Permian Basin Acquisitions May Enhance Market Presence But Squeeze Future Margins

Key Takeaways

• Strategic growth through acquisitions and asset consolidations could enhance Viper's market presence and revenue in a fragmented market.
  
• Mergers and acquisitions, including Tumbleweed and Diamondback, aim to boost production and streamline operations, potentially improving revenues and net margins.
  
• Strategic acquisitions and strong market positioning enhance Viper's operational efficiencies, investor confidence, and revenue growth, supporting shareholder returns and capital allocation strategy.

Catalysts

Owns and acquires mineral and royalty interests in oil and natural gas properties in the Permian Basin, North America.

• The recent acquisition of Tumbleweed, combined with substantial organic growth opportunities on legacy assets, signals expectations for sustained production increases, potentially driving an upswing in revenues moving forward.
  
• The merger between Diamondback and Endeavor, with Endeavor previously being the second largest operator on Viper's royalty acreage, is expected to enhance synergies and streamline operations, potentially improving net margins due to optimized development plans and cost efficiencies.
  
• Viper's strategic growth plans through future mineral and royalty asset consolidations, in what is perceived as a fragmented market, could raise market presence and acquisition revenue as the company leverages increased scale from the recent conversions to a Delaware corporation and its inclusion into major equity indices.
  
• The anticipated strategic drop-down of Endeavor's mineral assets could result in leveraging up at Viper, temporarily impacting net margins but eventually enhancing earnings potential due to Diamondback's increased activity and synergies from combined assets.
  
• Continued capital allocation strategy returning 75% of free cash flow as dividends, while expanding float through equity raises, positions Viper for sustained shareholder returns, which might strain cash available for operational reinvestment or debt servicing, consequently impacting earnings and financial flexibility.

Viper Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Viper Energy's revenue will grow by 14.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 25.9% today to 14.2% in 3 years time.
• Analysts expect earnings to reach $169.9 million (and earnings per share of $1.87) by about December 2027, down from $205.8 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $197.1 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 38.1x on those 2027 earnings, up from 25.4x today. This future PE is greater than the current PE for the US Oil and Gas industry at 11.1x.
• Analysts expect the number of shares outstanding to decline by 21.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.09%, as per the Simply Wall St company report.

Viper Energy Future Earnings Per Share Growth

Risks

• The successful completion of the Tumbleweed acquisition and the continuous organic production growth from Diamondback's development are likely to enhance Viper's revenues and strengthen earnings moving forward.
  
• Viper's alignment with Diamondback and the completed merger with Endeavor, its second-largest third-party operator, could improve operational efficiencies and production capabilities, potentially positively impacting revenues and net margins.
  
• With the company's recent milestone of being added to the S&P MidCap 400 and Russell 1000, Viper has increased its investor base and market trading liquidity, which could support investor confidence and stock price stability.
  
• Viper's disciplined approach in consolidating high-quality mineral and royalty assets positions it as a strategic consolidator in the fragmented minerals and royalty market, potentially boosting future revenue growth and strategic advantage.
  
• The presence of a strong free cash flow and a target payout ratio of 75% of free cash flow to equity, even amidst leverage increases, suggests robust capital allocation strategy supporting shareholder returns and consistent cash flow, thus positively influencing net margins and earnings.

Valuation

• The analysts have a consensus price target of $57.92 for Viper Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $70.0, and the most bearish reporting a price target of just $45.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.2 billion, earnings will come to $169.9 million, and it would be trading on a PE ratio of 38.1x, assuming you use a discount rate of 7.1%.
• Given the current share price of $50.71, the analyst's price target of $57.92 is 12.5% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.