Texas Pacific Land Corporation

Moat: 4/5

Understandability: 4/5

Balance Sheet Health: 5/5

A unique land and resource management company with a history tied to the Texas Pacific Land Trust, TPL primarily benefits from oil and gas royalty revenue on its vast land holdings in Texas.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Texas Pacific Land Corporation (TPL) operates with a unique business model centered around land ownership and royalty income, primarily in the Permian Basin of West Texas.

Business Overview

TPL’s business is structured around its extensive land holdings, generating revenue primarily from:

  1. Oil and Gas Royalties: The bulk of their revenue is derived from royalty payments made by oil and gas operators extracting resources from their lands.
  2. Water Services and Operations: A smaller, but growing, revenue segment from the sale and disposal of water used in fracking operations.
  3. Land and Resource Management: This segment includes revenue from land sales, easements, and other ancillary services related to land.

The company’s most significant advantage is its large contiguous land position in the Permian Basin, a prime location for oil and gas extraction, and therefore has very stable demand for its products and services.

  1. Oil and Gas Market: TPL’s performance is closely linked to the global oil and gas market, specifically activity within the Permian Basin. Increased oil and gas prices generally lead to higher drilling activity, which means more royalty payments and greater business for TPL. However, prices are highly volatile and TPL management needs to prepare for that.
  2. Water Management: With increasing pressure on water scarcity and the rising volume of water use in hydraulic fracturing, water-related revenue is becoming increasingly important to TPL.
  3. Land Management: Although land prices in the area can fluctuate, there has been consistent demand for land for energy development as well as real estate purposes.

Competitive Landscape

  • Limited Direct Competition: As a land owner, TPL does not have other companies that directly compete against them for resource extraction, which provides them a competitive advantage. The level of mineral ownership in the region and the quality of its land are both high, resulting in an almost insurmountable competitive advantage for TPL.
  • Indirect Competition: Other players may include landowners or mineral owners and operators. The amount of royalties is set by contract and not by TPL. TPL may face pressure to reduce its price or compete on land features such as access to railroads, or pipelines.
  • Industry Consolidation: The industry has seen some consolidation in recent years, which may make some other players more significant to compete with, but TPL seems to continue to do well.

What Makes TPL Different?

  • Unique Land Holdings: TPL’s vast land ownership is difficult for competitors to replicate, providing a strong competitive edge. This has resulted in very high margins due to its ownership position.
  • Passive Income Model: They primarily earn royalties without having to invest in capital-intensive operations.
  • Limited Operating Costs: The company’s costs are primarily those related to running the business, with fewer production costs.

Financials

TPL’s financials reveal a strong and stable business model. Here’s a detailed breakdown:

  • Revenue: Revenue streams are concentrated in oil and gas royalties, which account for the majority of their profits. In 2022, total revenue hit $569 million and $483 million, up $36.5 million over the prior year. Land sales are a secondary, but significant, revenue stream and are subject to volatility (as sales are based on demand). Water-related revenues are a smaller, but fast-growing segment and provides diversification.
  • Profitability: TPL boasts extremely high profitability, particularly with net profit margins around 58% and operating margins around 67%. As an owner/lessor instead of a company that is mining the products, their costs are far lower than those of their counterparts.
  • Margins: The gross margin is over 95%, demonstrating their enormous pricing power. Furthermore, since they take a percentage of the sales of others, they are insulated from rising commodity prices.
  • Balance Sheet:
    • The company has strong cash reserves, totaling $371 million as of the end of Q3 2023, after a $250 million share repurchase program.
    • TPL has limited debt with long-term debt down to $182 million from $1100 million in the past 5 years, with the company having no short term debt. This is why the balance sheet health rating is so high at 5/5.
    • This also means they have a massive reserve of financial assets.
  • Cash Flow: The company consistently generates strong positive cash flow from operations, allowing them to pay high dividends and undertake share repurchase programs. However, the company also has a habit of accumulating cash, and it will be good for management to start using that cash in more profitable methods for investors.

TPL’s financial health is exceptionally robust, characterized by high profitability, low debt, and strong cash flows.

Moat Rating

TPL receives a moat rating of 4/5. This rating is justified based on:

  • Intangible Asset (Land): The most important source of TPL’s moat lies in its vast and unique land ownership. This provides a near-monopoly in the Permian basin. Land ownership is extremely difficult to replicate and results in extremely high return on capital and margins.
  • Regulatory Barriers (NIMBY): Due to NIMBY (Not In My Back Yard), it’s very hard to acquire new land, making existing land and land ownership extremely hard to replicate.
  • Cost Advantages: They extract value from its lands without capital expenditure and they also are insulated from rising commodity prices, because they take a cut of others’ revenues.
  • Scalability: The company can expand to other areas on its land and add more royalties, resulting in relatively high returns on growth capital.

Risks to the Moat and Business Resilience

  1. Regulatory and Environmental Risks: Increased environmental regulation could limit oil and gas production or add to operating costs, reducing their royalty income. A shift in environmental policies toward renewable energy could also depress future growth. This is a major risk for the company as it has only a very limited ability to adapt to environmental changes.
  2. Commodity Price Volatility: The price of oil and gas fluctuates wildly. This makes demand for TPL’s products and services a bit more volatile.
  3. Operational Risks: The company has very low operational risk, but some major disruptions in the companies that use TPL’s land could have negative impacts on TPL.
  4. Market Risks: The market is more interested in high growth and high valuation companies, which is usually the antithesis of a company like TPL. If growth slows further, price will suffer as a result. However, as a value oriented company TPL does seem quite insulated from this general market sentiment.
  5. Management: Management of capital allocation and overall strategy is paramount as this passive company depends mostly on external factors for profitability, rather than actively optimizing its business.

The nature of TPL’s revenue makes it vulnerable to oil and gas market fluctuations but somewhat immune to changes in the cost of goods sold.

Understandability Rating

TPL gets an understandability rating of 4 / 5. The business model is fundamentally quite easy to understand. TPL owns a lot of land and leases it out for the resource extraction. They derive royalties based on those extractions. The complicated part of the business is mostly the understanding of the energy industry and its relation to land value, which may not be understandable by many.

Balance Sheet Health Rating

TPL earns a balance sheet health rating of 5 / 5. Their strong cash reserves, minimal debt, and consistent cash generation indicate strong financial stability. They are very well-capitalized and can handle most financial shocks.

Recent Concerns / Controversies and Management Outlook

  • Oil and Gas Price: The company has noted the recent volatility in energy prices. While high prices usually imply higher activity and profits, extreme volatility may be a concern as investors or even oil companies may pause investments into drilling.
  • ESG: There is a potential headwind from regulatory policy regarding ESG standards, as it is unclear if TPL, as primarily a resource producer, will be negatively affected by it. The company is, however, trying to emphasize sustainable practices and also diversify away from oil and gas extraction.

The company’s outlook emphasizes long-term value creation through sustainable growth and diversification. It has a preference for paying off debt and also returning capital to shareholders through share repurchases and dividends. The management also intends to use technology and innovation to further improve operations.