Press release here.
There was lots of chatter around $7/share this quarter in Yahoo Finance discussion boards and Seeking Alpha comment threads. The report of $6.52/share is a little light relative to the aforementioned prediction but it represents a fine period of 53% and 145% growth in the O&G royalty and water businesses respectively.
The $6.52 Q3 print puts TPL at $21.79 per share in trailing 12mo earnings. If we stick with the 38x P/E that was discussed in the last post, that gets “fair value” to $828. I say “fair value” loosely as picking a P/E is more art than science.
In the coming days I’m going to do some segment analysis to show top line and bottom line trends. One thing that is becoming readily apparent is that easements and sundry income will be lumpy as easement income is no longer being smoothed.
One small aberration was the 167 acre land sale at $25.7k/acre. TPL land sales are rare these days and that price was really something. This isn’t going to happen but the whole trust sold at that valuation gets the value of the surface acreage to ~$23B. Again, that is a big stretch but the sale shows the “hidden asset” nature of TPL which is easy to overlook in the current era of high flying top and bottom line growth.
Horizon Kinetics commented on the 3rd Quarter recently. As most know, HK is a large holder of TPL and represents the gold standard for TPL commentary and sentiment. Comments on TPL were pretty light this quarter but appear favorable.
Would encourage a read of this whole piece. You don’t find much else like it from other managers.
In prior webinars we reviewed one technique for locating such securities: look among the multitude that have been excluded from the indexation vortex and which might therefore be anomalously cheap, and which might have business models that are not exposed to the same risks. We described some marine shipping companies, even large-cap ones like AP Mollar-Maersk, some drilling service companies like Subsea 7, non-standard security types like Texas Pacific Land Trust, which is not even a corporation, and so on. They have excellent or even perfect balance sheets, so are not at risk from interest rate or credit market shocks, and they operate in cyclically depressed industries so that they have plenty of positive revenue optionality, as well as profit margin and valuation optionality. In the extreme, if you owned only one, you might not be exposed to any conventional systemic risk.
We’ve made use of a similar improvement over existing market structure to be exposed to oil – since energy could be both a source of risk to the economy as well as a source of investment return – without the complexities and limitations of conventional oil producers. An ExxonMobil, for instance, must spend enormous sums of money, each and every year, to explore for new reserves to replace that which is depleted. Texas Pacific Land Trust, like Wheaton Precious Metals, is also a royalty company. Despite its $6 billion market value, it has only 47 employees. Its latest pre-tax profit margin, for the June quarter, was 89%. The only companies one might be able to identify with profit margins that high, and there are very, very few, are royalty companies.
This isn’t in direct reference to TPL but I thought was worth sharing. Sourcewater is a startup aimed at connecting buyers and sellers of water and water disposal services. The company’s website is worth a look to get a better perspective on the West Texas water bonanza.
I have no connection to this company. Sharing for context only.
I enjoyed this long form sales pitch from the company. Some excerpts:
Just in the past few years, the average frac has gone from needing about 4 million gallons of water (100,000 barrels) to needing 20 million gallons (500,000 barrels) or more – sometimes much more. And most operators now frac a bunch of wells at the same time for efficiency (called “pad drilling” or “zipper fracs”) so the amount of water they need in the span of just a few days could be millions of barrels, maybe even close to 100 million gallons – in just a few days.
In fact, water is in such high demand that oil and gas operators are buying water anywhere they can get it. For example, Pioneer Natural Resources, one of the top Permian operators, recently made a deal with the local cities of Odessa and Midland to buy and reuse their sewage water for fracking. Many operators are starting to recycle the water that comes out of the ground with the oil and gas they produce, taking that “produced water” and injecting it into the next frac to save on both freshwater needs and disposal costs.
Mineral rights are not usually owned by the person who owns the land. But under Texas law and in some other oil and gas states, surface landowners always own the water. That means a lot of people who were always locked out of oil booms of the past because they didn’t own their mineral rights can finally get in on the action. Any landowner near an active oil or gas formation with water under their land is sitting on a gold mine. Not black gold. Clear gold. Liquid gold.
Sourcewater already has thousands of active users registered on its marketplace with more than 1 billion barrels of water listed for sale and over 100,000 water sources just in Texas. Energy companies and service companies search for water on Sourcewater.com every single day, looking for the water they need for their next frac site. Ready to become a water millionaire? Create a free water listing on Sourcewatertoday.
Pull the link up in Google Chrome and click translate if you too failed first semester Spanish in undergrad.
TPL royalties have an approximate weighted average value of 5%, which is considerably lower than the standard paid in the Permian; This is a powerful incentive for producers to continue increasing production on TPL lands.
Another obstacle for investors who are comfortable with TPL is the near impossibility of assigning a value and anchoring it. TPL is an example of how optionality plays an important role. If I had to value TPL in the past, I would have assigned zero to the water business. I would not even have known.
In last year’s letter, I explained that I was looking for convex situations. These are situations in which, when the facts appear and are positive, they have a greater effect than when they are negative; TPL perfectly fulfills that attribute.
A few posts down, I posited a theory that $TPL share price weakness apparent in the first month of calendar quarters was due to a lack of buying from the trust. My hunch was that the trust was prohibited from buying due to it having material non-public information in the form of quarterly earnings (blackout). Some crude analysis showed that my theory appeared to hold water.
It was fun while it lasted. The (cruder still) analysis below shoots some holes in my bucket.
A logical extension of my blackout theory is that we should see a dip in average daily trading volumes during the first month of each quarter. This was barely the case. Since the stock split in July 2007, the first month of each calendar quarter has had an average daily volume that was lower than the average daily volume of the entire quarter in 23 out of 44 quarters. Or 52.2%. Hard to call that significant.
So, without wasting anymore of your time, here a couple charts that make the point. Volume in the first month of calendar quarters does not appear to follow any easily discernable pattern.
It’s hard not to marvel at growth in royalty barrels of oil (and the MCF of gas) that TPL has seen since 2008. Royalty oil barrels have seen a 26.4% CAGR over the past 9 years while GAS MCF has grown 28.6% on an annualized basis. As impressive as that is, growth recently has been going parabolic as detailed in the 2017 annual report.
Oil and gas royalty revenue was $61.3 million for the year ended December 31, 2017 compared to $30.0 million for the year ended December 31, 2016, up 104.4%. Oil royalty revenue was $38.8 million, up 76.3% and gas royalty revenue was $14.8 million, up 85.3%. Additionally, oil and gas royalty revenue for the year ended December 31, 2017 included $7.7 million related to an arbitration settlement with Chevron U.S.A., Inc.
Crude oil production increased 43.8% in 2017 compared to 2016. The average price received in 2017 was $47.33 per barrel, compared to $38.60 in 2016. Gas production increased 59.8% in 2017. The average price of gas received increased to $3.56 per MCF in 2017 from $3.07 in 2016. State oil and gas production taxes were $2.9 million in 2017 compared to $1.6 million in 2016.
Of course this can’t last forever but it is reasonable to expect continued growth for some intermediate period. Along with that growth will come top line growth if oil prices continue to play ball.
As detailed in the 2Q 10Q, 2018 will obviously be another leap.
Oil and gas royalties. Oil and gas royalty revenue was $30.3 million for the three months ended June 30, 2018 compared to $12.2 million for the three months ended June 30, 2017. Oil royalty revenue was $24.7 million for the three months ended June 30, 2018 compared to $8.8 million for the comparable period of 2017. This increase in oil royalty revenue is principally due to the combined effect of a 117.0% increase in crude oil production subject to the Trust’s royalty interest, and a 29.4% increase in the average price per royalty barrel of crude oil during the three months ended June 30, 2018 compared to the same period in 2017. Gas royalty revenue was $5.6 million for the three months ended June 30, 2018, an increase of 63.0% over the three months ended June 30, 2017 when gas royalty revenue was $3.4 million. This increase in gas royalty revenue resulted from a volume increase of 138.0% for the three months ended June 30, 2018 as compared to the same period of 2017, partially offset by a 31.7% decrease in the average price received.
Yes, you read that right. 117% increase in oil production. Where could we go from here?
Thinking about revenue, if we assume 2Q production growth to be equal that for all of 2017, we could get to a total annual royalty barrel number of 1,776,913. At a price of $61.20 (29% above last year), ballpark oil top line comes out at $109MM.
10% growth sequentially on that for the next 4 years gets us to $120MM (2019), $132MM (2020), $144MM (2021), and $159MM (2022). When 2018 estimates are included, that is $664MM cumulatively. Or about 11% of market cap.
That’s just oil. And at 10% growth. And for 5 years.
Tack on another ~30% to that number for gas and you get to $863MM. That gets you to 14% of market cap.
This is all before the taxman takes his (now reduced!) bite.
Nevertheless, the outlook for buybacks appears bright.
Author’s note: I probably screwed this up. Let me know where I went wrong. Also, let me know if you think my assumptions are terrible.
Special thanks to JackFutures from SeekingAlpha for sharing his many data series!
Trustee David Barry lifted 100 shares @ $810 on 10/11/18.
This follows his last purchase of 100 @ $292 on 3/3/17.
Robert Packer also lifted 100 the same way as Barry on 3/3/17.
These three transactions are the only insider buys recorded for the “boom” years of 2016, 2017, and 2018.
Positive sign? Overall you could argue that disclosed insider buys have been lower than seems rational. Mr. Barry buying up here might give some validation to the current price given his insider status and long time history with the Trust.
At a Special Meeting of the Holders of Sub-share Certificates of Proprietary Interest (“Sub-share Certificates”) held on January 12, 2017, the holders of Sub-share Certificates elected Mr. David E. Barry as a Trustee. Mr. Barry was born in New York City in 1945. He graduated from the College of the Holy Cross in 1966 with a degree in Physics and from Harvard Law School in 1969. Mr. Barry began his career at the law firm of Kelley Drye & Warren LLP in 1969, becoming a partner on January 1, 1978. He spent his entire career at this firm, including representing the Trust for many years, until he became a retired partner in 2012. Beginning in 2007 and then full time starting in 2012, Mr. Barry worked as President of Sidra Real Estate, Inc., a former client with commercial real estate holdings throughout the United States. In addition, in 2012 and 2014, Mr. Barry became President of Tarka Resources, Inc. and Tarka, Inc., respectively, both of which are involved in oil and gas exploration in Texas, Oklahoma and Louisiana and which firms merged on November 18, 2016 into Tarka Resources, Inc. Mr. Barry is a member of the bar of New York State and retired as a member of the bar of the State of Connecticut.
Both the WSJ and Bloomberg have run articles this year about the power (or lack thereof) of earnings blackouts. Both suggest that stock prices can get weak when companies are prevented from purchasing their own stock due to prudence around the possibility (or perception) of trading on insider information.
An astute TPL investor would conclude that buyback blackouts are a big deal for TPL since, well, buybacks are its core competency.
I’m not a statistician, nor do I play one on TV but it does appear to me as if the lack of buybacks is a material driver in month to month price action. Below is the simple average monthly return of all monthly periods since July 1980. YTD October 2018 at -8.99% is included as a full month in this analysis.
Note that “blackout” months (my assumption) are highlighted in red and represent 2 of the 4 lowest monthly average returns and 4 of the 6 lowest average monthly returns. If you consider December a throwaway month (tax planning), the blackout effect gets even stronger.
On the flipside, you really want to own TPL in Feb, May, Aug, and Nov which are the months TPL reports prior quarter earnings. Reporting is typically very early in the month. I assume TPL comes out guns blazing after that to do its buying.
Fun link here shared by JackFutures at in the 2Q earnings annoucement comment thread at seekingalpha.com. The interactive chart allows one to graph by well origination date, operator, county, and many other categories.
A few observations:
- If viewed by operator, the data suggests that Chevron and Anadarko are just warming up. My understanding is that TPL is most levered to these two operators (I could be wrong!).
- A view by county shows continued strong expansion in Midland, Loving and Reeves counties. Culberson still looks pretty quiet while Hudspeth isn’t even on the map.
- The “month of first flow” view gives one perspective on recent growth. It looks like production has just about doubled in in the 2017-2018 period.
- It appears as if the wells started in 2017 and beyond account for about 75% of current production.
- Lastly, if you go to the “well quality” tab and look at the bottom chart by “month of first flow”, you can see that the newer periods are fatter (more wells) and have more vertical trajectories (cumulative production by time) than earlier periods. One wonders what the next 8 quarters are going to look like.
My sense is that these will be important maps to watch if you are thinking about timing a sale of TPL as dangerous as that may be.
You might remember Kevin from the times he shaved 8+ figure$ off of the respective net worths of both Rich Kinder and Kelcy Warren.
Sorry for two non-TPL-specific articles on the same day. It’s not my intention to turn this into an energy news blog. That said, I think this article provides a really good lay of the land for the current state and circumstances of West Texas. The area is in full boom mode and is suffering from lack of takeaway (oil transportation infrastructure) and other constraints such as rising wages, employee mobility, jammed roads, and higher general input costs.
Like 2015/2016, it is probably reasonable to assume that too much $$ will be thrown at these problems and perhaps, in the long run, the area and infrastructure could be overbuilt. The boom / bust / boom / bust “feature” of West Texas remains a key to mentally modeling and valuing the unique entity that is TPL.
Some comments from industry executives were included in the article linked above:
Pipeline and trucking constraints in the Permian Basin are hurting us now. There was a $13 per barrel price deduction for August, and I hear it may go to $20 per barrel. This, over a long period of time, is going to impact my drilling program.
We are still lacking enough qualified drivers who are able to pass motor vehicle record checks and Department of Transportation preemployment drug tests. Additionally, the market is so competitive for drivers that they will jump ship for an extra 50 cents per hour.
We saw two factors capping growth in the second quarter. The Permian pipeline capacity and discount on WTI [Midland] have slowed completions. We expect to see fewer wells completed in the second half of 2018. Many E&P companies will spend their budgets for 2018 before the end of third quarter 2018. This higher spending rate was a result of higher efficiency and higher service company prices. The net result will be a decline in total completions in the second half of 2018. We think a rebound will happen in first quarter 2019, but the Permian will continue slow growth until the pipeline capacity is increased and the WTI [Midland] discount is eliminated.
Consulting firm Arthur D. Little has released a report (trying to get my hands on it!) that forecasts some big growth in extracted BOE, wells, and related CAPEX.
The Permian, which is the top oil producing field in the United States, is producing more than 3.4 million barrels of oil a day. Growth of 3 million barrels a day by 2023 would put it near 6.5 million barrels a day, a production level above Canada, Iran and Iraq.
Summary of the report from Rigzone:
Data in the report forecasts Permian activity through the next five years to:
-Rise by up to 3 million barrels of oil equivalent per day
-Possibly produce up to 5.4 billion barrels of oil equivalent per day
-Have a need for up to 41,000 new wells (mostly unconventional) to be drilled to meet production outlook
-Require more than $300 billion in capital expenditures (CAPEX) to keep pace with growth projections
Implications for TPL are many. We have to assume some of the projected new wells will be either on mineral interest land or sundry income producing surface land. It is also reasonable to project that growth in water needs will move linearly should AD Little’s forecast come to pass. Lastly, easements for pipelines, roads, and other infrastructure would be expected to grow in number and in total contribution to top line under the scenario detailed above.
I’m seeing chatter about $30yr/EPS as being a reasonable possibility after you annualize the expectations for Q3. $30 EPS puts the trailing multiple at 29X with the stock at $864 as I type. If a doubling in production is not unreasonable (per above) then we’re looking at a 14.5X multiple on future earnings for a company with significant hidden assets.
I don’t pretend to understand all the linkages here but one can have some fun with the site above and county well records (checkout Midland) on sutlog.com.
The county roster at the bottom of the ShaleXP page linked above might be fun to reference vs this old chestnut.