Fitch Ratings has upgraded the Long-Term Issuer Default Ratings (IDRs) of Viper Energy, Inc. and Viper Energy Partners LLC to 'BB' from 'BB-'.

Fitch has also upgraded Viper Energy Partners LLC's senior secured revolving credit facility to 'BBB-'/'RR1' from 'BB+'/'RR1' and Viper Energy, Inc.'s senior unsecured notes to 'BB'/ 'RR4' from 'BB-'/'RR4'. The Rating Outlook is Stable.

The upgrades and 'BB' IDR reflect Viper's increased size and scale, high-margin cost structure and lack of capex, strong credit metrics and Fitch's expectations for consistently positive FCF generation through the forecast. Viper's ratings also reflect its non-operated status, which Fitch believes is mitigated by its strategic relationship with parent Diamondback Energy, Inc. (NYSE: FANG; BBB/Rating Watch Positive), providing unique visibility into development plans, and the company's differentiated third-party strategy.

Key Rating Drivers

Increased Size and Scale: Fitch views Viper's meaningful growth in production, acreage and reserves as commensurate with 'BB' category thresholds for a mineral and royalty interest owner. Viper's production size has grown by nearly 40% since FY 2022 and 60% since FY 2021 through a combination of accretive M&A activity and organic growth initiatives. Fitch forecasts 2024 full-year production of 47 Mboepd (56% oil) with low-to-mid single-digit growth thereafter.

Fitch recognizes potential drop-down transactions following the pending merger between parent Diamondback and Endeavor Energy Resources, L.P. (BBB-/Positive Watch) could further enhance Viper's scale. However, impacts to the credit profile would be subject to the magnitude and funding mix of potential transactions.

Unique Asset Base: Viper's asset base is unique relative to growth-oriented independent exploration and production (E&P) companies. Viper owns and acquires mineral and royalty interests in oil and gas properties across the Permian Basin. Viper's net royalty acreage is highly contiguous and largely undeveloped; in the core of the Permian, it is less than 35% developed. Given the royalty structure, the asset requires no operating expenses and provides organic growth opportunities without any capex, resulting in higher margins than operating peers in the Permian.

FANG-Linked Production: Fitch forecasts Viper's net royalty production attributed to parent Diamondback Energy, Inc.'s operating activity to be maintained at approximately 60%-65%. Diamondback's highest-return wells are on Viper's net royalty acres in the Northern Midland Basin, and management expects Diamondback will continue to target this acreage in the near and medium terms. Fitch believes this linkage provides a production floor and drives Viper's production growth through the forecast. Fitch expects Viper's production growth from third-party operators to remain in the low- to mid-single-digit range.

In general, Viper has strong insight into Diamondback's volumes and drilling plans, given their shared management team. This reduces volumetric and cash flow risks, and provides considerably less visibility and certainty around volumes from third-party non-operated interests. Consolidation of mineral interests on third-party acreage could result in additional cash flow risk in the longer term. Viper attempts to offset this risk by targeting royalty interests on acreage that is highly contiguous and core to key third-party operators, including Pioneer Natural Resources Co. (AA/Stable) and Endeavor Energy Resources, L.P. (BBB-/Positive Watch), which is slated to merge with FANG in 4Q24.

Distribution Policy Provides Flexibility: Management's variable distribution rate of at least 75% of FCF rewards shareholders, while the remaining 25% provides Viper additional financial flexibility and capital optionality. The company's high margin profile and lack of capital costs supports robust FCF generation throughout Fitch's price deck. Fitch expects post-dividend FCF to be allocated toward repayment of the revolver in the near term and believes a portion could be used for M&A funding in the medium term.

Sub-1.5x Leverage Metrics: Fitch forecasts Viper's debt/EBITDA of 1.3x in 2024 at Fitch's $75 WTI price. Fitch expects leverage will remain below 1.5x in the outer years of the forecast following continued repayment of the revolver borrowings and low to mid-single-digit production growth.

Near-Term Hedging Program: Fitch expects Viper to maintain a near-term focused hedge program to protect from extreme downside while maximizing upside exposure. Currently, the company is hedging approximately 60% of its 2H24 oil production through deferred premium put options with an average strike price of $55/bbl. Management is also hedging Midland-Cushing oil basis and Waha natural gas basis to protect against in-basin price fluctuations, which have been volatile recently.

As leverage continues to improve, Fitch believes management will reduce overall hedge coverage but will continue to retain extreme downside protection through puts in order to maintain liquidity, fund distributions and repay debt.

Uplift from Linkage with Parent: Viper's IDR receives a one-notch uplift due to the moderate linkage between the company and its higher-rated parent, Diamondback. The linkage reflects the lack of strong legal ties (debt guarantees and cross defaults); weaker strategic ties, given Viper's low overall financial contribution; and moderate operational ties, as the companies have shared management personnel, including the same CEO, and as Diamondback generates stronger unit economics on Viper acreage.

Derivation Summary

Viper is an independent E&P company focused on owning the mineral interests of the liquids-oriented Delaware and Midland basins, with 1Q24 net production of 46.6 thousand barrels of oil equivalent per day (Mboed) (55% oil). Production size, due to the nature of the royalties business, is substantially smaller than its 'BB' category E&P peers Matador Resources Company (BB-/Positive; 150 Mboepd), SM Energy Company (BB-/Stable; 145 Mboed) and Vermilion Energy Inc. (BB-/Stable; 86 Mboed). Viper's production is larger than mineral and royalties peer Sitio Royalties Operating Partnership, LP (B+/Stable; 35.7 Mboepd).

As a minerals owner, Viper has minimal operating costs, which results in a Fitch-calculated unhedged cash netback of $39.2/barrel of oil equivalent (81% margin) for 1Q24, among the highest of Fitch's aggregate E&P peer group. This compares favorably to Sitio ($34.7/boe) Matador ($36.0/boe), SM (28.9/boe) and Vermilion ($23.3/boe). Viper's high unhedged cash netbacks and lack of capex result in peer-leading EBITDA margins and pre-dividend FCF margins.

On a debt/EBITDA basis, Fitch forecasts Viper's leverage at 1.3x in 2024 and remaining below 1.5x in the outer years of the base case at midcycle prices through production growth and reduction of revolver borrowings. Debt/EBITDA metrics are in line with the 'BB' category thresholds and Fitch's Permian-focused E&P peer group.

Key Assumptions

West Texas Intermediate oil prices of $75/bbl in 2024, $65/bbl in 2025, $60/bbl in 2026 and $60/bbl in 2027 and $57/bbl in 2028;

Henry Hub natural gas price of $2.50/mcf in 2024, $3/mcf in 2025 and 2026 and $2.75/mcf thereafter;

Single-digit production growth throughout the forecast;

Distribution rate of 75% in 2024 and thereafter;

FCF after dividends used to repay revolver borrowings;

No material M&A activity through the forecast.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade

Improving operational and/or strategic ties to Diamondback that leads to a stronger parent-subsidiary linkage;

Increased size and scale, resulting in midcycle EBITDA sustained above $750 million while maintaining a strong relationship with Diamondback;

Midcycle debt/EBITDA maintained below 2.0x on a sustained basis;

Leverage sensitivities are consistent with higher-rated peers and are unlikely to change upon future rating upgrades.

Factors that could, individually or collectively, lead to negative rating action/downgrade

Erosion in Diamondback's credit profile or material reduction in parent support for Viper (on an ownership, acreage or production basis);

Change in financial policy, particularly regarding publicly stated leverage targets and debt-funded M&A appetite;

Midcycle debt/EBITDA above 3.0x on a sustained basis.

Liquidity and Debt Structure

Adequate Liquidity: At March 31, 2024, Viper had cash of $20 million and $577 million of borrowing capacity under the revolving credit facility ($273 million outstanding; $850 million of elected commitments under the $1.3 billion borrowing base). Fitch believes management's financial policy decisions will continue to reward shareholders through distributions and buybacks in the near term but will also allow for repayment of the revolver.

Fitch recognizes Viper and its board has discretion to reduce its shareholder distribution percentage to preserve liquidity and/or pay down additional debt, consistent with its strategy in 2020 when the return of capital was cut to 25%.

Issuer Profile

Viper Energy, Inc. and its subsidiary Viper Energy Partners LLC own the oil and gas mineral, royalty, overriding royalty, and similar interests operated primarily by its parent company Diamondback Energy, Inc. and third parties in the Permian basin.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

MACROECONOMIC ASSUMPTIONS AND SECTOR FORECASTS

Click here to access Fitch's latest quarterly Global Corporates Macro and Sector Forecasts data file which aggregates key data points used in our credit analysis. Fitch's macroeconomic forecasts, commodity price assumptions, default rate forecasts, sector key performance indicators and sector-level forecasts are among the data items included.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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