The Bull Case for Texas Pacific Land (NYSE: TPL)
By Jack Stell, Quiver Analyst
Posted: 3 weeks, 1 day ago // Sept. 6, 2023 2:13 p.m. UTC
With Quiver Quantitative’s recent institutional holdings data, we can see that several hedge funds and asset managers have been increasing their holdings in Texas Pacific Land Corporation (NYSE: TPL). Firms such as State Street Corporation, Bank of America, and Citadel have all added to their TPL positions. Also, it must be noted that value investing hedge fund Horizon Kinetics holds 1,403,867 shares in Texas Pacific Land Corporation, representing around 18.5% of the business’ outstanding shares, with their holdings in the business valued at around $2.67 billion dollars. Most notably, State Street Corporation increased shares held by 7.1% (as filed on 6/30), bringing their total TPL holdings to 215,357 shares worth around $411 million dollars at current share prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on Texas Pacific Land Corporation.
In August, Texas Pacific Land Corporation posted earnings results for the second quarter of fiscal year 2023. Net income in the second quarter of FY23 was $100.4 million dollars, compared to $118.9 million dollars in the second quarter of FY22. Total revenues for the second quarter of FY23 were $160.6 million dollars, compared to $176.3 million dollars in the second quarter of FY22. These figures were largely affected by falling oil and gas prices (which of course affect oil and gas royalties), however, this was largely mitigated by increased revenue in the business’ water sales and royalties income. Additionally, Texas Pacific Land Corporation also declared a quarterly cash dividend of $3.25 per share.
Texas Pacific Land Corporation is one of the largest landowners in the state of Texas, holding approximately 874,000 surface acres of land in West Texas, with land ownership largely concentrated in the Permian Basin. The business’ surface and royalty ownership allows them to generate revenue throughout the oil and gas development value chain. During the initial development phase (where oil and gas infrastructure is constructed), Texas Pacific Land Corporation generates revenue in the form of fixed fees for the use of their land and revenue in the form of sales from materials used in the construction of the oil and gas infrastructure (i.e. caliche). During the drilling and completion phase, the business generates revenue by providing sourced and treated water, while also continuing to receive fixed payments for the use of their land. During the production phase, the business generates revenue from saltwater disposal on their land, in addition to revenue generated from oil and gas royalty interests. In addition to generating revenue throughout the oil and gas development value chain, the business also generates revenue from pipeline, power line and utility easements, commercial leases, and temporary permits related to a variety of land uses (midstream infrastructure projects and processing facilities).
Texas Pacific Land Corporation largely operates within the oil and gas industry, an industry that is quite cyclical. Revenues from oil and gas royalties may fluctuate based on market price fluctuations for oil and gas, along with production decisions made by operators who produce oil and gas on their land. Additionally, the business’ revenue streams from water sales and royalties, easements, and other surface related income may fluctuate from time to time. A lot of Texas Pacific Land Corporation’s revenue potential falls in the hands of the operators that drill on their land. If oil and gas prices plummet, and oil and gas drilling / development slows, so do the business’ revenue streams. Additionally, Texas Pacific Land Corporation’s four largest customers make up nearly 52% of the business’ revenue. While this may seem like a massive risk for the business, it is largely mitigated by the fact that these customers (Occidental Petroleum Corporation, Chevron Corporation, ConocoPhillips, and EOG resources) are amongst the largest energy companies in the world, leading to each of them being a strong and reliable revenue stream. While Texas Pacific Land Corporation isn’t an operator within the highly cyclical oil and gas industry, it is still largely affected by this cyclicality, something to keep in mind as an investor.
Management is solid, with their capital allocation priorities doing a good job of aligning shareholder and management interests while also creating large amounts of shareholder value. Management likes to repurchase shares, albeit lightly, to return value to shareholders. In 2022, management repurchased 48,959 shares at an average price of $1,795. While this may seem like a very small repurchase, it must be noted that Texas Pacific Land Corporation only has around 7.6 million shares outstanding. In 2023, the business has around $250 million dollars authorized for further share repurchases. In addition to share repurchases, Texas Pacific Land Corporation also likes to pay out a quarterly cash dividend, further returning value to shareholders and showcasing the business’ superb capital allocation priorities.
Texas Pacific Land Corporation is a very efficient business. The business currently operates at a LTM ROE of 54.3% and a LTM ROIC of 55.1%. With a WACC of 9.9%, Texas Pacific Land Corporation operates at a ROIC to WACC ratio of 5.56x, showcasing the business’ ability to reinvest cash back into the business at rates of return far higher than the business’ weighted average cost of capital. Furthermore, businesses that are able to efficiently reinvest cash back into the business at high rates of return are considered to be compounders, businesses that are able to rapidly compound intrinsic value over the long-term. Looking further at efficiency metrics, we can see that Texas Pacific Land Corporation has held a relatively high ROIC over the last few years, with the business operating at a 5-year average ROIC of nearly 79%. These high ROIC figures may show that Texas Pacific Land Corporation holds a strong competitive advantage or moat in the industry that it operates in.
Analyzing Texas Pacific Land Corporation’s income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, Texas Pacific Land Corporation has grown revenues at a CAGR of 28%, with gross profit growing at a CAGR of 27.2% in that same time period. It must be noted that while gross profit grew at a slower pace than revenue within the last decade (due to sliding gross margins), the business operates at very high gross margins. Currently, the business operates at a LTM gross margin of 95.9%, meaning that the business turns nearly all of their revenue into a profit. This means that Texas Pacific Land Corporation has plenty of cash to reinvest cash back into the business, repurchase shares, or offer / increase a dividend, all of which handsomely reward shareholders. In terms of earnings, Texas Pacific Land Corporation has grown EBITDA at a CAGR of 26.4% since 2013, with EPS growing at a CAGR of 29.5% in that same time period. It must be noted that Texas Pacific Land Corporation operates with an extremely low float of 7.62 million shares outstanding. Despite this extremely low float, management has decreased shares outstanding by around 1% since 2018.
Looking at Texas Pacific Land Corporation’s balance sheet, we can see that the business operates in good financial health. The business currently holds around $609 million dollars worth of cash and equivalents on hand, with no short term borrowings or long-term debt, showing the large runway the business has to operate. With a net debt of -$607.5 million dollars (meaning that the business has $607.5 million more dollars worth of cash on hand than debt), the business has plenty of runway to operate.
Looking at Texas Pacific Land Corporation’s cash flow statement, we can see stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ operational efficiency. Since 2013, Texas Pacific Land Corporation has grown net income at a CAGR of 28.1%, with free cash flow growing at a CAGR of 27.5% in that same time frame. While free cash flow margins have slided within the past few years, it is important to note that Texas Pacific Land Corporation also operates with very high free cash flow margins, with the 5-year average free cash flow margin coming in at 57.9% of revenue. With the ability to generate large amounts of free cash flow from revenues, Texas Pacific Land Corporation has plenty of opportunities to reinvest cash back into the business, repurchase shares, or increase / offer a dividend.
After conducting a reverse discounted cash flow analysis, we can see that Texas Pacific Land Corporation is trading at share prices that imply a 16.3% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. While Texas Pacific Land Corporation is a wonderful business, we are skeptical of this valuation. We believe that this valuation is quite high, especially considering the cyclicality of the oil and gas industry. We believe that a 10% growth rate in free cash flow may be a more appropriate growth rate to place on the business, which would bring us to a valuation of $1,266, implying a 33.7% decrease from current share prices. While it seems that the business is currently trading at a high valuation, that is just our assessment of the business. We encourage every investor interested in buying shares in Texas Pacific Land Corporation to do their own due diligence before deciding to take a position in the company.