Texas Pacific Land Corporation (NYSE:TPL) Q4 2023 Earnings Call Transcript
Texas Pacific Land Corporation (NYSE:TPL) Q4 2023 Earnings Call Transcript February 22, 2024
Texas Pacific Land Corporation isn't one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Ladies and gentlemen, good morning, and welcome to the Texas Pacific Land Corporation Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Shawn Amini, Finance and Investor Relations. Please go ahead.
Shawn Amini: Thank you for joining us today for Texas Pacific Land Corporation's fourth quarter 2023 earnings conference call. Yesterday afternoon, the company released its financial results and filed its Form 10-K with the Securities and Exchange Commission, which is available on the Investors section of the company's website at www.texaspacific.com. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings.
During this call, we will also be discussing certain non-GAAP financial measures. More information and reconciliations about these non-GAAP financial measures are contained in our earnings release and SEC filings. Please also note, we may at times refer to our company by its stock ticker, TPL. This morning's conference call is hosted by TPL's Chief Executive Officer, Ty Glover, and Chief Financial Officer, Chris Steddum. Management will make some prepared comments, after which we'll open the call for questions. Now, I'll turn the call over to Ty.
Ty Glover: Good morning, everyone, and thank you for joining us today. TPL ended 2023 with the best quarter we had all year. Performance was led by oil and gas royalty production of approximately 26,300 barrels of oil equivalent per day, which represents 20% sequential quarter-over-quarter growth and a new company record. We also received excellent contributions from our surface and water related businesses, as they accounted for over 40% of quarterly consolidated revenues. For produced water, we generated a royalty fee on 2.7 million barrels per day during the quarter, also a record. On sourced water, we recorded 517,000 barrels per day of sales volumes, of which 62% were off of our footprint, as demand for both brackish and treated water remain elevated.
Our surface leases, easements and materials segment, which we refer to by its acronym SLEM, generated $19 million of revenues, representing 5% growth sequential quarter-over-quarter. Performance for full year 2023 highlights the virtues of TPL's unique business model, especially during periods of volatile commodity prices. Despite oil prices falling by 18% year-over-year and natural gas prices declining by 64%, our water and SLEM businesses collectively grew revenues by 30%. For fiscal year 2023, our sourced water revenues grew by 32% year-over-year, produced water royalties grew by 17% and SLEM grew by 48%. This strong performance from our water and surface endeavors helped to substantially offset the negative impact from lower commodity prices.
Overall, TPL's business continues to operate efficiently, with fiscal year 2023 adjusted EBITDA and free cash flow margins of 86% and 66%, respectively. As we look ahead to 2024, TPL is well positioned to benefit from ongoing activity in the Permian Basin. Our land and water teams remain busy, and thus far, customers have indicated intentions to maintain strong levels of development on our royalty and surface acreage. Supermajor operators, in particular, continue to execute on robust, growth-oriented development pacing. This is especially relevant for TPL as these large operators account for majority of the development on TPL's royalty acreage. With respect to recent commodity price volatility, it's important to remember that TPL's royalty and surface acreage overlaps with some of the most highly economic shale within both the Delaware and Midland Basin and North America more broadly.
Should we see prolonged period of weak commodity prices, we would expect operators to maintain healthy development levels across their core Permian leaseholds while triaging other parts of their non-Permian portfolio. Should oil prices remain supportive at current levels or higher, then we'd expect activity levels to support higher production. We're optimistic and encouraged by what we see so far, and we're looking forward to maximizing our opportunities for this year. Chris will have more to share later on our outlook for the Permian and for TPL's business into 2024. I would also like to spend some time this morning reiterating and elaborating on TPL's capital allocation priorities. First, our North Star is maximizing shareholder value. That's always been the goal and that dictates everything we do here.
On that point, we believe the key to maximize TPL shareholder value is to maximize free cash flow per share. Cash is finite. Over the long term, what a company can pay in dividends, repurchase in shares and invest in itself are fundamentally limited to the cash it generates. Thus, if we can expand free cash flow on a per share basis and not just near term but also long term productive capacity for future free cash flow per share, then we'll be able to sustainably and consistently increase our capacity to return greater amounts of capital back to shareholders. The more cash we can ultimately return to shareholders, the more valuable the enterprise. If maximizing free cash flow per share is the goal, the question then becomes, how do we achieve it?
Our primary options are to invest in organic opportunities, buyback our stock, acquire external assets or pay dividends or some combination thereof. Each one of those options contains an economic and strategic reality. Our job is to determine the long-term returns for each option and then allocate capital accordingly. If we can do that well, we create shareholder value. In practice, there are no simple answers, but we try and solve these items with a fundamental bottoms-up intrinsic value approach. So, let's quickly go through our capital allocation options, deconstruct how we evaluate returns and where those returns and priorities stand today. Starting with organic investment. Here, we look at what opportunities are available to leverage the company's existing assets, people and expertise to expand its business.
Potential organic investments are predicated on generating double-digit returns on capital, while also balancing our preference for high-margins and a capital-light business model. Our investment into the water business serves as a great case study. For most of TPL's long history going as far back as 19th century, there was basically zero organic investment. In 2017, that changed as we began to take advantage of TPL's unique ownership of both royalty and surface acreage. Without diving too deeply into the commercial and competitive dynamics that drove why we structured the individual pieces to make up the water business, namely an operated source water business and a contracted throughput royalty for produced water, the key takeaway is that each business was deliberately and carefully commercialized to provide the optimal balance between generating high returns on investment, moderating capital requirements, enhancing the overall business profile, and ultimately, maximizing long-term free cash flow per share.
Since 2017, we have cumulatively invested approximately $140 million of capital into the water business. The water business in return has generated about $470 million of cumulative after-tax cash flow. And that does not include any of the significant benefits we derive both from sourcing water for our operator completion activities or from facilitating essential produced water solutions for oil and gas wells on TPL royalty acreage. For fiscal year 2023, our water services and operations segment closed with a net PP&E balance of about $84 million, from which we generated $99 million of net income during the year, resulting in excellent returns on capital. As it stands today, we've developed the largest sourced water network in the broader Northern Delaware Basin.
We invest approximately $5 million to $10 million annually towards various growth and cost savings initiatives, with each project individually assessed to determine economics as we continue to explore various opportunities and ideas to enhance our business. Overall, the growth of the water business has provided us with substantial free cash flow growth to the overall enterprise. With that growth in free cash flow over the years, TPL has been able to pay out increasingly larger dividends and execute on larger buybacks, all the while maintaining high cash flow margins, low capital intensity and a net cash balance sheet. Beyond water, we're also searching for new opportunities to leverage our surface ownership. Many fan lines we've discussed in the past are a good example.
Consistent with our current makeup, the overwhelming preference is to commercialize new projects in a capital-light high-cash flow margin manner. To the extent there's a project that can provide both exceptional returns and is strategically critical within the context of the overall enterprise, then we have the wherewithal to strategically deploy capital just like we did for the water business. Next, let's discuss share repurchases. When you buy back company shares, you're basically still buying assets. It's just that these assets are already owned by the company. The question is, what is the return generated by buying back your own shares? We look at share buybacks in a similar manner as we look at purchasing external assets. If buying back TPL stock, we're buying a claim on over 20,000 net royalty acres on an [indiscernible] basis and nearly 1 million surface acres.
Those assets will generate a cash flow stream. What we do is go piece by piece and evaluate the full cash flow potential over the life of each asset. After aggregating the various components of the business, we can measure that value against the price to acquire. That price for a buyback is our publicly traded share price. There's just as much art and science to this, given all the various inputs, and we do our best to generate reasonable assumptions. We run various scenarios, sensitizing important factors, commodity prices, of course, being a major item. We have reservoir engineers on staff to assess resource potential track-by-track for our royalty acreage. We run a bottoms-up lifecycle analysis across our water and [spud] (ph) businesses.
We also own a forever land asset that we are actively working to monetize and that is basically an option value for future revenue potential. So, we account for that. After aggregating everything, we have an internal appraisal of our intrinsic value. We can then measure that against the stock market's appraisal of those exact same assets. If we can generate a double-digit IRR at a mid-cycle oil price of approximately $75 oil and $3 gas, then buybacks become an extremely attractive option to deploy significant capital. We still have over $200 million remaining on our current buyback authorization, but we have the tools in place to quickly execute a robust share repurchase program. Beyond just these opportunistic parameters, we do anticipate maintaining some level of buybacks throughout the year.
There are still benefits to buying more of the assets we know so well and to just being in the market supporting stock. We have a long history of repurchasing shares. We recognize that has been an important element of the TPL story through the years and that's something we want to reinforce. On that point, we received feedback from some investors on why TPL doesn't just stick to what it did in the past and just use all of its cash to buy back shares. After all, that strategy was a core factor in driving some phenomenal returns through the decades. It's a fair point and it's worth diving into the buyback strategy of TPL of yesteryear versus the buyback strategy today. For most of its existence, when TPL was effectively just a liquidating trust, the strategy back then was to take the modest cash it generated from some vertical oil and gas wells, raising leases and asset sales and to use those proceeds to repurchase shares.
With the benefit of hindsight, those buybacks worked incredibly well because few knew or understood that one day modern horizontal drilling and hydraulic fracturing would unlock the ocean of oil that was locked in the shale lying underneath the trust's royalty acreage. Thus, you were buying back assets that would later become some of the best shale assets at a valuation that only reflected some minor ancillary operations. It was quite a deal. Today, the extent and quality of the shale resource on TPL land is widely recognized. So much so that our stock trades at a meaningful premium to peers. That's also become evident recently with nearly $100 billion of Permian lease operator acquisitions occurring just in the last few months. Although, we resolutely believe TPL has a unique irrevocable set of assets and an outstanding team that justifies a premium, buying back our stock today isn't the same steal that it was decades ago, not to say that it isn't a good deal today.
Buyback economics from decades past aside, we will not hesitate to aggressively ramp buybacks when the opportunity arises. Furthermore, if returns across organic CapEx, M&A, dividends or buyback were all equivalent, our preference would be to lean into buybacks. Our bias is buybacks. Turning to external acquisitions. Over the last few years, we've been candid in our interest in evaluating potential opportunities. We have a huge service and royalty footprint. We have a talented team of industry professionals. We have capabilities to monetize land like few others can, and we have the technology and systems to efficiently scale. It's for all of those reasons why we believe we're in a prime position to consolidate high-quality Permian surface and royalty assets.
We approach M&A similar to buybacks. We evaluate each asset from a bottoms-up intrinsic value approach. The same assumptions we use to value our own assets, whether it's commodity prices, track-by-track resource potential or surface and water opportunities, we use to analyze third-party assets. Again, the goal here is to generate at least double-digit IRRs in invested capital and incremental free cash flow per share. For any package that's of meaningful interest to us, in addition to extensive financial analysis, we also perform significant asset and operational due diligence. Because TPL already owns great assets, we have no interest in diluting down our asset quality, our growth prospects or our unique business model. For any deal, the economics have to work, it has to make us a better enterprise and it has to enhance shareholder value.
It's a very high bar and we'll keep it high. And finally, if the company only has modest opportunities to deploy capital towards organic or external growth and if buybacks are relatively less attractive, then dividends are another effective way to return capital back to shareholders. A good example was back in May of 2022, WTI crude was over $100, nat gas over $7, both basically at highs over the last decade. Valuations then for external assets were based on essentially peak commodity prices and peak multiples. Buybacks during this time were also relatively less attractive given this above-cycle commodity price. We had modest capital needs for our organic endeavors. Without great options to use the capital ourselves, we paid a $20 per share special dividend and gave back cash back to shareholders.
If we find ourselves in a similar situation in the future, then large special dividends are readily available. Our capital allocation strategy will adapt as industry and market fundamentals evolve. Our cash balance at year-end has grown to $725 million, as we've harvested cash flows over the last couple of years during this period of relatively high commodity prices and as we've held back on large procyclical spending. Today, commodity prices are lower and we have an opportunity to deploy substantial capital countercyclically as weaker competitors pull back as valuations fall and as opportunities grow, or if commodity prices rise, our business will benefit tremendously. We're very much in a position of strength and the company will excel in most any environment.
With that, I'll turn the call over to Chris.
Chris Steddum: Thanks, Ty. Consolidated revenues during the fourth quarter of 2023 were approximately $167 million, representing 6% sequential quarter-over-quarter growth. Adjusted EBITDA was $151 million, and free cash flow was $116 million. Free cash flow for the quarter grew 15% on a year-over-year basis, driven by higher royalty production, sourced water sales, produced water royalties and SLEM revenues, and partially offset by lower oil, natural gas and NGL prices. Since Ty has already reviewed some of our other highlights for the quarter and full year 2023, I'll spend some time now on how we're thinking about things for 2024. As it relates to development in the overall Permian, our general view is that if oil prices stay around or above $75 per barrel, that is generally constructive for continued growth.
If oil prices weakened to $70 or less for an extended period of time, we would expect overall Permian activity levels to slow and overall production volume to flatten. Specific to TPL, our business overall tends to be dominated by supermajors and large independents, which tend to maintain development plans even during times of sideways commodity prices. Over 50% of our current drilled but uncompleted wells, otherwise known as DUCs, are held by supermajor Chevron, Exxon, Conoco, BP and Occidental. 80% of our current DUCs are held by operators with an enterprise value of at least $15 billion. Although rig counts have fallen in the overall Permian compared to a year ago, we have seen rig counts on our acreage remains stable. New spud activity on a net basis in the fourth quarter was a company record and our overall near-term well inventory remains robust.
We are seeing persistent strong activity in Loving in Northern Culberson and in the Central Midland subregion. In addition, continued operator efficiencies have condensed permit to production pacing even despite wells with increasingly longer lateral lengths. Our water team today is just as busy as last year and indications that they've received from operators is that development activity will remain at high levels. Our land agents also remain active as demand for pipeline easements, surface leases, wellbore easements, and caliche is strong. As we previously indicated, we believe that TPL royalty production can grow at a level that exceeds overall Permian growth, although like we've experienced over the past year or so, short-term quarter-to-quarter performance, can be somewhat volatile due to greater co-completion developments, operator short-term development patterns, specific net revenue interest for various tracks and check spud timing.
To conclude, TPL is in a great spot today. Our balance sheet arguably has never been stronger. The business still maintains strong cash flow and profitability margins. TPL still remains unhedged on commodity prices, so we capture the full upside as commodity prices improve. And if commodity prices weaken, then we have ample means and multiple ways to take advantage. And with that, operator, we will now take questions.
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