Kimbell Royalty: Weak Near-Term NG Prices Weigh On 2023 Projections

Kimbell Royalty Partners (NYSE:KRP) is now looking at a lower amount of distributable cash flow in 2023 due to natural gas strip falling to near $3. Despite its recent acquisition of oil-heavy Permian mineral and royalty interests, its 2023 production still will likely be around 55% to 60% natural gas. Kimbell’s hedges aren’t that helpful either since at last report they cover under 20% of its 2023 production and were mostly added when commodity prices were lower than they are now.

This results in a projection that Kimbell can generate approximately $2 per unit in distributable cash flow in 2023 at current strip. This would lead to a $0.375 per unit quarterly distribution with a 75% payout ratio. Kimbell’s 2024 distribution cash flow may be stronger than 2023 due to expectations for a rebound in natural gas prices plus better hedges.

Kimbell’s Hatch acquisition is helpful due to its higher oil percentage (57% oil) and oil prices holding up much better than natural gas prices. Due to weaker expectations for 2023 natural gas prices, I have trimmed my estimated value for KRP stock to $19.50 per unit, but still believe that $4.00 Henry Hub natural gas is a reasonable longer-term expectation.

Notes On Hedges

Kimbell’s hedges cost it a fair bit of money in 2022, as it paid $37 million in derivative settlements during the first three quarters of 2022. Kimbell’s hedging situation for 2023 is improved, although it still has legacy hedges that were mainly added when commodity prices were pretty low. It also does not appear to have added a large amount of 2023 hedges when commodity prices improved.

Thus Kimbell’s 2023 hedges include approximately 16% of its oil production hedged at $59.35 and approximately 19% of its natural gas production hedged at $2.90. It has some 2024 hedges that are at better prices, but its 2023 hedges still have negative value at current strip prices.

These hedges are reported as of September 2022, and it is currently unknown if Kimbell added more hedges in conjunction with its Hatch acquisition. Kimbell did not report having any basis hedges, so it is exposed to the wider natural gas differentials that are expected for at least the early part of 2023.

Updated 2023 Outlook

The current strip for 2023 is now approximately $80 WTI oil and $3.10 Henry Hub natural gas. Approximately 58% of Kimbell’s 2023 production is expected to be natural gas after factoring in its Hatch acquisition.

Kimbell is now projected to generate $230 million in revenues before hedges in 2023 at those commodity prices. Kimbell’s 2023 hedges have an estimated value of negative $7 million. I am continuing to model Kimbell’s production at a bit over 18,000 BOEPD in 2023. Natural gas production growth may tail off in the latter part of 2023 in response to weak natural gas prices, although that should lead to improved prices for 2024.

Type	Barrels/Mcf	Realized $ Per Barrel/Mcf	Revenue ($ Million)
Oil (Barrels)	1,883,035	$78.00	$147
NGLs (Barrels)	903,740	$31.00	$28
Natural Gas [MCF]	22,746,800	$2.30	$52
Lease Bonus and Other Income			$3
Hedge Value			-$7
Total			$223

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The lower current natural gas strip for 2023 reduces Kimbell’s projected distributable cash flow in 2023 to $158 million. This is around $2.00 per unit assuming 79 million outstanding units.

If Kimbell goes with its current 75% payout ratio, that results in approximately $1.50 per unit in annual distributions, or approximately $0.375 per unit each quarter.

	$ Million
Marketing And Other Deductions	$18
Production Costs And Ad Valorem Taxes	$17
Cash G&A	$17
Cash Interest	$13
Total Expenses	$65

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Kimbell’s year-end 2022 net debt may have been around $225 million, so it seems likely to keep its payout ratio around 75% so that it can pay down some of its debt during 2023. At $185 million in net debt at the end of 2023, Kimbell’s leverage would be around 1.1x.

Notes On Valuation

I have revised my estimated value for Kimbell down to around $19.50 per unit based on current 2023 strip and then long-term prices of $4.00 Henry Hub natural gas and $70 WTI oil after 2023.

Kimbell’s distributable cash flow per unit may end up higher in 2024 (close to 10% higher based on current strip) than in 2023 due to a combination of improved natural gas prices and no hedging losses.

Similarly, at long-term prices of $70 WTI oil and $4.00 natural gas, Kimbell should be able to generate around $2.15 to $2.20 per unit in distributable cash flow.

Conclusion

Kimbell’s distributable cash flow expectations for 2023 have taken a hit due to weak natural gas prices. Kimbell’s 2023 hedges also only cover a small amount of its production and were mainly added when commodity prices were lower than they currently are as well.

Thus at current strip of just over $3 Henry Hub gas, Kimbell may be able to generate approximately $2.00 per unit in distributable cash flow. I believe that its distributable cash flow for both 2024 and in the longer-run can be better than 2023 though, at around $2.15 to $2.20 per unit. This supports an estimated value of approximately $19.50 per unit in my opinion.