Investment thesis

Sitio Royalties Corp (NYSE:STR) is a pure oil, natural gas and royalty company focused on acquiring high-growth energy-weighted rights. The company recently completed two significant acquisitions, increasing production and total assets by more than 30%. The company considers dividend payments will increase by 15% after the acquisition, which can give a dividend yield of 14% at current share price levels.

Company presentation

The Company operates in the petroleum and natural gas industry with the acquisition of royalty interests, mining interests, non-participating royalty interests, overriding royalty interests and primarily royalty properties located in Eagle Ford Shale and Permian. The properties consisted of underlying royalties at approximately 256,000 gross acre units. All well sites are feasible in North America, and the company produces oil at a breakeven price of $35 per barrel. The Company operates in 4 segments: Oil, Natural Gas, Liquefied Natural Gas and Rental Premiums. The company generated 69% of its revenue from the sale of oil and 19% from the sale of natural gas, 10% from the sale of liquid natural gas and 2% from rental premiums for the year ended December 31, 2021. oil and natural gas production has been depleted, but the average selling price of all products has increased by more than 70%, leading to strong quarterly results in fiscal year 2021. Oil prices oil and natural gas reached record highs in the first half of fiscal 2022 due to supply chain disruption and supply shortages due to the Russian-Ukrainian war. Recently, oil and natural gas prices have declined due to the economic downturn. Still, I believe that relative to historic levels, prices may remain higher as the scarcity of supply is still there. It may increase in the coming period as the European Union has decided to stop accepting all oil and natural gas exports by the end of fiscal year 2022. The company will be one beneficiaries of higher prices in fiscal years 2022 and 2023. The company acquired 19,700 net royalty acres (NRA) in the Permian Basin to increase production. She also entered into a derivative contract to hedge market volatility and improve cash flow certainty.

Permian Basin Accretive Acquisitions

Recently, the company announced the acquisition of more than 19,700 NRAs in the Permian Basin from Foundation Minerals, a subsidiary of Quantum Energy Partners. The deal was executed for $323 million and was financed by borrowings under the company’s credit facility and unsecured loan facility. The company has also acquired more than 12,200 NRAs in the Permian Basin from Houston-based Momentum Minerals. The company closed the deal for $224 million, which will be funded through debt financing, and it is expected to close in the third quarter of fiscal 2022. After the two acquisitions are fully integrated, the company estimates that the production will increase by more than 30%, or 3,500 boe/day. If the company maintains the traditional dividend payout ratio of 65%, the two acquisitions will add approximately 15% to dividends per share in the second half of fiscal 2022. With this acquisition, the company’s assets in the Permian Basin increased by more than 30%, and the company’s total assets increased by more than 22%, to 173,000 NAV. The company has increased its NRAs by 300% since June of fiscal 2021. After the closing of both acquisitions, pro forma leverage is expected to be 1.5x. I think with the increase in production the company is well positioned in the industry and could be one of the beneficiaries of higher prices due to the scarcity of supply which can increase the payouts of dividends in the coming quarters.

Solid forward dividend yield of 10.79%

The company currently pays an annual dividend of $2.51, which equates to a dividend yield of 9.44% from current levels. Following this acquisition, the company estimates dividend growth of 15%, provided the company maintains the 65% dividend payout ratio intact. The estimated annualized dividend payout is $2.88, giving a forward dividend yield of 10.79% at the current share price. The dividend hike is sustainable as oil and gas prices are still high relative to historic levels, and will remain range-bound until supply becomes tight in the global market.

What is the main risk facing STR?

Oil and natural gas price fluctuations

The oil and gas spaces are highly volatile and price fluctuations are a prominent theme in this space. STR is strongly affected by fluctuations in the prices of these raw materials, as the royalties received by the company are based on the prices of oil and gas at that precise moment. The company takes certain steps to reduce its exposure to large price fluctuations and hedge its position by entering into derivative contracts for future oil production. Some of these contracts are fixed price swaps, collars and basis swaps. The company has been successful in mitigating volatility through its hedging activities, but this is a risk that is permanently associated with the oil and gas space and cannot be ignored.

Technical analysis and fundamental valuation

STR recently crossed the 50-day weighted moving average (WMA) and is currently trading at its 100-day WMA. This indicates that the stock has good momentum and can see a strong upside from current price levels if the stock can hold above the 100-day WMA. The RSI indicator is not showing any divergence at the moment, but the stock is consolidating in the 50-60 band. This suggests that the stock is in buy territory. Overall, technical indicators are positive for the stock and reflect a buying opportunity.

STR is trading at a P/E multiple of 11.37x with full year EPS estimates of $2.35. I think the stock is trading at an attractive valuation at the current share price. Given the strong dividend yield of 9.44%, the stock becomes even more attractive to investors looking for a stable and high dividend yield. I think the stock has good upside potential given the recent buying of the Permian Basin, which should generate significant growth for the company. Given these factors, I believe the stock may trade at a 14x higher valuation in the near future, giving us a target price of $32.9, up 22.8% from the current price of $26.7.

Conclusion

The purchase of the Permian Basin is expected to drive significant royalty growth for the company over the coming quarters. The company has a dividend yield of 9.44%, which is very attractive given STR’s growth prospects. It faces the risk of fluctuating oil and natural gas prices, but has managed to mitigate this risk through effective hedging strategies. The company is an excellent investment opportunity for investors looking for high-dividend stocks at an attractive valuation. I recommend a buy for STR after considering all growth and risk factors.