TPL - Black Gold And Vast Lands: The Texas Pacific Land Corp Story

2023-09-22 11:56:04 ET

Summary

• Texas Pacific Land Corp is one of the largest land and mineral rights owners in the US, with access to natural resources.
• TPL has delivered impressive returns of around 31,000% since the turn of the century.
• The company's future growth opportunities include solar farms, wind farms, and other innovative land uses, while its main revenue source remains oil royalties.
• TPL's impressive history calls for cautious consideration due to its high valuation, yielding less than 3% FCF, reminiscent of 2020's low-rate environment.

Introduction

Oil. It’s a part of our everyday life, even if you drive an electric car, your day-to-day consumption is supplied by a network that (largely) runs on oil. Trucks, trains, jets, boats, all of them, require oil, yes , even the electric ones . How so? Because to create the inputs for EVs the suppliers require oil to transport goods and employees to the factories. There's no getting away from it.

And then there’s land. Chances are, you're on land right now as you're reading this article… That is unless you’re on a plane or a boat, in which case, I am jealous. But when you "land", you will be on, well, "land" , once again.

Land, like oil, is another thing we simply cannot do without.

And so what do you take when you cross these two necessities and wrap them up into one business?

Texas Pacific Land Corp ( TPL ), that’s what.

Texas Pacific Land Corp, once a trust, now a corporation, is one of the country's largest land and mineral rights owners, owning 100s of thousands of acres of land in west Texas. While much of that land doesn't make for great land to build homes on, what it does offer, is access to a treasure trove of natural resources.

And a treasure it has indeed been having returned around ~31,000% since the turn of the century!

Within this article, I’ll explain the business of TPL, its history, its opportunities for future growth, and my take on the valuation.

Black Gold: The True Tales of Texas Pacific Land Co

Hearing about returns that TPL has delivered is sure to make one’s ears perk up a bit. While there’s no promise of future returns being anywhere like those of the past, it's business is at least worth a study.

Let me take you back to the start...

In the annals of financial history, there exists a remarkable chapter that recounts the saga of the Texas Pacific Land Trust, an investment that stands as a testament to shrewdness and prudent management. This narrative unfolds across more than a century, marked by astute decisions and the cultivation of an inheritance of immense proportions.

Our tale starts in the latter half of the 19th century, in a vast and untamed expanse known as the American West. It was in the year 1888 and following the bankruptcy of Texas Pacific Railroad Company, the Texas Pacific Land Trust was established. This trust was endowed with a substantial land, granted by the court to be used to compensate the bondholders of the now defunct railroad.

However, the true brilliance (or luck) of this investment lay not only in the sheer expanse of the land but also in the vision outlined within the trust's charter. This charter, which would prove prescient in the decades to come, set forth a strategy of long-term land management rather than immediate divestiture. The trustees displayed remarkable patience, choosing to cultivate and steward these vast lands, leasing them for agricultural and grazing purposes, and, most notably, retaining mineral rights for oil and gas exploration.

And so, Texas Pacific Land was born. As time flowed steadily onward, the Texas Pacific Land Trust evolved into one of the most substantial landholders within the state of Texas. Beneath its vast acreage lay not only fertile soil but also substantial oil and gas reserves, lying in wait-like hidden treasures. The trust's decision to retain mineral rights proved to be a masterstroke, as the oil and gas industry burgeoned in Texas. The resulting royalties and revenue streams flowed steadily.

As years passed, the trust's land values surged, accompanied by a corresponding increase in its unit (now share) price. Those discerning shareholders who recognized the trust's inherent potential reaped substantial rewards from their investments.

What’s next?

While the vast oil reserves have resulted in huge royalties for Texas Pacific and riches for shareholders, as investors, many have the mindset of “what’s next”. I believe it’s for that reason why we routinely see huge IPOs which typically flounder as investors move to the next hot craze.

So I cannot make the argument that Texas Pacific will benefit from the AI revolution or the blockchain. But I do feel reasonably confident that they will be able to continue executing their time-tested strategy while moving, slowly and carefully, into adjacent growth opportunities like solar farms, wind farms, and other innovative land uses. The bread and butter of this business are oil royalties and investors (and management) stand to benefit from that status quo.

Quarterly Update

In August TPL reported its financial performance for Q2 2023, disclosing a net income of $100.4 million and revenues amounting to $160.6 million (down 9% YoY). Despite a decrease in oil and gas royalty revenue attributed to lower commodity prices, TPL experienced growth in those new revenue streams I just mentioned, notably in its water segment. It's also worth noting that operating expenses increased, particularly in legal and professional fees and water service-related expenses.

Clearly, based on last quarter’s results, the company remains exposed to the short-term volatility of global commodity markets. But I would investors to step back, way back, and think about the potential cash flow generation these royalties could earn over the next hundred years, not the next hundred days.

Long-Term Financial View

Revenue

As I just mentioned, I'm not a fan of short-term financial observations, great businesses are built over decades, not months. As such, I find the above chart insightful, as you can see the company began, slowly, and steadily, growing through the nineties and early two thousands, sure this growth paled in comparison to the dotcom stocks which were all the rage, but the growth was there, albeit slow.

And then, that slow growth became rapid growth. Following the crash in 2008 and the increased desire for energy independence, oil exploration in west Texas boomed. Soon after, the royalties began to "gush" as well.

Looking above revenues did not increase in a straight line, there were periods where the decreases, at that point in time, looked quite large. But what was important was for investors to stay the course and not be distracted by the topic de jure.

Cash Flow

As a largely royalty-driven business, TPL's cash flow scales with a tight correlation to its revenue growth. Since royalties scale with minimal/no further investment so too does free cash flow.

At 431M per annum, this company is now raking in free cash flow!

Return of Capital

Given the simple, business model and low capital requirements, the company returns a substantial portion of its free cash flow to investors each year, typically through a combination of buybacks and dividends.

Again, the total amount returned will vary based on the year, but keep an eye on the long-term and you can see that this is a company that places a priority on rewarding shareholders. I expect the future will look similar to the past in this regard.

Valuation

On the valuation front, we can see that shares trade for nearly the same FCF multiple as its 5-year median. That said, the 5-year median has been increasing over the past couple of decades as investors become more confident about the long-term prospects of its royalty business in West Texas based on its recent performance.

While the business model is clearly sound, at 33.5X FCF, I'm worried. Yes, the growth has been fantastic and all signs point toward higher oil prices for longer, but as we investors see over and over again narratives can quickly change.

Conclusion

In summary, TPL stands as a testament to the rewards of long-term thinking and patient stewardship. Yet, as we consider the road ahead, a cautious stance is warranted. The company's impressive track record notwithstanding, the current valuation indicates lofty expectations.

An investment in TPL has less than a 3% FCF yield, this harkens back to valuations we saw in 2020 when rates were zero. That's why I don't feel that today's prices represent a great value, despite TPL being a great business.

For now, I rate Texas Pacific Land Co a 'Hold', though I will be looking to buy if a large correction occurs.

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