2023-05-31 22:38:49 ET
Summary
- Dorchester Minerals has an asset-light business model that de-risks it from the boom-and-bust cycle of the energy sector.
- DMLP's high profitability and low valuation make it attractive for investors, particularly income-seekers.
- Dorchester Minerals' focus on returning free cash flow to unitholders provides an edge in beating the market.
Dorchester Minerals, L.P. ( DMLP ) has not always been a market-beater, but, in a world of historically high energy prices, the firm’s underlying qualities give it an edge in the struggle to beat the market. Its asset-light business model, profitability, and high distribution rate, combined with its low valuation and 14% FCF yield, makes it very attractive for all investors, not just income-seekers.
Leading the Market
In the last five years, Dorchester Minerals unit price has risen by more than 58%, while its industry group, which consists of Black Stone Minerals, L.P. ( BSM ), Viper Energy Partners, L.P. ( VNOM ), and Kimbell Royalty Partners, L.P. ( KRP ), grew by an average of -8.98%. The SPDR MSCI World Energy ETF (WNRG), which tracks the MSCI World Energy Index and serves as a proxy to the wider industry, grew by just over 17%. Taking dividends into account, the firm’s total unitholder return ((TUR)) was 175.6%, while its industry group had a TSR of 29.3%.
Asset Light Business Model
Dorchester seeks to give its unitholders an attractive yield through managing its assets and protecting its balance sheet, while keeping its cost structure below that of its peers. It is not Dorchester that invests in drilling, completing and developing its acreage, rather, it is the operators on the partnership’s mineral interests that do so. What Dorchester does invest in is the acquisition of accretive mineral or other interests, mostly by issuing equity as consideration in contribution and exchange transactions. Overall, the business looks to preserve its conservative capital structure, something made possible by a partnership agreement that prohibits Dorchester from assuming any leverage. At the present, the firm is focused on acquiring, owning and administering Royal Properties and net profits interest (NPI).
The effect of this is that Dorchester’s business is very asset light. Furthermore, it is de-risked from the boom-and-bust cycle of the oil and gas industry. This is so because firms in the industry tend, because they have no pricing power, to chase the direction of oil and gas prices. So, when prices rise, managerial overconfidence takes over, they overestimate future free cash flows ((FCF)), raise too much capital, and overinvest in the business. When those anticipated profits do not emerge, capital leaves the industry, and businesses are forced to de-leverage, and reduce investments, until profitability returns. Dorchester’s model, by prohibiting leverage, and focusing on being a profit-taker rather than an operator, takes a lot of the risks of the capital cycle out of the business.
An interesting way to see just how asset-light the business is, is that the firm’s net income has ranged from about a quarter to three-quarters of total assets.
Another aspect of this asset-light business model is that the firm’s investment needs are very low, and this can be seen through the share of assets that acquisitions, capex, and depreciation & amortization have, which, in total, have largely remained below 20%.
A Profitable Business
An asset-light business model implies that the firm enjoys high returns on invested capital ((ROIC)), which is the case with Dorchester. In the last five years, ROIC has increased from 49.9% in 2019 to 97.2% in the trailing twelve months ((TTM)). The firm’s ROIC is higher than the industry group ROIC, which was 20.44%. In that time, net income has risen from $52.77 million in 2019 to $128.05 million in the TTM period, compounding at 19.39% a year. According to Credit Suisse’s “The Base Rate Book” , 20.3% of firms in the 1950 to 2015 period had a 5-year earnings CAGR of between 10% and 20%, in that reference period, the mean and median 5-year earnings CAGR were 7.3% and 5.9%. The mean net income for the industry group was $$290 million.
Another indication of the firm’s profitability and attractiveness is that its gross profitability, which is gross profits scaled by total assets, is 0.93, compared to the 0.33 threshold that Robert Novy-Marx found as attractive. The industry group gross profitability is 0.33, indicating an overall industry attractiveness.
Overall, Dorchester is very profitable with respect to its industry group, with superior gross profitability, ROIC, and operating margin.
Company | Ticker | Gross Profitability | ROIC | Operating Margin | Net Income (in millions) | FCF (in millions) |
Dorchester Minerals, L.P. | DMLP | 0.93 | 97.20% | 75.08% | $ 123.89 | 157.19 |
Black Stone Minerals, L.P. | BSM | 0.57 | 50.20% | 77.76% | $ 596.93 | 476.49 |
Viper Energy Partners, L.P. | VNOM | 0.26 | 5.10% | 77.28% | $ 169.04 | 599.57 |
Kimbell Royalty Partners, L.P. | KRP | 0.25 | 13.20% | 57.64% | $ 127.92 | 36.33 |
Industry Group | 0.33 | 20.44% | 66.30% | $ 285.41 | 417.34 |
Source: Company Filings and Author Calculations
Distributions Are Supported By FCF
In the last five years, FCF has grown from $66.55 million in 2019 to $157.19 million in 2022, compounding at 18.76% a year. In that time, the firm generated a total of $486.89 million, or 44.6% of its market cap. Distributions to the General Partner and unitholders have risen from $70.9 million in 2019 to $147.24 million in the TTM period, compounding at 15.74% a year. The nature of the firm means that the bulk of FCF is returned to the General Partner and unitholders, so we should not be concerned about any lack of margin for growth, or differential between FCF and distributions. We should observe only that distributions have grown largely in line with FCF growth, and the firm is an important source of income for income-seeking investors.
Although, throughout its history, these characteristics have always been there, with high oil & gas prices, the firm’s FCF are at historically high levels and are likely to remain so, giving it an edge in TUR in terms of beating the market.
Valuation
Dorchester has a price/earnings (P/E) ratio of 8.72, which, although higher than the industry group P/E ratio of 7.67, is lower than that of the S&P 500, which is 24.34 . FCF yield, which is a better screen than traditional P/E multiples, is 14.41%, compared to 11.2%, indicating that the firm’s FCF are trading at a cheaper price than that of its industry group. According to New Constructs , the 2,000 largest firms in the United States have an FCF yield of 2.7%. We have also seen that Dorchester’s gross profitability, at 0.93, is much higher than Novy-Marx's 0.33 threshold, which also happens to be the industry group gross profitability.
Company | Ticker | Gross Profitability | P/E Ratio | FCF Yield |
Dorchester Minerals, L.P. | DMLP | 0.93 | 8.72 | 14.41% |
Black Stone Minerals, L.P. | BSM | 0.57 | 5.65 | 14.62% |
Viper Energy Partners, L.P. | VNOM | 0.26 | 11.48 | 14.13% |
Kimbell Royalty Partners, L.P. | KRP | 0.25 | 6.80 | 2.72% |
Industry Group | 0.33 | 7.67 | 11.20% |
Source: Company Filings and Author Calculations
Conclusion
Dorchester has a simple business model that is de-risked from the boom-and-bust cycle of the energy sector and makes it very asset-light. That asset-light model is also one that requires very little investment to keep going, which means that the bulk of FCF are returned to unitholders. This makes the firm an important source of income and gives the company an edge in the struggle to beat the market.
For further details see:
Dorchester Minerals Has An Extra Lever Against The Market