Drop-Down Transaction With Diamondback Will Boost Production Amid Volatility

Key Takeaways

• The transformational deal with Diamondback is set to improve efficiency and production, potentially boosting revenue and cash flow.
  
• Strong financials and credit upgrades support strategic growth through M&A, enhancing future earnings and EPS.
  
• Ongoing market volatility and low commodity prices may lead to decreased revenue, cautious capital retention, and hindered growth opportunities for Viper Energy.

Catalysts

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

• The transformative drop-down transaction between Viper and Diamondback is expected to enhance operational efficiency and production capabilities, potentially boosting future revenue and cash flow.
  
• The company's strong balance sheet and high free cash flow margins position it to endure market volatility, which may lead to strategic opportunities that could enhance future earnings.
  
• Viper's alignment with Diamondback, focusing on wells with high royalty interest, is likely to optimize capital efficiency and support durable production levels, potentially impacting net margins positively.
  
• Viper's exposure to well-capitalized third-party operators, particularly in the Permian Basin, may stabilize and potentially increase production levels, aiding in consistent revenue growth.
  
• Investment-grade credit upgrades provide Viper with enhanced access to capital, enabling strategic M&A activities that could drive future growth and increase EPS.

Viper Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Viper Energy's revenue will grow by 26.6% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 45.6% today to 18.5% in 3 years time.
• Analysts expect earnings to reach $322.1 million (and earnings per share of $2.42) by about May 2028, down from $391.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $378 million in earnings, and the most bearish expecting $247.9 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 54.4x on those 2028 earnings, up from 13.4x today. This future PE is greater than the current PE for the US Oil and Gas industry at 11.3x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.21%, as per the Simply Wall St company report.

Viper Energy Future Earnings Per Share Growth

Risks

• The period of lower commodity prices and significant market volatility is mentioned, which could lead to decreased revenue and profits if these conditions persist.
  
• The decision to retain incremental capital instead of raising the dividend might indicate caution regarding future market conditions, suggesting potential impacts on earnings if the volatility continues.
  
• The potential for a sub-$50 oil price environment could result in decreased activity levels and project delays, which may negatively affect future cash flows and production revenues.
  
• The presence of market volatility makes mineral deals harder to come by, which could hinder growth opportunities and impact future revenue streams.
  
• The reliance on third-party operators and the risk of them pushing projects to the right due to commodity price volatility could affect production levels and thus impact future revenue streams.

Valuation

• The analysts have a consensus price target of $54.571 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 $62.0, and the most bearish reporting a price target of just $48.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.7 billion, earnings will come to $322.1 million, and it would be trading on a PE ratio of 54.4x, assuming you use a discount rate of 6.2%.
  
• Given the current share price of $39.97, the analyst price target of $54.57 is 26.8% 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.