Texas Pacific Land Stock Analysis & Deep Dive

Let's play Monopoly and start with the best lots

Nov 03, 2023

Intro

With the booming oil industry in Texas and Warren Buffett continuous buying of Occidental Petroleum I searched for a ways to profit from the boom in the Permian Basin. Texas Pacific Land (TPL) is one of the purest plays available for the Permian Basin and refers to itself as the ETF of the Permian Basin.

The Company

In 1871 The Texas & Pacific Railway was created and the state of Texas gave 3.5m acres (ca. 14.000 square kilometer) of land to start the company. When the Texas & Pacific Railway filed for bankruptcy, all the land assets were placed in the Texas Pacific Land Trust to have a save place. More than a century later this makes TPL one of the largest landowners in the state of Texas. In 2017 the management of TPL made the active decision to become an active corporation vs continuing as a passive trust as it has been in the previous 100+ years. This led to an increase in CapEx to start and enlarge the water business. Due to the new structure of the company, the name was changed from Texas Pacific Land Trust to Texas Pacific Land Corporation.

This is one of their remaining steam locomotives.

Not known at the time of the creation of the trust were the great oil & gas reserves which are located on the lands now owned by TPL. This makes the land incredibly valuable. Today TPL owns 874k surfaces acres of land (3.5k square kilometers) in West Texas of which the vast majority is based in the Permian Basin. On top of that, TPL has royalty rights in additional 460k acres (1.8k square KM).

TPL makes money through royalties from oil, water and surface rights. What makes TPL special is the fact that the company owns the land and therefore the assets and resources both on the surface and below the earth. At the same time, TPL does not participate in the high CapEx necessary business of actually developing and operating the oil wells.

TPL had revenues of $667m in 2022 with only 100 employees. This makes for a crazy revenue ratio of $6.7m per employee

The Industry

Oil is still driving the world and overall oil demand keeps rising. Thanks to the advances in new drilling methods such as fracking, the US overtook Saudi Arabia and Russia in 2017 as the largest producer of oil in the world. Most of this additional supply of oil is coming from the Permian basin, in which TPL coincidentally owns large pieces of land.

The Permian basin is located mostly in Texas and also covers some part of New Mexico.

The first well in the Permian Basin was drilled in 1920. In the 1970 gas output reached a peak of 10bn cubic feet per day and 2m barrels of oil. Output fell sharply by more than 60% until the mid 2000s. With the rise of horizontal drilling and fracking the output of the Permian basin has skyrocket.

The attack of Russia on Ukraine led to a strong price increase in both gas & oil. The price for WTI reached more than 100$ a barrel for the first time since 2014. This increase in the oil price led to increased drilling in the Permian Basin of which TPL benefits strongly. The Permian Basin accounts for an ever increasing share of the overall US oil and gas production.

If you are interested in how fracking works, I can highly recommend this video. You will also see why TPL is expanding into the water side of the business. Loads of water is used in the process and TPL is happy to provide their customers with it.

The Business

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TPL takes an average of 4.4% of the oil revenue which is being produced on their land which contributes 68% of overall TPL revenue. TPWR (Texas Pacific Water Resources) contributes 24% of the overall revenue, while SLEM which is defined as TPL’s cumulative easements and other surface related income adds the remaining 8% of overall revenue. Every now and then TPL sells a small piece of the owned land, which increases revenues as a one time effect in the period.

Net production of thousand barrels of oil equivalent per day (mboe/d) has been increasing steadily for TPL. This effect is a great hedge against falling or flat oil prices since the increase in volume will make up some of the losses.

The easements (the right of use for a defined piece of land) come in many different forms. These include oil, gas and water pipelines, roads as well as land for solar farms. These easements are signed for 30 years plus and renew every ten years with an additional payment. TPL estimates that the easements have great potential to become a major revenue contributor in the long term.

TPWR provides brackish and treated water for well completions and facilitates produced water disposal. The royalties attributed to water are stable even across downturns in WTI oil price and offer a nice hedge against before mentioned oil prices. Almost all of TPL’s CapEx in the last years can be attributed to the development of water service and operations.

While the revenues from oil and gas royalties (blue line) fluctuate heavily from quarter to quarter due to changing prices for oil and gas, the revenue from water sales & royalties (orange line) are steadily rising.

As of 31.12.2022 only 14% of all royalty acres is developed. Based on the spud rate (creation of a new well) of 2022 TPL has 14 years of inventory at or below 40$ per barrel left. This means, that TPL has many undeveloped sited of cheap oil left for lease. TPL has a total of 24,074 locations of which 19,281 are still undeveloped and provide ample opportunity for future growth.

Texas Pacific Land has a great summary of the different stages and revenue streams through the life cycle of a well. Taken from the annual report:

“Our surface and royalty ownership provide revenue opportunities throughout the oil and gas development value chain. While we are not an oil and gas producer, we benefit from various revenue sources throughout the life cycle of a well. During the initial development phase where infrastructure for oil and gas development is constructed, we receive fixed fee payments for use of our land and revenue for sales of materials (caliche) used in the construction of the infrastructure. During the drilling and completion phase, we generate revenue for providing sourced and/or treated produced water in addition to fixed fee payments for use of our land. During the production phase, we receive revenue from our oil and gas royalty interests and also revenues related to saltwater disposal on our land. In addition, we generate revenue from pipeline, power line and utility easements, commercial leases and temporary permits principally related to a variety of land uses, including midstream infrastructure projects and processing facilities as hydrocarbons are processed and transported to market.”

TPLs major customers are oil and gas exploration companies, such as Occidental Petroleum (17% of overall revenues) and Chevron (14% of total revenues).

The Management

The CEO, CFO and the rest of management bring a lot of experience in the oil and gas industry. TPL’s management has a strong focus on capital management and uses almost all proceeds to either buy back shares or distribute earnings in form of dividends. In 2022, $247m were spend on dividends and another $88m were used to buy back shares. TPL has paid a dividend for 66 years straight and has increased its dividend in each of the last 19 years.

Risks

Since most of the revenue is derived as a percentage of oil and gas production, TPL is exposed to fluctuations in the oil price (both good and bad). Due to the fact that TPL does not own the wells itself, the operators could decide to stop drilling and therefore seriously diminish TPLs revenue streams.

As stated in the Q1/23 report

“The Company continues to generate meaningful free cash flow across both of our operating segments. Although broader oil and gas industry activity may be impacted by an evolving commodity price and economic environment, our expansive position across high-quality Permian acreage continues to see strong near-term development while still retaining tremendous value for the long-term.”

Fracking itself might face increased scrutiny for its hazard on the nature. The potential pollution of groundwater and unforeseen seismic effects are the top risks. Some countries in the EU banned fracking for exactly these reasons.

The Fundamentals

We know now that TPL is operating in a very interesting niche, but just how profitable is it?

Since TPL has gross margins in the high 90s, a lean organisation and almost no CapEx, net income and FCF follow the revenue step by step. The business has shown tremendous growth. Revenue grew from $42m in 2013 to $667m in 2022. Net income and FCF from $27m and $30m in 2013 to $446m and $428m in 2022. This is a 16x fold increase (!).

Revenue in 2023 will be a bit lower than in 2022 due to the decrease in oil price but the underlying fundamentals stay intact. Ever increasing production paired with stable or rising prices in the future will bring new records for revenue and net income as well as FCF.

Valuation

Since it is hard to value all the owned land, I focus on the business itself, while keeping in mind that Texas is one of the fastest growing states in the US and the land will most certainly increase its value. Interestingly the land assets have no value on the balance sheet and the line item is called “Real estate and royalty interests assigned through the 1888 Declaration of Trust, no value assigned”.

The valuation of an EV/FCF of 32.8 doesn’t scream “hey I am a bargain”. Considering the advances made in the last years, the potential of an elevated oil price and additional wells, I believe that TPL is at an attractive valuation. The average P/E ration of the last 5 years has been 32.

Summary

If you want to invest in the commodity sector, or more specially in the oil sector I would go with a company which has low CapEx and is situated in a great location. With TPL you get both. Full exposure to the Permian basin while not having to deal with high CapEx for exploration and development of new wells.