Here’s today’s menu:

• Introduction

• Stock information

• Company background

• Financial performance

• Stock price performance

• Valuation

Introduction

Texas Pacific Land Corporation (TPL) earns money through a variety of revenue streams related to its extensive land holdings in West Texas, primarily in the Permian Basin. TPL is not an oil and gas producer itself, but rather generates income from the activities of others on its land.

Stock information

Company background

TPL's business model is characterised by high cash flow margins and relatively low ongoing capital expenditure requirements. The company is also exploring new revenue opportunities related to renewable energy, environmental sustainability and technology.

Here is a breakdown of TPL's revenue sources:

• Oil and Gas Royalties: TPL owns significant oil and gas royalty interests in the Permian Basin. As a royalty owner, TPL receives a percentage of the revenue generated from oil and gas production on its land without incurring any capital expenditures or operating expenses for well development. This revenue stream fluctuates based on market prices for oil and gas and production decisions made by the owners and operators of the wells. In 2023, oil and gas royalties comprised 57% of TPL's total consolidated revenue.

• Water Sales and Royalties: TPL, through its subsidiary Texas Pacific Water Resources (TPWR), provides a full range of water services to operators in the Permian Basin, including water sourcing, produced-water treatment, infrastructure development and disposal solutions. TPL earns revenue from sales of sourced and treated water, as well as royalties from the transfer or disposal of produced water on its land.

• Easements: TPL grants easements for pipelines, power lines, utility lines and subsurface wellbores across its land, generating revenue from these agreements. Easements usually have terms exceeding 30 years and renew every ten years with an additional payment.

• Commercial Leases: TPL leases land for various commercial purposes, including processing, storage and compression facilities, as well as roads.

• Land and Material Sales: TPL occasionally sells tracts of its land to third parties, generating revenue from these transactions. The company also sells materials such as caliche and sand, which are used in constructing oil and gas infrastructure and completion operations.

Financial performance

Whoa! Look at the return on capital employed (ROCE). It is averaging 54%. Remember our rule-of-thumb that anything above 15% is good. This is great.

Whoa again! Look at those margins. The average free cash flow (FCF) margin is 62%. The average for the S&P500 is 15%.

I’m going to stop saying “whoa”, but look at the revenue growth. It's a bit choppy, but on average it is growing at a fabulous 23%.

Stock-based compensation (SBC) is small - thankfully.

Capital expenditure is low. This is to be expected because the company doesn't produce oil and gas, it lets other companies do that on its land.

Debt to total capital is currently about 10%. That means only 10% of the company is financed with debt. That is very conservative - which is a good thing. The less money a company borrows, the less chance it has of getting into trouble if business goes down.

Let me explain the debt thing a bit more.

In simple terms, a company can be financed with either equity or debt. Equity is the money that the owners put into the company (and retained profit). Debt is the money borrowed, usually from a bank. When a company borrows money, it has to pay interest and it has to pay back the original amount borrowed (i.e the principal amount).

Since the bank doesn’t own the company, when they lend money, they impose conditions. For instance, they insist on being paid before you (the owner) can take your share of profits. They also ask you to put up surety for the amount borrowed. For example, if you cannot pay back the debt and interest, they might take your land, buildings or equipment and sell it to get their money back.

As you can imagine, if a company borrows a lot of money and the business goes down, it can have trouble paying its debt. If that happens, the bank gets to control the company and can sell things to get its money back. That is a bad situation for the shareholders, so it is important that a company is able to afford debt and not to use too much.

Stock price performance

TPL’s stock price performance has been volatile over the past decade, but recently it went ballistic. Here are the returns over time:

• 1-year: 147%

• 3-year: 49% per annum

• 5-year: 46% per annum

• 10-year: 40% per annum

By comparison:

• The Nasdaq 100 has grown at 17.9% per annum for 10 years.

• The S&P 500 has grown at 13.1% per annum for 10 years.

• The MSCI World Index has grown at 10.08% per annum for 10 years.

The one year return is unbelievable. But even the past month is unbelievable with TPL up 27%.

It’s best to exercise caution when looking at companies with extremely volatile stock prices. With these stocks it is better to buy shares over time. That way you can average the price you pay, rather than buying in at an all time high.

No.1 versus No. 2

Let’s put Texas Pacific’s recent extreme share price growth (green line) in context by comparing it to Nvidia (purple line).

Next to Nvidia, it is barely noticeable. Which goes to show how amazing Nvidia’s growth has been.

Valuation

TPL has great operating performance, but that performance varies from year to year. For that reason it is slightly more difficult to value Texas Pacific. Valuation is more difficult because it is hard to forecast cash flows when they vary a lot. And you need to forecast cash flows to value a company.

Anyway, TPL has gotten very expensive this year. It is selling for more than our most aggressive valuation and it is far above our moderate valuation.

Conclusion

Texas Pacific Land Corporation is an Extraordinary Company.

TPL’s operating performance is volatile, but that doesn’t make it a bad company. It just makes it hard to predict.

With a market cap of $31 billion, it is small in comparison to the mega-caps like Nvidia at $3.4 trillion. However, it is nice to see a top performer that comes from an industry other than technology.

TPL is expensive at the moment, so we will add it to the ROA Watchlist and monitor it for now.

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