumb for upstream E&P companies, so certainly for a mining company with no CapEx obligations below 2x seems perfectly reasonable. I think when we look at the environment, when we look at the best governance of its category on E&P companies, I think that has changed now to probably be less than ad hoc.
-Kimbell Royalty Partners Q4 2021 Conference Call (previously linked).
Despite strengthening their cash performance throughout the second half of 2021, their net debt actually increased to end the year at $210.1 million, 40.07% above its $150 million level. dollars during the previous analysis. This primarily relates to their additional $54.8 million in oil and gas property acquisitions, as well as various other relatively small miscellaneous cash outlays, such as loan origination costs. By 2022, unless there are new acquisitions, their net debt will tend to decline as they will retain 25% of their free cash flow, but the magnitude obviously remains uncertain as it depends on highly volatile oil prices.
Unsurprisingly, their higher net debt resulting from their acquisitions pushed their leverage higher after the second half of 2021 with their net debt to EBITDA and net debt to operating cash flow ending the year at 2.41 and 2.30 respectively. In addition to being above their results of 1.40 and 1.48 in the previous analysis that followed the first half of 2021, their new results are now in the moderate territory between 2.01 and 3, 50. Meanwhile, their net leverage ratio that management uses ended 2021 at just 1.7, as shown in slide five of their spring 2022 investor presentation, which differs from my net debt to EBITDA ratio primarily due to the different treatment of gains on derivative instruments. Fortunately, from a financial stability perspective, there is no day and night difference between these results, especially given their capital allocation strategy which matches their cash outflows to their cash inflows, excluding acquisitions.
Looking ahead, the very strong oil price outlook for 2022 makes it highly likely that their leverage will plunge simply due to the higher earnings component from 2021, which could quickly see management achieve its net debt target of 1.00 or less. While oil prices are unlikely to stay above $100 a barrel forever, that alone seems unlikely to push management to increase the share of its free cash flow allocated to distributions. Using their 2021 earnings as a basis, reducing their net leverage ratio from 1.70 to 1.00 would require a significant reduction in their net debt of 41.18%, which equates to $86.6 million. dollars and so since that’s roughly equal to their entire operating cash flow for 2021, it’s likely to take several years to get there.
Even though their leverage has increased, fortunately their liquidity has remained broadly unchanged after the second half of 2021, with their current ratio dropping to 1.60 from its previous result of 1.33, thus roughly negating their leverage ratio. cash which decreased to 0.25 from its previous result of 0.45. . Meanwhile, their credit facility which houses all of their debt has seen its borrowing base increase to fund their acquisition, although at $275 million it remains only slightly above 217.1. millions of dollars that they have already taken. Fortunately, their capital allocation strategy means it should no longer be needed and should see its availability increase as their 25% retained free cash flow repays its withdrawals, in the absence of any future acquisitions, helping thereby smoothing out any need for refinancing in June 2024 when it matures.
After a year of high oil prices in 2021, it looks like looking ahead, 2022 will represent another year of status quo with the same capital allocation strategy. Although, fortunately, with the current very strong outlook for oil prices, it still looks to be very profitable, with the triple-digit oil price outlook potentially lining up with record payouts. Given that their payout yield is already at a high 9.35%, even without any further increases, I now think a move to a buy rating is appropriate with a very high yield of 10%+ for 2022 virtually assured.
Notes: Unless otherwise stated, all figures in this article are from Kimbell Royalty Partners’ SEC Filingsall calculated figures were performed by the author.