Michael Boyd on SA

Texas Pacific Land Trust: A Different Approach

Fun read here.  Good alternative viewpoint on valuation.  I agree that 2019 comps are going to be a challenge.

I don’t think bulls would disagree that the company’s greatest assets are its land and mineral interest holdings. Given that, it’s puzzling to me to see focus on earnings per share, cash dividend distributions, or other measures of earnings power. Investors have lost sight of what’s supporting the underlying valuation: The land and its value. As any commercial real estate owner will agree, while commercial property values often correlate to earnings power, they frequently do not align. I see a lot of similarities here to the real estate sector, followers of my work know I spend a good chunk of time analyzing REITs. With that in mind, a focus on the actual current trading value of the land itself is natural for me, but even in REITs it has not common among smaller shareholders. That is clearly a mistake, as investors that have chased earnings yields at all costs in distressed real estate (malls, senior housing) have gotten shellacked. Coming into looking at this company at the request of a peer, this disconnect was my No. 1 concern and something I felt was missing in the discussion. While there’s going to be some correlation – higher revenue and earnings from lands naturally will tend to drive associated land values higher – they do not necessarily move in lock step.

On the far west land held by the Trust…

According to the most recent Texas Rural Lands report (data above), this rangeland is worth about $400/acre in the Far West Texas and Trans-Pecos. While acreage sales in this area are minimal (mainly trading hands between conservationists and ranchers), the Texas Rural Lands report has reported stable valuations in this region for some time, albeit with some range. In valuing the firm, I’ve used the low end of the range based on grazing rental revenue. Why? Texas Pacific Land Trust has historically booked about $0.55-$0.60/acre in grazing lease rental revenue on these lands which is at the low end of the rental range given in the above report. Logic follows that lower-than-average grazing lease revenue implies lower-than-average property value. Additionally, there would be some clear discounting involved in an accelerated wind down in this part of the portfolio given the lack of transactions out there.

In 2015, the surface acreage constituted roughly a third of total enterprise market valuation – on my analysis of the sum of the parts today it will be closer to 10%. The business model has shifted from high multiple, low earnings power assets (rangeland surface acreage) to low multiple, high earnings power assets (royalties). This is the danger of using historical multiples in projecting future value; business models change.

On the value of mineral rights…

With the company looking to post around $115mm in revenue this year, this values these assets at between $1,500-1,750mm on the high end of comps, not too far off the above figure based off usual private market rule of thumb.

On water…

At the end of the day, I think the assets can be valued similarly to the oil business. Margins are similar enough, and while the water reserves are not going to be depleted at the same rates as wells, water usage will be highest when exploration activity is aggressive and new wells are being drilled. Perhaps there’s some room for interpretation here, but I’d peg the business as a $900-1,000mm business as it stands today.

Boyd values the company at $3.3B via a conservative sum of the parts analysis.

It’s tough to call what investor expectations might be into Q4 and 2019 when it comes to earnings – particularly because there’s no Wall Street coverage – but my gut is that flat/negative comps beginning in Q2 2019 are going to surprise many people that own the company. I’ve learned that owning companies with that kind of outlook rarely plays out well, and my feeling is that this will be much cheaper before it sees the $700-800/share level again unless bulls are blessed with a dramatic reversion in the collapse in crude oil pricing. I think there are better opportunities out there in the oil patch.

Overall, I don’t disagree with the sum of the parts valuation.  $3.3B is certainly short of the current $4.2B market capitalization.  Sum of the parts puts the price at $430.  We were just there so it’s not out of the realm of possibility.

That said, and I may sound naive here, but I what I think is overlooked is 1) no debt, 2) unique governance (long term decisions take precidence over quarerly beats), 3) share cancellations (ownership concentration), and 4) long term optionality on the land.

If you’re in for the long term, all four factors work in your favor.  My gut says that a simple sum of the parts undersells all that TPL entails.  That (my gut) and a dollar will get you a cup of coffee.

I follow many industrials in my line of work.  Over the past ten years I’ve seen most all of them all 1) add leverage, 2) make short sighted moves to “beat” earnings, 3) buy stock back at high valuations only to neutralize the concentration via issuance for management comp, and 4) squander and neutralize competive assets and divisions by buying “synergistic” losers via M&A.  TPL seems, to me, to be the opposite of that.

4 thoughts on “Michael Boyd on SA

  1. A helpful read to offer a contrary input. I like how he made a distinction about new valuation methods due to the fast growing oil and gas revenues which are different valuations than in the past, and I liked his comparison value real estate approach.

    However, I think he missed some important factors, which are really hard to value in his “sum of the parts” analysis.

    – TPL has few employees and a profit margin near 70%. There are no contemporary oil and gas companies with those kind of numbers.

    – They cannot issue any new shares, have debt, or award stock options to anyone. Given how many companies, and especially the high debt, generous option granting and low margin Permian operators I follow, TPL is entirely unlike any of them. I like having ownership in a company that cannot do these shareholder diluting actions,

    -No analysis on the potential value adding land swap that is underway.

    – The recent USGS survey has dramatically higher estimates of oil in the basin. The analysis does not take this fully into account this upsizing when pricing the value of reserves.

    -The TPL land position is huge. There are many pay zones to the Permian, and probably some undiscovered/unexploited zones. TPL will get royalties based on what future discoveries are made, and whatever the price of oil is. These are resources with a long economic life.

    In short, valuation is difficult, and its super hard to have any precision. His analysis suggests in the bear case TPL is 22% overvalued. The soft stuff I have outlined should be worth at least that much as an offset.

    Time will tell, but I like the over and not the under here, especially after the 37% knockdown from the $860 high compared to the end of year price.

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  2. Over 100 replies to this analysis following the Seeking Alpha article, basically split between those who appreciate the contrarian view of the author on TPL valuation and those who vehemently disagree. I tend to align with Ted’s point about the factors that the author missed and cause him to understate the true value of the assets. One main point I takeaway is how difficult it really is to assign value and future potential and that management and/or Murray Stahl should lead an initiative to provide shareholders more of detailed account of all the activity. Despite the shocking selloff in 4th quarter, I’ve always contended that the upside in the long-term very much exceeds the downside risk. The great rebound we’ve seen over the last week really affirms that there is very strong support, especially if oil prices have stabilized.

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  3. I understand why investors want more information, but I think historically this company has never managed for investors. I have heard there is someone who checks TPL wells routinely to determine if they are being paid correctly, but I doubt that information will be distributed. I don’t know if that is necessary by their charter. It would still be past data requiring extrapolation like most of us are doing already. The large investment by the majors, and the confidence and percentage of HK ownership are sources of comfort in investing in TPL.

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    • The compliance process you mentioned of keeping track of the proper royalty payments netted that cash settlement from Chevron in 2017, so whoever for TPL is checking the wells paid for himself many times over. There is always a risk of sketchy reporting going on by the big players using TPL lands, so let’s hope there is a sound process in place to prevent cheating on the royalty payments.

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