Wednesday, March 13, 2024

Wednesday Night Links

  • During wartime the British would suspend the convertibility of bank notes with the promise to restore convertibility at the previous parity after the war. This allowed the Bank of England to help finance the war with note issuance without the fear of a wave of redemptions at the Bank and a drain of its gold reserves. In addition, the commitment to restore the previous parity was equivalent to a promise to offset any inflation created during the war from note issuance with a corresponding deflation after the war. Many people, including many economists, have criticized this practice since the policy-induced deflations were particularly costly. They argue that after the war it might be best to let bygones be bygones and simply devalue the unit of account to avoid the costly deflation. However, if one recognizes the state’s desire for emergency financing, it is obvious that this commitment to restore the previous parity is necessary for long-term emergency financing. Without that commitment, money demand would decline over time in anticipation that the currency would be permanently devalued in an emergency and this would make it difficult for the state to use the same tool of emergency finance in the future. [Economic Forces]
  • Ferran Adrià, the legendary chef of El Bulli, once said that Mao was the most consequential figure in the history of cooking because: “[Spain, France, Italy and California] are only competing for the top spot because Mao destroyed the pre-eminence of Chinese cooking by sending China’s chefs to work in the fields and factories. If he hadn’t done this, all the other countries and all the other chefs, myself included, would still be chasing the Chinese dragon.” [Mr. and Mrs. Psmith’s Bookshelf]
  • Take, for example, the 15-minute city, which is a radical proposal that people should be able to get pretty much anywhere they need to go within fifteen minutes and ideally without needing a car. It’s a lovely idea, and the parts of residential America that are like that — most of them former suburbs — are insanely desirable and therefore insanely expensive. If it were easy to make more of them, you’d think the market would have figured out how! And if I had any confidence whatsoever that anyone involved in municipal planning could produce more neighborhoods like that — leafy green places full of parks, libraries, schools, and shops — or even that they wanted to have safe, clean, and reliable transit options, I’d be all for it. But these are the same people who are gutting public safety in the cities while failing to maintain or enforce order on existing transit. These are the same people who imposed draconian Covid mitigation policies like Zoom kindergarten, padlocked churches, and old people dying alone with nothing but a glove full of warm water to mimic human touch, all of which were meant to buy time for…something (human challenge trials? nationalized N95 production?) that never happened. It’s easy to ban things; it’s hard to do things. So you’ll excuse my doubts about their ability to build a 15-minute city that looks like Jane Jacobs’s ideal mixed-use development, with safe, orderly streets and a neighborhood feel. One rather suspects they would find it far more within their wheelhouse to simply abolish single-family zoning or imposing restrictions on who can go where, when. [Mr. and Mrs. Psmith’s Bookshelf]
  • Charles Town (later Charleston), South Carolina, modeled on the capital of Barbados, was filled with theaters, taverns, brothels, cockfighting rings, private clubs, and shops stocked with goods imported from London. Life in the city was a constant churn of social engagements, signalling, and status competition: in 1773, a pseudonymous correspondent wrote in the South Carolina Gazette that “if we observe the Behavior of the polite Part of this Country, we shall see, that their whole Lives are one continued Race; in which everyone is endeavouring to distance all behind him, and to overtake or pass by, all before him; everyone is flying from his Inferiors in Pursuit of his Superiors, who fly from him with equal Alacrity…” [Mr. and Mrs. Psmith’s Bookshelf]
  • To a certain way of thinking, after all, cities are where you get culture, like live theater and fusion cuisine and $20 cocktails; they’re where you get cool parties and bodega cats and the other essential elements of twenty-first century self-actualization. Children interrupt all that: they’re a weird time-consuming hobby, like building model railroads or running ultramarathons, so the suburbs, which are full of children, are a sort of ticky-tacky storeroom for humanity either larval or on hold. Suburbs are where interesting people go once they have kids and cease to be interesting. But if you regard children as not just a lifestyle choice but part of becoming a human being, if you believe that creating a home for your family is not drudgery but a valuable undertaking, then you begin to see the point of even an exurban subdivision. (Though I still like sidewalks.) [Mr. and Mrs. Psmith’s Bookshelf]
  •  My startup Terraform Industries looks to apply solar to produce synthetic fuel, consuming substantial amounts of land (though less than agriculture) in the process. Something like 2 billion acres, or 7% of Earth’s land surface area, would be sufficient to provide every man, woman, and child on Earth with US levels of oil and gas abundance and commensurate prosperity. It’s possible to imagine a future where people consume even more than that – widespread personal supersonic transport, for example – but ongoing conversion of land use away from intensive industrial agriculture toward inherently more productive solar synthetics is a clear net win for the environment. [Casey Handmer]
  • The “Yale or Jail” mentality that shuffles moderately intelligent people who would make excellent craftsmen into low-earning degrees at noncompetitive colleges7 gives unearned status to many of those who work at computers in air conditioning. Status is a substitute for cash in human economies, leading to an oversupply of white collar workers, and the cultural rot is continually reducing the number of working-class people who are employable. I predict that wages for people doing physical work will increase substantially in the coming decade, and ironically it may be these workers who have the most leverage to improve their working conditions. [The Tom File]
  • So why is strong government less appealing these days? Well, COVID happened. And our governments were pretty damn strong in dealing with it. They made strong laws and enforced them. And what did they do with their power? Absolutely retarded shit. They destroyed the world economy and made 95% of people completely miserable for 18 months. Up to 3 long years in some places. Again, as an Orient enjoyer I was very sympathetic of strong, effective government. My life has been pretty cozy thanks to it for the past decades. But after seeing boomers, hypocondriacs and neurotic menopausal women take the reins and use it against healthy people, I'm fucking done with strong effective government. [Spandrell]
  • Battery demand is growing exponentially, driven by a domino effect of adoption that cascades from country to country and from sector to sector. This battery domino effect is set to enable the rapid phaseout of half of global fossil fuel demand and be instrumental in abating transport and power emissions. This is the conclusion of RMI’s recently published report X-Change: Batteries. In this article, we highlight six of the key messages from the report. [RMI]
  • All we have managed to do halfway through the intended grand global energy transition is a small relative decline in the share of fossil fuel in the world’s primary energy consumption—from nearly 86 percent in 1997 to about 82 percent in 2022. But this marginal relative retreat has been accompanied by a massive absolute increase in fossil fuel combustion: in 2022 the world consumed nearly 55 percent more energy locked in fossil carbon than it did in 1997. [JP Morgan]
  • Let’s do a first principles-based bottoms up cost estimate. What is the Platonic ideal of a solar array? An array needs a 50 um thick layer of silicon to be fully opaque, and perhaps 100 um of necessarily flexible plastic “backing” material to provide mechanical support. Throwing in power cabling and installation rigs, I expect the installed cost of solar arrays to fall to $30,000/MW within 15 years, again with no miracles required. This is roughly 10x cheaper than the current cheapest costs. If we’re prepared to consider the implications of materials science wizardry – essentially expanding the class of known manufacturing techniques to include arbitrary configurations of known elements, a solar array could be made that’s even thinner, lighter, and cheaper, or even self-assembling. But even without such science fiction, existing manufacturing techniques will be extended to give us at least another decade of steeply falling costs, along with commensurate additional installations. The market will demand it and industry will provide. [Casey Handmer]
  • Your particular contribution is to pluck a worthy idea from the infinite sea of possibility, to determine how it must take form in the physical world, and to contrive a way to connect it to the engine of capitalism so it can generate self-sustaining wealth and value for its users. [Casey Handmer]

Friday, March 8, 2024

Earnings Notes V (Q4 2023)

[Previous earnings notes for Q4 2023: I, II, III, and IV.]

Franco-Nevada Corporation (FNV)
As you may recall from our notes last year on Rise of the Mining Royalty Companies, Franco-Nevada was the original mining royalty company, and is the largest, with a $20 billion market capitalization. Newmont acquired Franco-Nevada in 2002 and spun it back out in 2007.

FNC gets 64% of revenue from gold, 17% from oil and gas, 10% from silver, 5% from "other mining," and 3% from PGM metals. The revenue mix is 32% Canada and U.S., 30% South America, and 26% Central America and Mexico. Unfortunately, their biggest asset, the Cobre Panama mine in Panama which is operated by First Quantum Minerals, is currently on preservation and safe maintenance because of a political dispute.

FNV has net cash on the balance sheet, so the enterprise value is $18.5 billion. For 2023, revenue was $1.2 billion and cash from operations was $985 million. (So the OCF/EV yield is 5.3% and the OCF margin is 82% of revenue.) They spent $520 million on acquisitions of new interests and paid $233 million of dividends. (A 1.2% dividend yield.) General and administrative expense is only 2% of revenue.

Note that FNV's average selling price for gold in the fourth quarter was just under $2,000/oz and it comprised 66% of their revenue, but the price of gold just hit $2,200/oz.

Costco Wholesale Corporation (COST)
Look at a chart of Costco - it's like a meme stock. Even after a post-earnings (fiscal Q2 2024 release) selloff, it is still up 50% (not including dividends) over the past year. The market capitalization is now $324 billion. 

Total revenue was up 5.7% year-over-year, and comp sales in the U.S. (adjusted for gasoline price changes) were up 4.8%. Operating income for the quarter was up 8.4%, to $2.1 billion. (Note that membership fees for the quarter of $1.1 billion are equal to 54% of operating income.) Operating cash flow for the first half of fiscal 2024 has been $5.4 billion. The company spent $2.1 billion on capex (new stores) and paid shareholders $8 billion of dividends.

So the shares are pricey, but growth is good.

OTC Markets Group Inc. (OTCM)
This is an idea for a royalty-like business that is not as expensive as a business of similar quality (e.g. Intercontinental Exchange) because it is smaller. In the fourth quarter, OTCM had an operating income margin of 35% of its revenue less transaction based expenses. The market capitalization is currently $670 million and the enterprise value $638 million.

Free cash flow for 2023 was $31.5 million, a 4.9% yield on the enterprise value. (If you subtract stock based compensation, the FCF is only $25.6 million, a 4% yield on the EV.) Last year, the company returned $26.5 million to shareholders via dividends and $3.4 million via repurchases, which is a shareholder yield of 4.5%.

One concern is that growth has not been great recently for how expensive the stock is. The free cash flow has been lower each of the past two years. However, if you look back five years (to 2018), net revenue then was $56 million (vs $101 million last year), free cash flow (excluding SBC) was $20 million (vs $26 million last year) and shareholder returns were $15 million. So free cash flow was only up 30% in five years, not nearly as good as Enterprise Products Partners (for example).

Petróleo Brasileiro S.A. (PBR)
Our guest writer @pdxsag first wrote about Petrobras for us last June when it was trading for $12.25 per share, an $85 billion market capitalization and an enterprise value of $118 billion. At the time, their recent quarter's free cash flow was $7.9B for a FCF/EV yield of 27%. The market capitalization (at $15 per share) is now $97 billion and the enterprise value is $124 billion. Last year (see results), Petrobras generated cash from operations of $43 billion and had $12 billion of capex, for free cash flow of $31 billion. They paid $19.7 billion in dividends and repaid $10 billion of debt. (A FCF/EV yield of 26% and a shareholder yield of 20%.)

Petrobras shares were down 10% on March 8th after some alarming comments from the company about reducing dividends to invest in an energy transition. Is it worth investing in a country where you would not want to drink the water just to get a bit higher free cash flow yield than you can get on Canadian oil sands?

Natural Resource Partners L.P. (NRP)
Let's start with the highlights from NRP's Q4 2023 conference call:

*Years of hard work and persistence are paying off. The business is generating robust levels of free cash flow, the capital structure is solid and our financial outlook is much improved. As of today, our total remaining obligations, which include debt, preferred equity and warrants, stand at approximately $270 million, a 40% decrease from just 1 year ago. I would like to express my sincere thanks for the support of our employees, external stakeholders and Board of Directors, without which none of these results would have been possible. We retired $178 million of preferred equity at par in 2023 and settled 1.5 million warrants, both with cash. And early this year, we settled an additional 1.2 million warrants utilizing cash and common units. There are two factors we consider when deciding whether to settle warrants with cash or common units: First, do we have ample liquidity, which we define quite conservatively, I might add; and second, is the market value of the common units less than our estimate of intrinsic value? If the answer to both of those questions is yes, we settle with cash. While we will not comment specifically directly on our view of intrinsic value, I will say that it was our inability to answer yes to the liquidity question that caused us to issue units to settle a portion of the warrant exercises early this year. We continue to add additional bank revolver capacity that will provide financial flexibility to settle warrants with cash and accelerate redemptions of preferreds.

*We received $81 million in cash distributions from Sisecam Wyoming in 2023, which is the highest annual amount of regular distributions we've ever received. This result was driven by record high sales prices, both domestic and export during the first half of the year. Unfortunately, global soda ash export prices fell significantly in the back half of the year as new low-cost soda ash supply came online in China, Turkey and the United States. We expect 2024 to be a challenging year as global soda ash markets absorb significant new production volumes, a process that we believe will take several years to complete. Cash distributions to NRP will adjust accordingly as profit margins compress due to the combination of lower sales prices and inflation-driven cost increases. Despite the current headwinds facing the soda ash industry, our long-term view of our investment in Sisecam Wyoming has not changed. We are one of the world's lowest-cost producers of a product that has favorable long-term fundamentals, driven by urbanization, the megatrends for renewable energy and the electrification of the global auto free fleet.

*You are right in what you summarized initially that at our current run rate that it's not too long before we get to the point where we're obligation free. But I don't want to speculate now on what we would do in 1.5 years, 2 years from now if we had excess cash. I can tell you at this point in time, we don't see opportunities in the market. If we were in that theoretical situation where we had excess cash today, they are not on the horizon overly attractive opportunities to deploy capital. That being said, I will point out that we are focused on the task at hand right now, and we're not out beating the bushes for places to deploy capital. I think you can rest assured that we are going to be quite thoughtful about anything we do with respect to deploying capital in any manner other than distributing it out to unit holders. 

At the current unit price of $92, the market capitalization is $1.2 billion (using the February 2024 unit count and not the year-end). They have spent $55.7 million repurchasing warrants in Q1 2024 and have hopefully earned about the same amount from two months of cash flow. If that is the case, the enterprise value is currently around $1.4 billion. Last year's free cash flow of $313 million represents a 22% yield on the enterprise value.

Thursday, February 29, 2024

Canadian Natural Resources Limited - 2023 Earnings ($CNQ)

[Previously regarding Canadian Natural Resources Limited (CNQ).] 

An outstanding year from the titan of the Canadian energy industry. Some key highlights from the results (dollar figures in USD):

  • CNQ achieved its target net debt level of $7.4 billion in Q4 2023 (slightly earlier than their forecast of Q1 2024). This means that they will target 100% return of free cash flow to shareholders via dividends and buybacks.
  • Capital expenditures were 4.7% lower in 2023 than in 2022, yet production of liquids was up 4.3% and total production (including natural gas) was up 4%. They averaged 974k bbl/d for the full year and 1.05 million bbl/d in Q4.
  • Out of $9.1 billion of cash from operations, $5.6 billion of capital was returned via share repurchases, dividends, and debt repayment, and $3.6 billion was spent on capex. The share count was 2.8% lower year-over year.

The current market capitalization of CNQ (at a $75 share price) is $75 billion, and the enterprise value is $82.5 billion. Cash from operations for the fourth quarter was $3.6 billion and the company spent $722 million on capital expenditures. The remaining free cash flow for the quarter was $2.9 billion, of which $450 million was used for debt repayment, $1.15 billion was used for share repurchases, and $725 million was used for share repurchases. The free cash flow yield on the enterprise value was 14% and the shareholder yield was 12% (both based on the quarter's results annualized).

This was during a quarter with an average WTI price of $78. In its latest investor presentation, CNQ says that free cash flow per share would be 40% higher at $95 WTI than at $80 WTI. Notice also on slide 8 of the presentation, CNQ management points out that oil sands mining and upgrading requires much less capital expenditure to maintain production than shale. They call this the "long life no decline advantage".

The net present value of future net revenues, before income tax, discounted at 10%, is $78 billion for proved developed producing reserves and $138 billion for total proved plus probable reserves.

This is very speculative, but if WTI did go back to $95, that implies that the shareholder yield would be 16.8%. If that happened and investors decided to value CNQ, with a 40+ year reserve life, more like a "quality compounder" (such as Marriott or Visa) at a 4.2% shareholder yield, shares would quadruple. (We have observed in the past that investors double count: low multiples when things are bad, high multiples when things are good.)

Tuesday, February 27, 2024

Genesis Energy Limited ($GEL)

We mentioned Genesis Energy (GEL) in one of the earnings notes earlier this month. Genesis has four segments: offshore pipelines in the Gulf of Mexico, carrying crude and natural gas produced offshore to refineries along the Gulf Coast; a soda ash business in Wyoming (like the business where NRP owns an interest); sulfur services (which removes sulfur from refinery inputs and sells it as sodium hydrosulfide); onshore pipelines and terminals; and a marine transportation business with boats and barges to transport crude oil and refined products.

The offshore pipelines contributed $407 million of operating income for 2023, soda and sulfur contributed $282 million, marine transportation did $110 million, and the onshore pipelines and terminals $28 million. Adjusted EBITDA for 2023 was $756 million. 

The market capitalization of the partnership (at $11 per unit) is $1.35 billion. Genesis has quite a bit of leverage: $3.75 billion of debt, and $814 million of convertible preferred units. (The distribution rate on the preferred units is 11.24%.) The enterprise value is thus $5.9 billion, and the EV/EBITDA is 7.8x. Guidance for 2024 is $680-$740 million of EBITDA and $200-$250 million of capex, which would mean anywhere from $430 to $540 million of cash flow, which is a range of 7% to 9% on the enterprise value. 

Management thinks that cash flow is going to "ramp" from 2025 onwards as offshore volumes grow (with two new platforms coming online) as well as additional soda ash earnings. 

In addition to our record results in 2023, we also achieved some significant project milestones that will continue to benefit the partnership for many decades to come. First and foremost, we reached substantial completion and commissioned our Granger expansion project. This almost four-and-a-half-year construction project overcame many challenges and delays as a result of the Covid-19 pandemic, but I could not be prouder of our team on the ground in Green River, WY for their tireless effort getting this project to the finish line. This project will add approximately 750,000 short tons per year of additional soda ash production capacity at Granger, bringing its total production capacity to approximately 1.25 million short tons per year, and significantly lower Granger’s operating cost per ton, making it one of the most efficient and lowest cost production facilities in the world. I would also point out that Granger has multiple decades of reserves in the current seam at these new production rates along with hundreds of millions of tons of additional measured and indicated trona resources in those same seams.

As we mentioned last quarter, we also successfully laid the 105 miles of the SYNC pipeline in over 5,000 feet of water, which as many of you can imagine is an engineering marvel. This was a tremendous achievement and a testament to our offshore engineering, construction and operation’s teams that helped complete this portion of the project on schedule. In addition, we made significant strides in advancing our CHOPS expansion project, which includes installing pumps at certain strategic junction platforms. These offshore projects are long-term investments that are underpinned by existing upstream developments which have production profiles going out multiple decades, not years, and have ample capacity to handle much more than the currently discovered and contracted volumes.

Regarding uses of capital:

We opportunistically accessed the capital markets on two separate occasions in 2023 and successfully issued $500 million in new 8.875% notes due 2030 in January and $600 million in new 8.25% notes due 2029 in December, which allowed us to re-finance our 2024 and 2025 unsecured maturities, respectively. More importantly, the combination of these two re-financings ultimately triggered an automatic 12-month extension of our senior secured facility’s maturity date, which now expires in February 2026. These transactions have provided us with the financial flexibility and liquidity to complete our remaining spend on our major capital growth projects in 2024 and bridge us to 2025 when we expect to begin harvesting increasing amounts of free cash flow driven by both earnings’ growth and materially reduced growth capital expenditures. In addition, we utilized a portion of our available liquidity to opportunistically re-purchase $75 million of our Class A convertible preferred units throughout the year at a discount to the contracted call premium as well as purchase 114,900 of our Class A common units at an average price of $9.09 per unit.

Concluding an investment cycle is very powerful if it works: you get higher earnings and the capital expenditures decline, resulting in a big increase in free cash flow.

Wanted to add some highlights from the Q3 investor call - another instance of a quarterly call with no questions.

* Regardless of the makeup of our 2024 results and any uncertainty that might exist today, it is important to remember that the long-term outlook for Genesis remains intact and as strong as I have seen it during my tenure at the company. In fact, 2024 should really be viewed as a transition year for Genesis, as we expect to complete our ongoing growth capital expenditures in mid-to-late 2024, in advance of the significant step changes in offshore volumes and corresponding segment margin contributions beginning in late 2024 and accelerating into 2025, as the Shenandoah and Salamanca developments are expected to come online. The combination of these events will provide us with increasing amounts of cash flow after all of our cash obligations and generate increased financial flexibility to continue to simplify our capital structure, return capital to our stakeholders and ultimately allow us to continue to build long-term value for everyone in the capital structure for many years ahead.
* To put this in perspective, the 9.4 million acres of leased but as yet undeveloped acreage is more than 6.5 times the size of ExxonMobil’s total gross acreage position in the Permian Basin post their recent acquisition of Pioneer. Suffice it to say, there is a tremendous resource in the Gulf of Mexico that has yet to be explored under existing and valid leases, and it should undoubtedly provide for decades and decades of drilling inventory and future production volumes, a large percentage of which should find their way to our industry-leading infrastructure in the Central Gulf of Mexico
* The sheer size and scale of the resource in the Gulf of Mexico being produced from such a relatively small percentage of the existing and valid leases, its proximity to the Gulf Coast refinery complexes and its industry-leading low greenhouse gas footprint is extraordinarily impressive and fascinating to us. And some of us have been working this basin from an infrastructure point of view for well over 30 years. All of these attributes provide further evidence as to why we have seen a number of operators turning their focus away from onshore shale basins, as these basins have seen or will soon see peak production and they have instead started to focus on the Gulf of Mexico, where production is increasing, there is a vast swath of undeveloped acreage and countless new large-scale developments both sanctioned and yet to be sanctioned on the horizon.
* Along these lines, we have successfully laid the 105 miles of the sink lateral and remain on schedule and importantly on budget with this project and our CHOPS expansion project, both of which we expect to be ready for service in the second half of 2024. The contracted Shenandoah and Salamanca developments and their combined 160,000 barrels of oil per day of incremental production handling capacity remain on schedule and will be additive to our then base of volumes in 2024. These two new projects, combined with our steady base volumes and increasing inventory of identified subsea tiebacks, provides us with the visibility to generate north of $500 million per year of segment margins starting in 2025. All of this is to say, we remain well positioned to deliver steady, stable and growing cash flows from our offshore pipeline transportation segment for many years to come.
* All natural producers of soda ash, which only supply approximately 28% of global demand, enjoy this advantage, with operating costs of about half of the costs of synthetic producers, which supply the other 72%, and in general, a significantly smaller environmental footprint relative to synthetic producers. Furthermore, those natural producers with solution mining operations have the absolute lowest cost of production and thus continue to have a competitive advantage over all producers during periods of excess supply and or lower demand. Increasing our exposure to low-cost solution mining was a central investment thesis in our Grainger expansion project and once fully ramped, roughly half of our total production capacity will be from solution mining.
* Our Marine Transportation segment continues to meet or exceed our expectations as market conditions and demand fundamentals continue to remain steady. As mentioned in the release, we continue to operate with utilization rates at or near 100% of available capacity for all classes of our vessels, as the supply and demand outlet for Jones Act tanker tonnage remains structurally tight.
This structural change in market dynamics has been driven by a combination of steady and robust demand, the continued retirements of older equipment and effectively zero new construction of our types of marine vessels. This lack of new supply of marine tonnage combined with strong demand continues to drive spot day rates and longer term contracted rates in both of our fleets to record levels. To provide some additional context, we along with other industry participants, continue to believe that current day rates that are still not — are still not yet high enough to justify the construction of new marine equipment. In addition to the significant cost of a new vessel, the long construction period, which can be three plus years to four plus years in some cases for larger vessels, the lack of available shipyards to build a new vessel and the need to keep day rates elevated through the construction period and for a prolonged period of time once underwater to justify construction, all point to a market that should remain structurally tight for the foreseeable future.
* In advance of this additional cash flow, we have utilized a portion of our available liquidity this year to opportunistically repurchase $75 million of our Series A Preferred Equity at a discount to the contracted call premium, as well as purchase 144,900 of our common units at an average price of $9.09 per unit. As we have stated in the past, we will continue to be opportunistic in acquiring any security across our capital structure to the extent we feel they remain mispriced on the market. As we have an increasingly clear sight — clear line of sight to generating roughly $200 million to $300 million or more per year of free cash flow starting in 2025, we will continue to evaluate the various levers we can pull to return capital to our stakeholders, including paying down debt, raising our common distribution, repurchasing additional amounts of our corporate preferred security or continuing to purchase our common unit or mispriced debt security.

And then from the Q4 call:

*We remain focused on completing our growth capital program in the next nine to 12 months, all while having no debt maturities until 2026 and an increasingly clear line of sight to generating roughly $250 million to $350 million or more, of free cash flow on an annualized basis after all cash obligations starting in 2025. I would also point out, that this expectation remains on track even if, it might take a little bit longer than we expect for the inevitable recovery in soda ash export prices off the lows we're seeing here in early 2024. We will continue to evaluate the various levers we can pull to return this capital to our stakeholders including paying down debt, raising our common distribution, repurchasing additional amounts of our corporate preferred security, continuing to purchase our common units or any mispriced debt securities all while maintaining an appropriate level of liquidity and of course maintaining a focus on our long-term leverage ratio.

Monday, February 26, 2024

Earnings Notes IV (Q4 2023)

Alpha Metallurgical Resources, Inc. (AMR)
Alpha Met is the largest U.S. met coal producer, representing about one-fifth of total U.S. production. According to their recent investor presentation, 71% of AMR's met coal production is exported, with India accounting for 37% of their export sales over the past five years.

The market capitalization of AMR is now $5.7 billion after earnings. AMR stock has been on an absolute tear since they are allocating lots of cash to share repurchases. (Up 151% since we mentioned last March.) Their current assets less total liabilities (ignoring deferred taxes) are now $255 million, so we would put the enterprise value at just under $6 billion.

For the fourth quarter of 2023 (release, 10-K), AMR's adjusted EBITDA was $266 million and for the full year (2023) it was $1 billion. That puts the EV/EBITDA at about 5.8x. AMR sold 4.6 million tons of met coal in Q4, 18% more coal than the prior year quarter. They got $184/t for met coal versus $155/t the previous quarter. Their cost of met coal sales was up slightly to $119 per ton from $110 per ton the prior quarter.

Cash from operations was $199 million and capital expenditures were $62 million for the quarter, for $137 million of free cash flow, an annualized yield on the enterprise value of 9%. That seems somewhat rich, especially compared with the FCF/EV yields of a coal royalty owner like Pardee, Beaver Coal, or Natural Resource Partners.

AMR had said that they were going to cease paying and focus their cash on share repurchases, "as long as buybacks make sense from a market, trading price, and valuation perspective." They paid $13 million of dividends for the fourth quarter and bought back $137 million of stock, for a shareholder yield of 10.5% (annualized) on the current market capitalization. They shrank the share count by 17% year-over-year!

AerCap Holdings N.V. (AER)
We mentioned aircraft lessor AerCap way back in the "What I Would Buy Instead of Tesla" post in October 2020. At that point the market capitalization was $3.3 billion, which was only a third of book value. They had $35 billion of aircraft (at book value net of depreciation), $10 billion of other assets, and $35 billion of debt, for a net of $10 billion of shareholder equity. It was trading for 3x earnings and we said, "If lots of airlines go bankrupt, this is a zero. If things return to normal, it's worth close to triple."

The market capitalization is now $16 billion and the share price did in fact triple. The share count and market capitalization grew in March 2021 when AER acquired GE's aircraft leasing business (GE Capital Aviation Services) for cash and stock. The other big development was when Russia invaded Ukraine, 152 AER aircraft were stranded in Russia. However, settlements were received from various Russian airlines and insurance companies.

Looking at the 2023 results, book value has grown to $16.6 billion as of year-end 2023. AerCap has $57 billion of "flight equipment," $14 billion of other assets, $46 billion of debt, and $8 billion of other liabilities. So the shares are now at 1x book value.

In 2023, AER earned $3.1 billion. Note that there were $1.3 billion of recoveries related to the Russian planes, so a real steady-state number would obviously be lower. Operating cash flow for the year was $5.3 billion. They spent $4.1 billion (net) on new aircraft and aircraft downpayments. They spent $2.6 billion on share repurchases which was more than their free cash flow, however they have some float from things like security deposits received from customers. With the $2.6 billion of repurchases, they shrank the share count by 18% during 2023.

We like specialty finance businesses with barriers to entry. Another example would be Burford (BUR). Good luck starting an aircraft leasing company; it's not like opening a bank to make mortgages at 4%. The concerns that we have with AER are the leverage (assets 4.4x their equity) and the China risk. They have 16% of their planes on lease to Chinese airlines so in the event of a Taiwan conflict, they could have a massive hole blown in their balance sheet. Why does China need to finance its planes with western capital, anyway?

Lamar Advertising Company (LAMR)
The reason that we initially became interested in Lamar was its high free cash flow margins - the signature feature of a "royalty-like" business.

The market capitalization of Lamar at $108 per share is $11 billion and the enterprise value is $16 billion. During the fourth quarter of 2023 (release), the company reported operating cash flow of $254 million, which was up 4% from the prior year quarter. This quarter's operating cash flow yield on the enterprise value (OCF/EV) annualizes to 6.4%.

Revenue for the quarter was $556 million, which was up 4% from the prior year quarter. Notice that Lamar enjoys a healthy operating cash flow margin of 46% of revenue. The quarterly dividend of $1.25 per common share was a total of $128 million returned to shareholders, a 4.6% dividend yield. (As a REIT, Lamar is required to distribute 90% of earnings to shareholders.)

For the entire year 2023 (10-K), Lamar generated $784 million of cash from operations (37% of revenues). The company reinvested $317 million in acquisitions and capital expenditures and paid $511 million in distributions to shareholders.

Let's compare Lamar's results for the year 2023 with those of 2018 (five years ago). Their shares outstanding have grown only 3% in five years, revenue has grown 30% (a bit better than the 25% PPI inflation), and cash from operations has grown 39%.

So, cash from operations per share went from $5.70 to $7.67, an increase of 35%. It is nice that this is comfortably outpacing PPI inflation. Obviously, CFO is different than free cash flow because it ignores both maintenance and growth capital expenditures, but by using CFO we normalize for the different levels of growth expenditures over time. And billboards do not exactly require tons of maintenance. (They actually said on the Q4 2023 earnings call that maintenance capex is $50 million in 2024 which is less than $500 per billboard.)

Management also mentioned on the call that they think that M&A and consolidation is going to "accelerate" over the next 18 to 36 months.

ONEOK, Inc. (OKE)
The market capitalization of ONEOK is $42 billion, not quite as big as Enterprise Products ($60B) or Enbridge ($73B). You may recall that OKE acquired our Magellan Midstream last year. For 2023, OKE earned $2.7 billion, generated $4.4 billion of operating cash flow, spent $1.6 billion on capital expenditures, and paid $1.8 billion of dividends. Earnings were obviously up significantly over 2022 thanks to the Magellan acquisition, which was funded with both cash and stock. Since the acquisition closed in September 2023, the best proxies that we have for the going-forward results are the Q4 2023 and management's guidance for 2024. Guidance in the investor presentation is for $2.6 to $3 billion of net income, $5.9 to $6.3 billion of adjusted EBITDA, and somewhere near $2 billion of capital expenditures, mostly for growth.

Friday, February 23, 2024

Exxon Mobil Corporation ($XOM)

We were just noticing in going over earnings releases that good ol' Exxon Mobil is trading at a shareholder yield of 8%. We like doing comparisons over long time frames, and Exxon went into a drawdown in the summer of 2016 that lasted for 6 years on a price basis, until 2022. Let's compare Exxon's results for 2016 and 2023.

In 2016 (10-K), Exxon's upstream segment earned $196 million, the downstream (refining) earned $4.2 billion, and its chemical business earned $4.6 billion. They produced 2.4 million barrels per day of liquids and 4 million BOE/d total. The refinery throughput was 4.3 million barrels per day.

They had 4.2 billion shares outstanding for a market capitalization of about $350 billion, and $81 billion of net liabilities for an enterprise value of $431 billion. Cash from operations was $22 billion and they spent $12.4 billion (net) on capex for a free cash flow of $9.6 billion. (A 2% yield on the enterprise value.)

They paid $12.5 billion in dividends (3.6% yield) and bought back $1 billion of stock, borrowing to pay the difference between the free cash flow and the shareholder returns (which were 3.8% total and not fully earned).

In December 2019, three years later and just prior to covid, shares were about 25% lower. There was a further drawdown with covid.

For 2023 (release), the upstream segment earned $21 billion, the downstream earned $12 billion, the chemicals segment earned $1.6 billion, and specialty products earned $2.7 billion. They produced 2.4 million barrels per day of liquids and 3.7 million BOE/d total. Their refinery throughput was 4.1 million barrels per day.

They now have 4 billion shares outstanding for a market capitalization of $416 billion, and $43 billion of net liabilities for an enterprise value of $459 billion. (Leverage has decreased from 19% of enterprise value in 2016 to only 9% now.) Cash from operations was $55 billion and they spent $21 billion net on capex for a free cash flow of $34 billion. (A 7.4% yield on the enterprise value.)

They paid $15 billion of dividends and bought back $18 billion of stock, which is a shareholder yield of 8% on the current market cap.

So they have kept production and refining capacity flat for seven years, and their earnings per barrel produced and refined have grown significantly. Free cash flow has increased 3.5x but the enterprise value is only 6% higher because of the valuation compression. The FCF/EV yield (valuation) has compressed by almost three-quarters even as the balance sheet has gotten less risky.

The biggest profit center is their non-US upstream. They do not disclose the upstream profits by project, only by U.S. and non-U.S. They are big in offshore, and so far we are finding that offshore is even more front-loaded / inflation protected than the oil sands. They also have an LNG business selling to Asia and Europe. That’s a significant barrier to entry. And again, front loaded cost.  

Exxon is a blue chip so one of the things you wonder is could we see much higher earnings at say $100 oil, plus a revaluation to a shareholder yield of say 4%? That would make it a multibagger, plus an 8% yield along the way.

Thursday, February 22, 2024

Earnings Notes III (Q4 2023)

Chesapeake Energy Corporation (CHK)
Investors liked Chesapeake's earnings announcement this week, sending shares up about 10%. The key was that the company promised to cut capital expenditures and let production fall! They said that they will cut capex by 20% and expect production to be 22% lower in 2024 than 2023. That's a difference of 770 million cubic feet which is about 0.65% of U.S. production; not insubstantial. Chesapeake's announcement was also enough to lift the futures curve for natural gas.

The market capitalization (after the release) is now $11 billion. The company has $1 billion of net debt so the enterprise value is $12 billion. During the fourth quarter of 2023, cash from operations was $470 million and capital expenditures were $379 million for free cash flow of only $91 million, a FCF yield on the enterprise value (annualized) of a mere 3.3%.

Chesapeake is not earning its cost of capital at these natural gas prices, but with so little debt, you have a call option on natural gas that is not in immediate danger of expiring. Management points out in the investor presentation that there is going to be 12 bcf/d of LNG export capacity coming online by 2028. They think that the realized netback per MCF will be $4-6, far above the current $2.87 average realized price in the third quarter. With a cash production cost of over $1/mcf, there is subsantial leverage to higher natural gas price if LNG export drives a higher commodity price. (At $5/mcf, earnings more than double.)

Still, there are other ways to get exposure to natural gas that do not require so much capital and operating expenditure. Dorchester Minerals (DMLP) is getting about one-third of production (in BOE terms) from natural gas, which is being practically given away for $2/mcf. And we will look at Blackstone Minerals and Kimball Royalty Partners below.

Marathon Petroleum Corporation (MRO)
This Marathon is the E&P company, not the refiner (MPC). Another capex cut! Management said in the earnings release that investors should "expect 5% to 10% fewer net wells to sales in 2024 to deliver flat year-on-year total oil production as the Company optimizes well mix to maximize corporate returns and FCF generation." Very nice.

Also up about 8% after earnings, so the current market capitalization is $14 billion. They didn't publish a balance sheet with the Q4 release, but the enterprise value should be about $20 billion. During the fourth quarter of 2023, cash from operations was $1.1 billion and capital expenditures were $360 million for free cash flow of $681 million, a FCF yield on the enterprise value (annualized) of 13.6%. Shareholder returns during the fourth quarter (mostly repurchases) were $417 million, which is a shareholder yield of 12% (annualized). Their guidance for 2024 is $1.9 billion of free cash flow, assuming $75/bbl WTI and $2.50/MMBtu Henry Hub natural gas. That would be a 9.5% yield on the enterprise value.

Suncor Energy Inc. (SU)
The current market capitalization of SU (at a $33.50 share price) is $43.5 billion, and with $10 billion of net debt, the enterprise value is $54.5 billion. Cash from operations for the fourth quarter was $3.2 billion and the company spent $1.1 billion on capital expenditures. The resulting free cash flow for the quarter was $2.1 billion, which is a 15% yield (annualized) on the enterprise value. In the fourth quarter, Suncor returned $1.15 billion via repurchases, dividends, and debt repayment for an annualized shareholder yield of 10%. The fully diluted share count was down 3.5% y/y at the end of the year.

Upstream production was up 6% year over year to 808,100 barrels per day in the fourth quarter. Refinery utilization was 98% versus 94% the prior year quarter. Upstream capital expenditures were up 17% year-over-year, for a "production shortfall" of 11%. Oil sands "base" capex was up only 5% and production was up 10%, for a negative production shortfall. This is what we want to see from our slow decline oil sands with front loaded cost!

The oil sands segment generated funds from operations for the fourth quarter of $1.9 billion, with a production volume of 757 thousand barrels per day and an average crude price realization of $61/bbl. The refining and marketing segment generated funds from operations of $592 million, processing 456 thousand barrels per day and making a gross margin (LIFO) of $34.35 per barrel.

Texas Pacific Land Corporation (TPL)
The market capitalization of TPL (at $1,563 per share) is now $12 billion. The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $749 million and the enterprise value is $11.25 billion.

In the fourth quarter of 2023 (8-K), production volumes for TPL were 26,300 BOE per day, which was up 23% from the prior year. Oil volumes were up the same amount. This was the highest quarterly royalty production level in TPL history. Royalty revenue was up 2% thanks to the higher volumes, even though the price of oil was $78.46 versus $83.16 the prior year. Water sales, water royalties, and easement income were up 37% year-over-year, although the water service business has operating expenses, which were up.

Total expenses were $29 million (excluding depreciation) versus $25 million the prior year. Thankfully legal fees were only $3 million this quarter and not the gigantic $17 million we saw one quarter earlier this year during the heat of the shareholder activist battle.

Interesting to note that the expenses (again excluding depreciation) are a hefty 17% of total revenue. That's partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $134 million for the quarter, and if you add back $3.9 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $138 million, which would be an annualized yield of 4.9% on the current enterprise value. (It was up 8.9% year-over-year.) For the full year, the company spent $100 million on dividends and $43 million on share repurchases. 

The share count shrank by only 0.33%; management let net current assets grow by $225 million during the year, to $818 million. That cash could have been used to shrink the share count an additional ~2% if it had been deployed at times when the share price was weak.

Black Stone Minerals LP (BSM)
Black Stone Minerals is another publicly traded minerals partnership. They had an IPO in 2015 although predecessor entities have been around much longer. They are bigger than Dorchester, with a market capitalization of $3.2 billion. Current assets net of all liabilities are $144 million and there is also $300 million of convertible preferred, making the enterprise value $3.4 billion. (The convertible preferred gets a quite expensive ten year yield plus 5.5% distribution rate, which is currently 9.8%.)

For the fourth quarter, BSM reported distributable cash flow of $119 million on total revenue of $191 million, which represents a yield of 15% on the market capitalization. Oil production was 1 million barrels and natural gas production was 16.5 bcf; production was therefore almost three quarters in terms of energetic equivalent BOEs. (But oil was a much greater percentage in terms of revenue.)

Something different about Black Stone compared with Dorchester is that they hedge their production. They have 570,000 barrels swapped for each quarter of 2024 at $71.45/bbl and 210,000 barrels swapped for each quarter of 2025 at $70.50 per barrel. That's about half of 2024 and a quarter of 2025 production hedged. For natural gas they have around 10 billion bcf swapped for each quarter of 2024 at $3.56 per bcf and 1 billion bcf for each quarter of 2025 at $3.65 per bcf. That's 60% of this year and a small proportion of next year.

Heading into 2023, they had swapped natural gas at $5/mcf, which obviously has supported the trailing distributions. Also noteworthy is that one of the big drillers on their Haynesville acreage (Aethon) is taking a "time out" on its drilling commitments due to low gas prices. So both volumes and prices will be lower in 2024, plus the preferred stock yield reset from 7% to 9.8% in November 2023, which will reduce income to common by a further $8.4 million per year.

Why hedge? Unlike Sitio, Black Stone does not have significant leverage. It sounds like they are bullish on natural gas over the longer term, once more LNG export capacity opens. Anyway, this is one to keep in mind if we were to get bullish on natural gas. A $5 natural gas price might give them an extra $125-150 million of earnings every year, which would be a decent boost to the current cash flow yield. (Of course, that would be assuming that management didn't bungle it with a hedging trade.)

Kimbell Royalty Partners LP (KRP)
One last publicly traded mineral partnership. Something interesting is that KRP is a limited partnership that has elected to be taxed as a corporation, so there is no K-1. There is a good bit of nepotism in the C suite to be aware of. Robert Ravnaas is the Chairman and CEO; David Ravnaas is the President and CFO, and there is also a Rand Ravnaas as VP of Business Development. KRP had its IPO in 2017 and has grown from acquisitions in 2018, 2019, 2022, and 2023.

Kimbell has a market capitalization of $1.5 billion. They have $269 million of net debt and $325 million of convertible preferred stock outstanding, for an enterprise value of $2.06 billion. Production in Q4 was 24k boe/d, coming mostly (55%) from the Permian and the Haynesville. Their recent investor presentation gives more guidance than other partnerships. They estimate that at $2 natural gas and $80 oil, their distribution (at a 75% payout ratio) would be $1.61, which would be a 10.4% yield on the current price.

Kimbell also hedges - they swapped about 140k bbl of oil and 1.3 bcf of natural gas for each quarter for the next two years (2024-2025) at prices ranging from $82-67/bbl for the oil and $3.52-$4.32/mcf for the natural gas. That is about a quarter of their oil and gas production levels.

As we mentioned in the past about Sitio, we are not big fans of borrowing (expensive capital) to buy mineral properties and then hedging the commodity price. It seems like the outcome that mainly delivers is scale. We can see how that would be important to insiders, though, since they get paid as a function of scale. The CEO of KRP was paid $5.2 million in 2023 and his son was paid $4.7 million. The CEO owns $17 million of common units and his son owns $11.7 million. 

Our humble opinion is that Dorchester has the simplest, cleanest model with the fewest moving parts, least promotional management, and longest track record.

Sprouts Farmers Market (SFM)
We wrote about Sprouts back in October 2023. At that point, the market capitalization was $4.3 billion and the enterprise value was $5.8 billion. Shares have been on a tear and the market capitalization is now $5.5 billion (+28%).

What we like about Sprouts is two things. First, the Sprouts stores are extremely well run and well merchandised, putting pressure on (and taking customers from) the tired old grocers that are owned by Kroger and Albertsons. Second, the business generates free cash flow even while expanding, which the company has been using to cannibalize its own shares. During 2023, Sprouts grew the share count by 21 net (5%) to 407 stores while shrinking the share count by 5.3%.  

For the full year 2023, Sprouts did $6.8 billion of sales (up 6.8% versus 2022) and generated $465 million of cash from operations (7% OCF conversion), spending $238 million on capital expenditures and an acquisition (compared with $265 million of depreciation and amortization), while paying off $125 million of debt, and repurchasing $203 million of stock.

As we said, the market capitalization is $5.5 billion and the enterprise value is $7 billion. That gives a FCF/EV yield of 3.2%. Reported net income per share (diluted) is $2.50 for the year, which gives a P/E ratio of 21.5x, and which was up 4.6% y/y. Management guidance is to open 35 new stores in 2024, with total revenue growth in the mid single digits.