Strong Free Cash Flow Conversion
Riley’s asset base delivered 22% Y/Y organic growth in net operated oil production in FY23 from reinvesting about two-thirds of discretionary cash flow into the ground. Solid growth reflects the manageable capital intensity of the company’s conventional oil-producing assets in the Permian Basin. The midpoints of management’s FY24 capital and operating guidance imply that Riley expects to increase oil production ~10% Y/Y from a capital program that is ~10% lower than FY23. The midpoint of management’s oil FY24 oil production guidance is 14.5 Mb/d, representing ~67% of total expected production. Our updated FY24 and FY25 adjusted EBITDA estimates are $290 million and $319 million, respectively. Our estimates are based on average NYMEX oil prices of $79.19/bbl for FY24 and $80/bbl for FY25. Oil accounts for 99% and 97% of our revenue estimates, respectively, and contributes to nearly 70% of estimated adjusted EBITDA margins in both years. Our estimates imply that Riley’s asset base supports management’s capital allocation priorities of: (1) investing a portion of discretionary cash flow for growth; (2) maximizing capital structure flexibility; and (3) returning cash to shareholders through a fixed base dividend. In FY23, 61% of free cash flow was allocated to debt reduction and 39% returned to shareholders through the dividend. Our free cash flow estimates for FY24 and FY25 are $116 million and $139 million, respectively. After allocations to fund the required $5 million quarterly senior notes amortization and current $1.44/share annualized dividend, we estimate that Riley will have surplus cash to allocate to the opportunities that management believes will maximize returns. Riley’s power joint venture, formed in 1Q23, is supplying reliable baseload electricity to its Champions assets in Yoakum County, Texas. Reliable baseload power will reduce Riley’s dependence on an increasingly intermittent power grid. The ability to use electricity to power drilling rigs and some other heavy service equipment will also reduce the company’s diesel consumption. The economic benefit is capturing value from natural gas, which accounted for 14% of FY23 production but less than 1% of revenue. Management is exploring additional opportunities to capture value from its gas production. Riley is currently trading at 3.2x and 2.6x our FY24 and FY25 adjusted EBITDA estimates, respectively, and an 18% free cash flow yield based on FY24 estimates. The dividend yield is 4.5%.
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