Texas Pacific Land
“The best business is a royalty on the growth of others, requiring little capital itself.” -Warren Buffett (Trades, Portfolio)
Texas Pacific Land Trust (TPL, Financial) is the best business most investors have never heard of. The Company has a storied history as a railroad operator, but not so rich a history of railroad profits. Today, the Company is an exceedingly profitable, fast-growing, uniquely diversified royalty operation; in arguably the lowest-cost oil basin (Permian Basin) outside of the Middle East oilfields.
The Texas Pacific Railroad Company was created by federal charter (and Texas state charter) in 1871 to build a railroad from the eastern border of Texas in the town of Marshall (near Shreveport, Louisiana) to San Diego, California. The Company’s charters were issued at the tail end of the speculative railroad boom after the Civil War. This boom was largely financed with debt issued to European banks and investors. The failure of Jay Cooke & Co. in September 1873 triggered the (first) Great Depression throughout the U.S. and Europe.
Railroad construction literally came to a grinding halt all over the U.S. By 1876, the Company had only laid 444 miles of track and just 972 miles of track by 1886. Such lack of development triggered losses of chartered land. As if such troubles weren’t enough for the Company to deal with, hurricane-induced flooding in 1886 and 1887 and crop failures due to drought at the same time drove the final railroad spike in the Texas and Pacific. By 1888, the Company filed for bankruptcy. The bond holders received the 3.5 million acres of granted land in Texas. Stock certificates of trust were issued to the debtors and would later be traded on the New York Stock Exchange. The mineral estate was bought by Texaco (now Chevron). The Company owns a royalty interest in 500,000 acres of this land as well.
(An aside for railroad buffs: At the same time of the Texas and Pacific charter in 1871, the state of Texas also granted permission for the Company to purchase the Southern Trans-Continental Railroad Company and the Southern Pacific Railroad Company. These two purchases were completed the next year. An act of Congress changed the name of the Company to Texas and Pacific Railway Company. In 1976, the Company merged with the Missouri Pacific Railroad (MoPac; the former Pacific Railroad), which by then included 10 other roads). MoPac would ultimately be acquired by the Union Pacific Corporation in 1997.)
Fast forward to today, and the Company’s acreage in Texas goes right through the heart of the most lucrative acres within the prolific Permian Basin – particularly the Delaware Trend within the Delaware Basin. With hydraulically fractured horizontal oil and gas well drilling becoming the mainstay within the U.S. by 2011, such technology transformed the economics of the Texas Pacific Land Trust.
Indeed, between 2005 and 2010 earnings per share weren’t going anywhere stuck between $0.78 per share and $1.17 per share. That would change in 2011. In 2011 and 2012, the Company was $2.21 and $2.20 per share, respectively.
After 2013, the Company’s gushing oil and gas equivalent royalties (paid in barrels) began to gush in size to make Jed Clampett blush. From 2013 to 2019, earnings per share would grow from $3.16 per share to $41.09 per share. The collapse in the price of oil in the pandemic year of 2020 cut earnings per share in half to $22.07. The Company should earn +$36.00 per share in 2021. If oil prices stay between $70 to $80 per barrel, the Company should earn at least $50.00 per share.
In the years before developing the Company’s water business, the oil and gas royalty business generated pure profits. Operating margins were consistently in the high 80s and low 90s. The capital spent on building and maintaining the newer water business is relatively small, but not immaterial. Thus, operating margins are still a robust 75-80%. In fact, the Company’s free cash flow margins (+60%) are higher than the most profitable companies within the S&P 500 Index.
Today, if you are an oil or gas exploration and production company and you desire any activity on the Company’s 23,700 royalty acres in the rich Permian Basin as well as 880,000 surface acres (think grazing and hunting leases, plus the huge optionality of future solar panels, wind farms, and mineral rights), this is all at zero cost on the Company’s books. Furthermore, the Company estimates that just 7-8% of their royalty acres have been drilled, plus they believe that there is 21 years’ worth of inventory under $40 per barrel breakeven oil.
The Company’s burgeoning water business has become a key source of income in arid West Texas. Started in 2017, from the sale of brackish, non-potable water to the E&P operators, other water-related services continue to emerge and develop, including water disposal, recycling, sourcing, and treatment. The Company’s water operations and services have rapidly grown from $31 million in revenue to likely reach a revenue run-rate of $115 by year-end 2021. According to Company reports, just over $100 million has been in the water business and annual maintenance capital looks to be around $10 million. The water-related royalties alone are now generating over $15 million in revenue per quarter. As water becomes more valuable to E&P operators, the Company’s water related operations and services will be an excellent use for continuing capex.
Our Letters over the past 30 years have never been a platform for our company or individual political views. The supply of political opinions and discourse seems to be at all-time highs these days. The demand from our clients for our personal political views remains cheerfully near zero. That said, we will still call the economic realities as we see them in investment matters that might have differing views as to our personal political differences.
We would not be surprised should the price of oil and gas remain structurally high (higher) over the years to come. The global oil and gas industry has suffered from underinvestment in exploration and development for years. Today, the worthy societal goals, priorities, and initiatives of Net-Zero 2050 and ESG goals continue to exacerbate the lack of investments in production and exploration of fossil fuels. Nationwide government, public and corporate desires to become carbon neutral as fast as possible continue to collide with the current reality that the world’s demand for fossil fuel shows little sign of abating, while shortages worsen – particularly within the all-important OPEC+. More aggressive net-zero policies in Europe have left the continent woefully short of stored heating oil before the winter season, only to see prices skyrocket. Fossil fuel shortages in China have led that country to refire coal plants. From the vantage point of 2022, the necessary bridge of fossil fuels looks to be measured in decades. Over the intervening years, the rich, low-cost Permian Basin will become even more critical to our nation’s energy needs.
Texas Pacific Land Trust is a pure play on the compelling economics of the Permian Basin. The Company likes to refer to itself as the “ETF of the Permian,” given the diversity of their revenue streams and the diversity of the Company’s royalty operators. Royalty companies are few in number, and rarer still are the handful of those that gush cash and grow like Texas Pacific Land Trust. Our oldest clients may remember our successful investment in Franco-Nevada Mining – another “golden” royalty company.
From David Rolfe (Trades, Portfolio)'s Wedgewood Partners fourth-quarter 2021 letter.
