Could Texas Pacific Land Be a 5-10% Annual Return Stock?

Key Concepts

• Texas Pacific Land Corporation (TPL): A company with a business model centered around owning vast amounts of land, primarily in West Texas, with significant mineral rights.
• Irreplaceable Assets Business: A business model where the core assets are unique and cannot be easily replicated or replaced.
• Pick and Shovel Play: A business strategy that provides essential tools and services to other companies operating in a specific industry, rather than directly competing in the core business. In this context, TPL provides land, water, and other services to oil and gas companies.
• Royalty Play: A business model that generates revenue from a percentage of the production or sales of another company.
• Corporate Conversion: A change in the legal structure of a company, in this case, from a trust to a corporation, with the aim of creating shareholder value.
• Durable Earnings Growth: The ability of a company to consistently increase its profits over time.
• Adjusted EBITDA Margins: A measure of a company's profitability before interest, taxes, depreciation, and amortization, adjusted for certain items.
• Free Cash Flow Per Share: The amount of cash a company generates per outstanding share of common stock after accounting for operating expenses and capital expenditures.
• Margin of Safety: The difference between the intrinsic value of an asset and its market price, providing a buffer against potential losses.

Business Strength

Texas Pacific Land Corporation (TPL) received a strong rating of 8 out of 10 for its business strength from both Dan Kaplinger and Jason Hall.

• Core Asset: The company's primary strength lies in its "irreplaceable assets business," specifically its vast land holdings. This land is unique due to its location and the resources it contains, particularly oil and gas.
• Diversification Beyond Minerals: While minerals (oil and gas) are the main source of revenue, TPL is actively seeking to monetize its land through other avenues.
• "Pick and Shovel" Strategy: Jason Hall highlighted TPL's evolution into an "all-inclusive pick and shovel play." This means they are not just a royalty company but are actively providing services like water to oil and gas companies, making it easier for them to extract minerals. This approach is described as "customer service to the oil patch."

Management

Both Dan and Jason rated TPL's management at 7 out of 10.

• Corporate Transition: Jason Hall believes the recent corporate conversion from a trust to a corporation will create value, though he is keen to see how TPL leverages more than just minerals and water for revenue.
• CEO's Trajectory: Dan Kaplinger expressed confidence in the CEO, noting his progression from a "rank and file land man in 2011" to CEO in 2016. This personal growth story is seen as a positive indicator.
• Expansion of Services: Management has been effective in executing the corporate transition and expanding services, particularly in the water sector, to better support partners.

Financials

TPL received high ratings for its financials, with Dan scoring a 9 out of 10 and Jason an 8 out of 10.

• Financial Profile: The financial profile is described as "good" with "no debt." The land assets have been owned for decades, contributing to high profitability.
• Massive Margins: The company boasts "massive margins," comparable to those seen in the software business, which is unusual for a company in this sector.
• Growth Limitation: The primary reason for not achieving a perfect score is the reliance on the value of produced assets for earnings growth, rather than the company's ability to increase the volume of its activities. Jason Hall expressed less conviction in TPL's ability to find enough new revenue streams for meaningful earnings growth. Dan Kaplinger, however, is satisfied with the strong financial performance, even without significant growth expectations.

Valuation and Future Outlook

• Projected Returns: Dan Kaplinger anticipates 5-10% returns over the next five years, aligning with his market call.
• Safety Score: Dan assigned a safety score of 6 out of 10, citing a concern that management might "get out in front of its skis" and push for growth where it's not readily available. He also noted the stock's recent decline of almost 50% from its highs, which he sees as creating a "margin of safety."
• Management Risk Mitigation: Jason Hall's safety score was higher at 7 out of 10. He acknowledged the risk of management making poor decisions but pointed to specific elements in their compensation structure that mitigate this risk:
  • Adjusted EBITDA Margins: 38% of compensation is tied to this metric.
  • Free Cash Flow Per Share: Another 38% of compensation is linked to this.
  • Stock Price Growth: A quarter of compensation is driven by stock price appreciation.
  • Jason believes this compensation structure incentivizes management to act in the company's best interest, focusing on profitability and growth.

Overall Score and Conclusion

Texas Pacific Land Corporation received a strong overall score of 7.0 out of 10 from both Jason Hall and Dan Kaplinger. The company is recognized for its unique and valuable assets, strong financial position with no debt and high margins, and a management team that is actively working to expand its business model. While concerns exist regarding the sustainability of significant earnings growth and the potential for management overreach, the compensation structure is seen as a key factor in aligning management's interests with shareholder value. The recent stock price correction is viewed as potentially creating a more attractive entry point for investors.