Land Use Rights on 900,000 Acres of Oil & Natural Gas Rich Fields in Texas Offer Potential for Sizable Shareholder Returns
Texas Pacific Land Trust (NYSE: TPL) owns 899,697 acres of prime land in 18 counties in Texas’ booming oil and natural gas producing regions, making it one of the biggest land owners in the state. The Trust generates revenues from multiple sources such as land sales, specialized leases (such as for grazing), easements, and oil and natural gas royalties in-perpetuity from 459,200 acres. The company was formed in 1888 from the bankruptcy reorganization of the Texas and Pacific Railway Company which owned 3.5 million acres of land in Texas that was subsequently turned over to bondholders who setup the Trust and gave bondholders proportional shareholding interests in it through sub-share certificates (“shares”). Over the years, the Trust has whittled down its holdings to the roughly 900,000 acres it owns today, with proceeds from land sales use to buyout shareholders through the years and to make investments in strategic land parcels that complemented existing Trust land holdings.
Texas Pacific Land Trust (TPL) Stock Charts:
99% Share Price Appreciation YTD, 22.5% Annualized 20-y ROR
The recent boom in oil and natural gas production in Texas has heavily benefited the company through associated royalty revenues, with shares up 530% over the past five years and up
almost 99% year-to-date (to $186.48 as of September 11, 2014).
Over the past 20 years, shares have returned a total annualized rate of return of 22.5% including dividends, well above the 8.6% return on the S&P 500 index over the same period.
And although shares have risen sharply, technical indicators such as Moving Average Convergence/ Divergence (MACD) and rising 50- and 200-day moving averages indicate a bullish and strong upward trend that some analysts say could lead to a doubling of shares over current price levels.
Shares are held by a very stable investor base with low average turnover, and this long-term low-turnover holding pattern suggests investors believe shares could deliver significant gains going forward.
49x P/E Ratio Less Than 61% Annual EPS Growth
At $186.48 (as of 9/11/2014), shares trade at a price-to-earnings ratio of 49.4x, giving the Trust a market capitalization of $1.6 billion. Its valuation is, however, well above its book value of $26.1 million because the Trust does not carry the land on its balance sheet as an asset even though it owns all rights to various land-based revenues and resulting cash flows including proceeds from land sales.
Land Rights, E&P Growth Potential Justify Valuation
In Q2 2014, the company generated $1.7 million from the sale of 1,395 acres of land at an average price of $1,198 per acre. In the year-ago quarter, it sold 43.7 acres at an average price of about $5,000 per acre. So, clearly, acreage rates vary by location and its premium properties are worth more than those with low oil exploration and production or easement potential. Conservatively assuming an average price of $2,000 per acre, its 899,697 acres of land are estimated to be worth about $1.8 billion but could be worth a lot more. So, intrinsically, rights on its land assets are likely worth more than the company’s current market capitalization of $1.6 billion and suggest shares could well have significant intrinsic value upside potential over current levels.
In addition, the expansion of E&P activities in Texas, with perpetual royalties, could significantly boost future income.
Small, Rising Dividend Stream; Yield Dwarfed by Share Price Appreciation
On March 14, 2014, the Trust paid an annual cash dividend of 27¢ per sub-share, its 11th consecutive annual increase in regular dividends, and offers a fairly unattractive dividend yield of just 0.2%. And though it primarily relies on land-based revenues, the Trust is not structured as a Real Estate Investment Trust or REIT.
Management Has Long Tenure, Experience with Trust Activities
The Trust has three trustees – Maurice Meyer III, John R. Norris III and James K Norwood. Maurice Meyer III serves as Trust Chairman and is a private investor based in Jupiter, Florida; he has served as a Trustee for the past 23 years and spent his entire career in the securities industry. Norris is a lawyer and a practicing attorney in Dallas, Texas, which allows him to provide counsel and insight to his fellow trustees and management on various legal issues that the Trust faces from time to time; Norris has been a Trustee for the past 13 years and had advised the Trust on legal matters for many years prior to his election as a trustee. Norwood has extensive experience as a real-estate appraiser in Texas and his expertise is invaluable to the Trust in administering its holdings, including leasing or selling land parcels.
David M. Peterson serves as General Agent and Secretary, Chief Executive Officer and Chief Financial Officer, and is based in Dallas Texas. Peterson joined the Trust in 1997 and was appointed Chief Financial Officer in November 2002. He was appointed General Agent and CEO on January 1, 2014.
Over the past year, management has delivered a 129% Return on Assets and a 162% Return on Equity, while growing earnings aggressively and selectively disposing off land assets, while maintaining very low administrative overhead.
61% Jump in Q2 Net Comprehensive Income Trumps 49x P/E Ratio
For the three months ended June 30, 2014, the Trust had rental, royalty and sundry revenue of $13.9 million, received $1.7 million from land sales in the quarter and $38,500 in interest from notes receivable, for total revenue of $15.6 million. Of this, the company spent $0.4 million on General and Administrative expenses tied to overseeing revenue and sales activities, and paid $0.45 million in taxes on property sales, with total operating expenses of $0.87 million. After expenses, the Trust generated Q2 operating income of $14.7 million with exceptionally high margins driven by its simple, low cost business model. After income taxes, the company had net comprehensive income of $9.9 million or $1.17 per sub-share (up from $0.71) on 8,439,914 sub-share and equivalent certificates outstanding.
Revenues were up 56.6% and comprehensive net income was up 61.4%, and this 61% growth in earnings per share justifies, and indeed is above, the company’s price-to-earnings ratio of 49x.
The quarterly increase in revenue and earnings was primarily from increases in oil royalty payments, easement and sundry income, and limited land sales.
Oil and gas royalties brought in $7.9 million in the second quarter, an increase of 23.7% compared to $6.4 million in the year-ago quarter. Oil royalties contributed the lion’s share with $6.3 million, up 30.9% from the year-ago quarter’s oil royalty revenue of $4.8 million. Q2 2014 revenue gains benefited from a 12.8% increase in the average price per royalty barrel of crude oil and a 16.1% increase in royalty-generating crude oil production.
Natural gas royalties were $1.56 million, up 1.2% over the past year from a 4.9% increase in volume that offset a 3.5% decline in gas prices.
Easement and sundry income was the second largest revenue contributor at $5.86 million in the second quarter of 2014, up 90.3% over the year-ago quarter revenue contribution of $3.1 million, with the increase primarily driven by increases in pipeline easement income due to higher trading and exploration activities on Trust land. However, this income category is unpredictable and varies significantly from quarter to quarter.
Interest income is derived from notes receivable on land sales and from short-term investments of cash on hand. In the second quarter, interest income dropped 70.8% to $41,880 due to a sizable decline in notes receivable to $1.3 million from $7.3 million a year ago.
General and administrative expenses decreased 18.7% to $422,649 due to lower legal and employment expenses.
At quarter end, the Trust had cash and cash equivalents of $24.1 million, notes receivable of $1.3 million, land service rights on 899,697 acres in 18 counties in taxes for total assets of $31.4 million.
In addition, the Trust had 1/16th nonparticipating perpetual royalty interest in 373,777 acres and 1/128th nonparticipating perpetual royalty interest in 85,414 acres.
Its $5.3 million in liabilities include accounts payable, taxes payable or deferred, and unearned revenue. Shareholders had collective capital of $26.1 million, up from $17.9 million at the beginning of the year, with 8,686,690 sub-shares outstanding, down from 8,439,914 at the end of the year-ago quarter.
For the six months ended June 30, 2014, the Trust generated $19.9 million in net cash from operating activities, and spent $6.7 million to buy back share certificates, and paid $2.3 million in dividends. As a result, net cash increased by $10.9 million to $24.1 million.
In Q2 2014, the Trust repurchased 25,141 sub-share certificates at an average price of $156.71.
The Trust offers significant capital appreciation upside, making it suitable for growth investors with a moderate tolerance for risk. While royalty revenues will be impacted by the volatility of oil and natural gas prices, the boom in Texas oil and gas production and related easement demands for pipelines and roads should boost revenue and cash flow in the years ahead. Shares currently appear to trade below intrinsic value and have a solid investor base with low turnover, and are attractive at current levels, especially after a recent dip related to falling crude oil prices.