Thursday, May 23, 2024

Thursday Night Links

  • Something there is that doesn’t love a wall, that sends the frozen-ground-swell under it, and spills the upper boulders in the sun; and makes gaps even two can pass abreast. The work of hunters is another thing: I have come after them and made repair where they have left not one stone on a stone, but they would have the rabbit out of hiding, to please the yelping dogs. The gaps I mean, no one has seen them made or heard them made, but at spring mending-time we find them there.
    [Robert Frost]
  • In 2007, I didn’t think there was much of a housing bubble. Maybe prices were a little too high, but I wasn’t panicking about it. Then 2008 and 2009 came, and everyone started saying, “Oh my goodness, there’s a housing bubble!” Our financial system almost fell apart, and I started signing on to the view that there had been a housing bubble. The way prices have evolved over the past ten years indicates that the original 2007 prices were not a bubble. So, I’ve swung back to my earlier view. There was some kind of strange collective panic in 2008 and 2009, but most of the prices have been validated or even exceeded. Back then, everyone said, “Oh, we built too many homes!” And today, everyone says, “Oh, we haven’t been building enough homes!” Not that many people have raised their hand and said, “Wait, both of these can’t be true.” Homes are pretty durable. Did we build too many homes outside of Orlando? Yes, we did. But for the most part, building more homes was the correct decision. The shadow banking system was the more fundamental reason for the global financial crisis. Hardly anyone understood it. When people woke up and realized that that system didn’t necessarily have all the proper safeguards – and it didn’t – they panicked. They didn’t have to panic, but they did, and things came close to falling apart. So, I changed my mind about that twice – maybe the third time is yet to come. [Tyler Cowen]
  • The Third Circuit held that each of the factors weighs in favor of a de novo standard of review. First, because demand futility is a pleading issue and the plaintiff’s allegations must be accepted as true, district courts are no better positioned than appellate courts to decide whether demand should be excused as futile. In fact, just like district courts, when appellate courts confront the dismissal of an action, the court reads the facts alleged in the complaint, assumes the truth of those facts, and decides whether those facts state a claim under the applicable legal standard. [Faegre Drinker
  • That uptick coincided with a steep drop in the number of Asian matriculants and tracks the subjective impressions of faculty who say that students have never been more poorly prepared. One professor said that a student in the operating room could not identify a major artery when asked, then berated the professor for putting her on the spot. Another said that students at the end of their clinical rotations don't know basic lab tests and, in some cases, are unable to present patients. "I don't know how some of these students are going to be junior doctors," the professor said. "Faculty are seeing a shocking decline in knowledge of medical students." And for those who've seen the competency crisis up close, double standards in admissions are a big part of the problem. "All the normal criteria for getting into medical school only apply to people of certain races," an admissions officer said. "For other people, those criteria are completely disregarded." Led by Lucero, who also serves as the vice chair for equity, diversity, and inclusion of UCLA's anesthesiology department, the admissions committee routinely gives black and Latino applicants a pass for subpar metrics, four people who served on it said, while whites and Asians need near perfect scores to even be considered. [link]
  • We use high-frequency interbank payments data to trace deposit flows in March 2023 and identify twenty-two banks that suffered a run—significantly more than the two that failed but fewer than the number that experienced large negative stock returns. The runs were driven by large (institutional) depositors, rather than many small (retail) depositors. While the runs were related to weak fundamentals, we find evidence for the importance of coordination because run banks were disproportionately publicly traded and many banks with similarly bad fundamentals did not suffer a run. Banks that survived a run did so by borrowing new funds and then raising deposit rates—not by selling liquid securities. [Federal Reserve Bank of New York]
  • Management offered another surprise by bringing forward the timing of its pivot to 100% free cash flow payout to shareholders. Formerly, it planned to pay out 75% of free cash flow when its year-end 2023 net debt balance fell by an additional C$1.5 billion. It now intends to distribute 100% of free cash flow when it reaches that point. Another positive change is that management now intends to favor share repurchases over dividends. Its goal is to maximize total returns, not only income or capital appreciation. As long as Suncor shares trade at a discount, it believes share repurchases remain the most effective way to increase value on a per-share basis. We agree. In the long term, income investors will also benefit from repurchases, as dividend payout potential increases on a per-share basis with a falling share count. Management’s official guidance calls for its debt target to be hit next year, but CEO Kruger hinted that the target could be achieved by year-end. This was yet another positive surprise on the call that caused Suncor's shares to trade higher. [HFI Research]
  • The ShotSpotter critique is emblematic of the RJA mentality. We are to believe that white neighborhoods are experiencing an epidemic of drive-by shootings and other crimes that the residents and the police ignore. If only ShotSpotter sensors were placed in white neighborhoods, they would pick up a proportional number of white shooters and white victims to match what is recorded in black and Hispanic neighborhoods. The belief that violent-crime rates are highest in minority communities is, according to RJA supporters, a function of over-policing, not of over-offending. But the bodies don’t lie. In 2021, blacks between the ages of 10 and 24 nationally died of gun homicide at nearly 25 times the rate of whites in that age cohort, according to the CDC. No one is hiding from the authorities the white corpses that would level that disparity. Black juveniles in New York, Chicago, Los Angeles, and Philadelphia were shot at 100 times the rate of white juveniles from March 2020 to December 2021. No one prevents white shooting victims from going to a hospital emergency room and getting counted in a city’s gun-violence data. [City Journal]
  • We find that what one buys can explain what type of payer they are, even after controlling for various socio-demographic variables and credit scores. For instance, buying cigarettes or energy drinks is associated with a higher likelihood of missing credit card payments or defaulting, while purchasing fresh milk or vinegar dressings is linked to consistently paying credit card bills on time. Using item-level survey ratings, we find suggestive evidence that buying healthier but less convenient food items is predictive of responsible payment behaviors. Furthermore, we observe a positive and robust correlation between displaying greater consistency in various dimensions of grocery shopping behavior and making timely credit card bill payments. For example, cardholders who consistently pay their bills on time are more likely to shop on the same day of the week, spend similar amounts across months, and purchase the same brands and product categories. [Using Grocery Data for Credit Decisions
  • Why does it cost so much to build a home? We formalize and evaluate the hypothesis that land-use regulation reduces the average size of home builders, which limits their ability to reap returns from scale and their incentives to invest in technology. Our model distinguishes between regulation of entry, which acts as a fixed cost and increases equilibrium firm size, and project-level regulation, which reduces project and firm size. If larger firms have stronger incentives to invest in technology, then such investment partially offsets the harm that regulation of entry does to consumers, but reduced investment exacerbates the negative impacts of project-level regulation. We document that the US has higher production costs than comparably wealthy countries, and that these costs are higher in more regulated American cities. Homes built per construction worker remained stagnant between 1900 and 1940, boomed after World War II, and then plummeted after 1970 just as land-use regulations soared. Residential construction firms are small, relative to other industries like manufacturing, and smaller firms are less productive. More regulated metropolitan areas have smaller and less productive firms. Under the assumption that one half of the link between size and productivity is causal, America’s residential construction firms would be 91% percent more productive if their size distribution matched that of manufacturing. [Why Has Construction Productivity Stagnated?]
  • Until Argentina’s fiscal problems are solved, peso inflation must continue, if only to service the national debt. In fact, to the extent currency holders can shift into dollar holdings more easily, inflation may even accelerate. The base of peso holdings to be taxed by inflationary seigniorage would grow ever narrower, necessitating an ever-higher inflation tax to keep the government in business. [Tyler Cowen]

Tuesday, May 21, 2024

Tuesday Night Links

  • The reason to be bullish gas pipeline cos is not AI. The reason to be bullish is that the 2025-6 wave of LNG will basically max out remaining spare & last mile capacity from existing pipes and current regulatory system makes greenfield interstate pipes very difficult. They will be collecting max rate for a decade, and most will get to reset max rates a bunch higher in their next rate case to catch up to general inflation. [Dirty Texas Hedge]
  • Devon Eriksen recently pointed out that today's Marxists are hostile to space flight and off-world colonization. But in Cold War times, Marxists who ran countries were aggressively futuristic about space, treating it as the empire of their dreams. What caused this turnaround? To understand this, it's helpful that to notice that spaceflight is not the only technology about which Marxist attitudes have done a 180. Nuclear power is another. More generally, where Marxists used to be pro-growth and celebrate industrialization and material progress, they're now loudly for degrowth and renunciation. But the history of western Marxism is more interesting than that. Western Marxists flipped to strident anti-futurism in the late 1960s and early 1970s while futurist propaganda in the  Communist bloc did not end until its post-1989 collapse. That 20-year-long disjunct was particularly strong about  nuclear power, with the Soviets providing ideological support and funding to the foundation of European Green parties and the US's anti-nuclear-power movement at the same time as they were pouring resources into nuclearizing their own power grid. And that's your clue. Domestic Marxism  favored making power cheap and abundant, while their Western proxies pushed to keep it expensive and scarce and preached degrowth rather than expansion. Futurism vs. anti-futurism: why? [Eric S Raymond]
  • On October 17, the Ethics and Public Policy Center filed an amicus brief in the Fourth Circuit Court of Appeals in Mahmoud v. Montgomery County (MD) Board of Education. This case was brought by parents of children enrolled in Montgomery County Public Schools after the School Board denied parents’ request to opt their children out of the Board’s new sexuality and gender curriculum. The brief, co-authored by EPPC fellows Eric Kniffin and Mary Rice Hasson, argues that the district court improperly downplayed the conflict between the curriculum and their religious exercise. It shows that the curriculum does more than teach “diversity” and “inclusion”: it advances gender ideology. Drawing on the work of EPPC’s Person & Identity Project, the brief shows that gender ideology is fundamentally incompatible with Christian anthropology and Catholic teaching. [EPPC]
  • Industrialisation leads to relaxed selection and thus the accumulation of fitness-damaging genetic mutations. We argue that religion is a selected trait that would be highly sensitive to mutational load. We further argue that a specific form of religiousness was selected for in complex societies up until industrialisation based around the collective worship of moral gods. With the relaxation of selection, we predict the degeneration of this form of religion and diverse deviations from it. These deviations, however, would correlate with the same indicators because they would all be underpinned by mutational load. We test this hypothesis using two very different deviations: atheism and paranormal belief. We examine associations between these deviations and four indicators of mutational load: (1) poor general health, (2) autism, (3) fluctuating asymmetry, and (4) left-handed-ness. A systematic literature review combined with primary research on handedness demonstrates that atheism and/or paranormal belief is associated with all of these indicators of high mutational load. [Edward Dutton]
  • It is a concern that the miners are expanding met coal production even while the commodity price has been weak and their own shares have been "cheap". Warrior's new Blue Creek mine is expected to produce 5 million tons per year and Peabody's North Goonyella / Centurion mine is supposed to produce 3 million tons per year. To put that in perspective, 8 million tons of new capacity is about equal to what Warrior produces in total now. It seems like a possible "base case" is that the miners' predictable over-investment in capacity will result in the commodity price trending towards marginal cost. The miners will be able to earn a profit margin during times of strong steel demand, but we are not really seeing anything that would show us that mining has become a good business or that the executives recognize that they are not in a good business. [CBS]
  • At current (January 2023) coking coal prices of about $190 a tonne, both hydrogen and MOE production routes will be probably become cheaper than the conventional blast furnace approach within a few years. (I’m assuming $40 a MWh for renewable electricity for use in either alternative process). Moreover, a carbon tax/border adjustment of $100/€100 a tonne will make coal-based steel entirely uneconomic against both hydrogen and MOE. [Carbon Commentary]
  • In the MOE cell, an inert anode is immersed in an electrolyte containing iron ore, and then it’s electrified. When the cell heats to 1600°C, the electrons split the bonds in the iron oxide in the ore, producing pure liquid metal. No carbon dioxide or other harmful byproducts are generated, just oxygen. Furthermore, MOE does not require process water, hazardous chemicals or precious-metal catalysts. The result is a clean, high purity liquid metal that can be sent directly to ladle metallurgy — no reheating required. [Boston Metal]

Thursday, May 16, 2024

Other Earnings Notes (Q1 2024)

[Previously regarding Lamar Advertising, Intercontinental Exchange, Marriott International, Royal Gold, and Sprouts Farmers Market.]

Lamar Advertising
The market capitalization of LAMR at $122 per share is $12.5 billion and the enterprise value is $16.8 billion. During the first quarter of 2024 (release), the company reported net income plus depreciation and amortization of $154 million, up 3% from $149 million a year earlier. The quarter's NI+D yield on the market capitalization annualizes to 4.9%. Revenue for the quarter was $498 million, which was up 5.7% from the prior year quarter.

Intercontinental Exchange
For the first quarter of 2024 (release), ICE earned $877 billion of adjusted free cash flow on $2.3 billion of total revenue (less transaction-based expenses) for a royalty-like 38% free cash flow margin. Revenue (less TBEs) was up 21% from the prior year and adjusted FCF was up 30%. (The diluted share count is up 2.5% y/y.) The current market capitalization of ICE is $79 billion and the enterprise value is around $100 billion, so at a 3.5% free cash flow yield on the enterprise value it is not super cheap. We like ICE's M&A goals: "deepen moats, gain intellectual property, increase customer wallet-share".

Marriott International
For the first quarter of 2024 (release), MAR earned $1.09 billion of adjusted EBITDA (less SBC) on $1.5 billion of total revenue (excluding cost reimbursements) for a royalty-like 71% margin. Revenue (excluding reimbursements) was up 5.2% from the prior year and adjusted EBITDA (less SBC) was up 2.6%. The current market capitalization of MAR is $67 billion and the enterprise value is around $80 billion. The adjusted EBITDA (less SBC) annualized yield on the enterprise value is 5.5%. The diluted share count was down 6.2% year-over-year. Despite being a $67 billion market capitalization company, Marriott spent only $109 million on capital expenditures in the first quarter. The company spent $1.1 billion on share repurchases and $151 million on dividends, for a shareholder yield of 7.7%.

Royal Gold
Reported results: Royal Gold's net income plus depreciation was $86 million for the first quarter of 2024 versus $110 million the prior year. The company spent $100 million on debt repayment and $26 million on dividends. Net liabilities are down to $55 million. The market capitalization is $8.45 million so the enterprise value is $8.5 billion. The NI+D yield on the market capitalization is 4.1% (annualized).

Sprouts Farmers Market
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 $7.7 billion at $77 per share (+79% since we wrote about it.). 

The enterprise value is $7.7 billion if you ignore the non-current $1.4 billion of operating lease liability, since the landlords finance their stores and they have no net financial debt (see 10-Q). They generated $213 million of cash from operations less stock-based compensation in the first quarter, and spent $51 million on capital expenditures, for $162 million of FCF. (A 8.4% annualized yield on the EV, or 7.1% if you capitalize the store leases into EV.) They bought back $60 million of stock and built the cash balance by $110 million. (The cash build was because of restrictions on being able to buy back shares.) Share count is down 2.7% year over year. They earned $1.12 per share so P/E is 17x. Sprouts is a growth monster at a reasonable price. They opened 7 stores in Q1, bringing total to 414 in 23 states.

Midstream Earnings Notes (Q1 2024)

[Previously regarding Enterprise Product Partners, Enbridge, and Genesis Energy. This is our first time writing about the Tortoise Midstream Energy Fund.]

Enterprise Products Partners L.P.
Highlights from the first quarter results from EPD:

Enterprise reported net income attributable to common unitholders of $1.5 billion, or  $0.66 per unit on a fully diluted basis, for the first quarter of 2024, a 5 percent increase compared to $1.4 billion, or $0.63 per unit on a fully diluted basis, for the first quarter of 2023. Distributable Cash Flow (“DCF”) was $1.9 billion for the first quarters of 2024 and 2023.  Distributions declared with respect to the first quarter of 2024 increased 5.1 percent to $0.515 per common unit, or $2.06 per common unit annualized, compared to distributions declared for the first quarter of 2023.  DCF provided 1.7 times coverage of the distribution declared for the first quarter of this year, and Enterprise retained $786 million of DCF. Enterprise repurchased approximately $40 million of its common units on the open market in the first quarter of 2024.  Including these purchases, the partnership has utilized 48 percent of its authorized $2.0 billion common unit buyback program. Adjusted cash flow from operations (“Adjusted CFFO”) was $2.1 billion for the first quarter of 2024, compared to $2.0 billion for the first quarter of 2023.  Adjusted CFFO was $8.2 billion for the twelve months ended March 31, 2024.  Enterprise’s payout ratio, comprised of distributions to common unitholders and partnership unit buybacks, for the twelve months ended March 31, 2024, was 56 percent of Adjusted CFFO. Total capital investments were $1.1 billion in the first quarter of 2024, which included $875 million for growth capital projects and $180 million of sustaining capital expenditures.  Organic growth capital investments are expected to be in the range of $3.25 billion to $3.75 billion in 2024 and 2025.  Sustaining capital expenditures are expected to be approximately $550 million in 2024.

The $0.66 quarterly earnings are a 9.1% annualized yield on the current unit price of $29. The quarterly distribution is only $0.515 because they are retaining earnings, so the current dividend yield is ~7.3%. The big question with Enterprise is whether all of the "growth" investments pay off by resulting in higher free cash flow generation? If so, cash from operations would increase and capital expenditures would (hopefully) decrease, resulting in a lot more cash available for distributions to unitholders.

We just noticed that Bruce Berkowitz owns EPD in his amusingly concentrated Fairholme mutual fund portfolio, where he has 86% in JOE (Florida land) and 9% in EPD.

Enbridge Inc.
ENB is an $80 billion market capitalization company yielding 7.2% (dividend) which is quite high compared to what it has yielded historically. (It rarely yielded more than 7% prior to 2017.) And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. Their first quarter (release) adjusted EBITDA was $3.7 billion, up 11% year-over-year. Distributable cash flow was $2.6 billion, up 8.9% year-over-year.

Half of the EBITDA is from their liquids pipelines. Segment EBITDA was $1.8 billion in Q1, up 2.2% year-over-year. They own the Mainline pipeline from the western Canadian oil sands and then the Line 5 that takes that crude to eastern Canada refiners. The Flanagan South and Seaway can also take that Mainline oil from Canada down to Gulf Coast refiners. ("We transport about 30% of the crude oil produced in North America. We transport about 65% of U.S.-bound Canadian exports.") The Mainline System moved 3.1 million barrels per day, about the same as last year.

A quarter of their EBITDA is gas transmission. Segment EBITDA was $936 million in Q1, up 4.9% year-over-year. They carry natural gas from western Canada to export, and also to the eastern U.S. Enbridge connects PA gas to the eastern U.S. as well as Gulf Coast. ("Enbridge moves about 20% of the natural gas consumed in the United States. We are the largest natural gas supplier to New England, the Southeast and virtually all of Florida. Our transmission network is also webbed throughout the Gulf Coast. We are also one of the largest offshore natural gas transporters in the Gulf of Mexico.") They are working on LNG export from western Canada, called the Woodfibre LNG project.

Other quarter is gas distribution (natural gas utility). Segment EBITDA was $566 million in Q1, up 6.8% year-over-year. ("Enbridge’s gas utility business, Enbridge Gas Inc., becomes the largest by volume in North America—with about 7,000 employees delivering 9.3 billion cubic feet of natural gas per day (Bcf/d) to about 7 million customers.") The Enbridge Gas business earns the most during the winter - the first and fourth calendar quarters of the year. This year's heating degree days in Enbridge's markets were only 1,377 HDDs, which was 20% lower than last year.

Enbridge also has a renewable power generation business that earned $190 million of EBITDA, up 89% year-over-year.

Genesis Energy Limited
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.

For the first quarter of 2024 (results), the offshore pipelines contributed $98 million of segment margin (the same as Q1 2023), soda and sulfur contributed $45 million (down 31% from prior year), marine transportation did $31 million (up 22%), and the onshore pipelines and terminals $6.5 million (up 21%). Total segment margin of $181 million was down 7.2% from the prior year.

The market capitalization of the partnership (at $13 per unit) is $1.58 billion. Genesis has quite a bit of leverage (see 10-Q): $3.84 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 $6.23 billion, and the EV/EBITDA is 9.6 times the first quarter's annualized EBITDA of $163 million.

Their guidance for 2024 had been $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 6.9% to 8.7% on the enterprise value. The first quarter's EBITDA annualizes to $652 million which is below the low end of guidance and would mean the free cash flow on the enterprise value would be 6.5% if capex for the year was $250 million.

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. 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.

The company just refinanced its 6.25% notes due 2026 with new notes yielding 7.875% that are due 2032.

Tortoise Midstream Energy Fund, Inc.
This (NTG) is a closed end fund that invests in "natural gas infrastructure entities operating real, long-lived, essential pipeline and logistical assets that are actively participating in the energy evolution". Something interesting about closed end funds is that the investors can not redeem from them. As a result from that, there is no arbitrage mechanism to force the market price of a fund unit or share to trade at the fund's net asset value. In this case, the unit price is an 18.9% discount to the net asset value of the fund.

As of April 30, 2024, the top holdings (71% of the fund's investment securities) of NTG were:

Targa Resources Corp (TGRP) 10%
Williams Companies Inc. (WMB) 9.4%
MPLX LP (MPLX) 9.1%
ONEOK, Inc.  (OKE) 8.9%
Plains GP Holdings, LP (PAGP) 8.2%
Hess Midstream LP (HESM) 6.6%
Energy Transfer LP (ET) 5.2%
Enterprise Products Partners LP (EPD) 4.7%
DT Midstream Inc (DTM) 4.4%
Western Midstream Partners LP (WES) 4.1%

Something else unique about closed end funds is that because they have permanent capital (unlike an exchange traded fund), they can use leverage. NTG has total assets of about $300 million and has borrowed $56 million of funds, comprised of $29 million of notes and $12.8 million on a credit facility. There is one note (Series S) for $25 million at a 2.5% interest rate that is due in December 2028. Two other smaller notes yield around 4% and are due in 2025 and 2026. The note at 2.5% is likely worth much less than par and thus the fund's net asset value, which does not discount the note to fair value, is somewhat understated. The credit facility is floating rate, currently 6.7%. In addition to the $42 million of debt, there is also $14 million of preferred shares. The bulk of this is $7.5 million due in December 2027 at a rate of 2.9%, again, so low that it would likely be worth less than par.

Another nice thing about closed end funds is that they "block" the investor from receiving and having to deal with the taxable income (and Schedule K-1) of the underlying investments that are partnerships.

We tend to like midstream investments right now, and investing in a closed end fund gives some benefits, like blocking the K-1s and giving a discount to the value of the underlying portfolio. The dream scenario would be if the midstream companies' earnings grew, they were revalued to higher earnings multiples (i.e. their dividend yields fell), and the closed end fund's 18.9% discount narrowed. 

Activists (such as Boaz Weinstein of Saba) are pressuring closed end fund managers to take steps to narrow the discounts. (Saba owns ~10% of NTG per recent disclosures.) First Trust had a bunch of midstream closed end funds, and they recently merged them into an exchange traded fund (EIPI). When your CEF becomes an ETF, the discount evaporates.

Tortoise has a bunch of midstream CEFs with no clear purpose for being separate, the same way First Trust did. It would be great if NTG were merged with the other, overlapping midstream CEFs and converted to an ETF. Closing that NAV discount would give a 23% return, on top of the underlying investment returns of the midstream investments.

It will be interesting to see whether the new First Trust ETF (EIPI), which its four CEFs were merged into, retains much of the AUM from those CEFs. If so, that would make it more compelling for other managers to convert their jumbles of CEFs into ETFs.

A step short of liquidating or converting to an ETF is for the closed end fund to buy back or tender for its own shares. Last October, all five of the Tortoise midstream funds tendered for up to 5% of their outstanding shares at 98% of net asset value. Not everyone tendered their shares, so for NTG a shareholder who tendered was able to sell the company 10.18% of shares tendered at 98% of NAV. If they continue with this "discount management program," shareholders may be able to eke out a little bit more return.

Wednesday, May 15, 2024

Oil and Gas Earnings Notes (Q1 2024)

We wrote about Exxon, Chevron, and Imperial Oil earnings in a post last month. Now, let's look at our big Canadian producers (CNQ, SU, CVE), our royalty owners (DMLP and TPL; we already looked at PREKF results), and our two big refiners (MPC and VLO).

Canadian Natural Resources Limited
The current market capitalization of CNQ (at a $76 share price) is $81 billion, and the enterprise value is $88 billion. Cash from operations for the first quarter (results) was $2.12 billion and the company spent $773 million on capital expenditures. The remaining free cash flow for the quarter was $1.35 billion, which is a 6% yield on the enterprise value.

Capital expenditures were down 11.5% from the first quarter of 2023, while production of liquids was up 1.3% and total production (including natural gas) was up 1.1%. They averaged 976k bbl/d of liquids during the quarter. The realized price of oil per barrel was $52 for crude and $66 for synthetic crude, compared with $44 and $71 the prior year.

The company spent $796 million on dividends and $448 million on share repurchases for a shareholder yield of 6%. The diluted share count is down 2.9% year-over-year. Regarding capital allocation, management said on the conference call: "2024 marks an important milestone as we are delivering 100% of free cash flow to shareholders this year. And with strong crude oil strip pricing for the remainder of the year, we are targeting to generate significant free cash flow."

Suncor Energy Inc.
The current market capitalization of SU (at a $39.50 share price) is $51 billion, and with $10 billion of net debt, the enterprise value is $61 billion. Cash from operations for the first quarter (results) was $2.06 billion and the company spent $915 million on capital expenditures. The resulting free cash flow for the quarter was $1.15 billion, which is a 7.5% yield (annualized) on the enterprise value. During the quarter, Suncor returned $736 million via repurchases and dividends, for an annualized shareholder yield of 5.8%.

Capital expenditures were up 20% from the first quarter of 2023, while production was up 12.5%. They averaged 835k bbl/d of production during the quarter, which was a record, including all-time high oil sands production of 785k bbl/d from oil sands. Refining throughput of 455k bbl/d was also the highest in company history. The upstream segment earned $1.2 billion pretax and the refining and marketing segment earned $824 million, for a total of $1.2 billion of net after-tax earnings.

Cenovus Energy Inc.
The market capitalization of CVE is $37.5 billion (at a $20 share price) and their enterprise value is $43.4 billion. The upstream segment earned $1.2 billion of operating margin during the first quarter (results) (compared with $613 million the prior year) and the downstream (refining) segment earned $294 million (compared with $186 million earned the prior year).

Upstream capital expenditures were up 6.4% year-over-year, to $690 million for the first quarter. Upstream production volumes were 801k boe/d, up 2.8% year-over-year. Cash from operations for the quarter was $1.42 billion which puts free cash flow at $745 million, for an annualized yield of 6.8% on the enterprise value.

During the first quarter, the company spent $194 million on common share dividends and $122 million on share repurchases. The $316 million returned to shareholders is a shareholder yield of 3.4% on the current market capitalization. Net debt at the end of the quarter was $3.6 billion. Management has said that they will increase shareholder returns (from 50% of "excess free funds flow" to 100%) once net debt drops below $3 billion.

Dorchester Minerals, L.P.
The market capitalization of DMLP is now $1.3 billion (at $32 per unit). For the first quarter of 2024 (10-Q), the partnership earned $18 million of net income (compared with $28 million the prior year), generated $28 million of cash from operations (compared with $39 million the prior year), and distributed $40 million to unitholders. The CFO yield on the market capitalization is 8.6% (annualized). The annual shareholder meeting was on May 15 and the company has released the investor presentation. The most recent (second quarter) distribution was $0.782 cents, paid on May 9. Over the trailing four quarters, the partnership has distributed $3.31, which is a 10% yield on the current unit price.

Texas Pacific Land Corporation
The market capitalization of TPL (at $600 per share) is now $13.9 billion. (The company had a 3-for-1 share split during the first quarter.) The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $900 million and the enterprise value is $13 billion. The company owns 868,000 surface acres, which is an enterprise value of $15,000 per acre just for the surface.

In the first quarter of 2024 (10-Q), production volumes for TPL were 24,800 BOE per day, which was up 19% from the prior year. Their oil volumes at 0.99 million total barrels for the quarter were up 25% year-over-year. Oil and gas royalty revenue was up only 3.4% year-over-year because natural gas prices were down. Water sales, water royalties, and easement income were all up year-over-year, although the water service business has operating expenses, which were also up. (TPL's "land and resource management" segment had an adjusted EBITDA margin of 94% and its "water service and operations" segment had a 75% margin.)

Total expenses were $34.3 million (excluding depreciation) versus $38 million the prior year. Thankfully legal fees were only $4 million this quarter and not the $16.6 million spent in the year ago quarter. Expenses (again excluding depreciation) were 20% of total revenue, partly because TPL has established a "water services" business which is lower margin than collecting royalty revenue.

Operating income was $136 million for the quarter, and if you add back $3.8 million of depreciation, depletion, and amortization, you get a "cash flow-like number" of $140 million, which would be an annualized yield of 4.3% on the current enterprise value.  

The company published a May 2024 investor presentation as well as a presentation on produced water desalination and beneficial reuse.

Marathon Petroleum Corporation
This Marathon is the refiner, not the E&P company (MRO). They refine almost 3 million barrels per day, which is the most in the U.S., followed by Valero (VLO) and ExxonMobil (XOM), each with about 2 million barrels per day. 

At the current share price of $172, the market capitalization of MPC is $60.6 billion and the enterprise value is $82 billion. During the first quarter (release), Marathon's refining and marketing segment earned adjusted EBITDA of $1.9 billion and its midstream segment earned $1.6 billion, for total adjusted EBITDA of $3.3 billion. The refining capacity utilization was only 82% during the quarter, compared with 89% the prior year (when refining EBITDA was a much higher $3.9 billion).

Cash from operations was $1.5 billion and the company had $585 million of capex during the quarter. The company repurchased $2.2 billion of stock and paid $300 million of dividends, for total shareholder returns of $3 billion, a 20% annnualized shareholder yield. (The company's cash balance drew down by $2.3 billion as they outspent cash flow.)

Valero Energy Corporation
At the current share price of $157, the market capitalization of VLO is $51 billion and the enterprise value is $57 billion. During the first quarter (release), Valero's refining segment earned operating income of $3.5 billion and its renewable diesel and ethanols segments earned a combined$200 million.

Cash from operations was $1.85 billion and the company had $660 million of capex during the quarter. The company repurchased $1 billion of stock and paid $356 million of dividends, for total shareholder returns of $1.38 billion, an 11% annualized shareholder yield.

Coal Earnings Notes (Q1 2024)

Metallurgical coal prices have been a bit soft so far this year. Since coal miners have operating leverage as well as capital expenditure requirements, you would expect that their free cash flows have suffered more than the royalty owners' have. And as we pointed out in January, the royalty owners  - which hold the senior securities in the capital structure of mines - seemed cheaper than the producers.

It is a concern that the miners are expanding met coal production even while the commodity price has been weak and their own shares have been "cheap". Warrior's new Blue Creek mine is expected to produce 5 million tons per year and Peabody's North Goonyella / Centurion mine is supposed to produce 3 million tons per year. To put that in perspective, 8 million tons of new capacity is about equal to what Warrior produces in total now.

It seems like a possible "base case" is that the miners' predictable over-investment in capacity will result in the commodity price trending towards marginal cost. The miners will be able to earn a profit margin during times of strong steel demand, but we are not really seeing anything that would show us that mining has become a good business or that the executives recognize that they are not in a good business.

People are working on electrolysis of iron ore (which would be like aluminum production) as well as hydrogen based reduction for steelmaking. Either of those innovations would disrupt metallurgical coal and what they would mainly require is cheaper electricity. It does not seem prudent to invest capital in new coal mines without establishing long term sales contracts with financially sound entities to sell the output. The miners could idle the expansion projects and have the option to start them at such time that they could guarantee an attractive market for the output.

We follow four coal producers and three royalty owners. The miners are Alpha Met (AMR), Warrior Met (HCC), Arch Resources (ARCH), and Peabody (BTU). The mineral owners are Natural Resource Partners (NRP), Pardee Resources (PDER), and Beaver Coal (BVERS). Some notes on the results:

Alpha Met
The market capitalization of AMR is now $3.7 billion (at $285 per share), down quite a bit from $5.75 billion at the high in February. Results for March 31st (10-Q) show Alpha's current assets less total liabilities (ignoring deferred taxes) were $248 million (about the same as year-end 2023) which puts the enterprise value at $3.45 billion now.

For the first quarter of 2024, AMR's adjusted EBITDA was $190 million (down from $266 million the prior quarter) which puts the EV/EBITDA at 4.5x. AMR sold 4.4 million tons of met coal in Q1, down from 4.6 million in Q4. They got $167/t for met coal versus $184/t the prior quarter, and the cost per ton was down slightly to $116/t versus $119/t.

Cash from operations was $196 million and capital expenditures were $72 million for the quarter (including $8.5 million of contributions to equity affiliates), for $124 million of free cash flow, an annualized yield on the enterprise value of 14%. They paid $3 million of dividends for the quarter and bought back $116 million of stock, for a shareholder yield of 13% (annualized) on the current market capitalization. The share count was down 14.8% year-over-year.

Warrior Met
The market capitalization of HCC is now $3.3 billion (at $63.25 per share), down about 10% from a recent all time high of $70 in late April. Results for March 31st (10-Q) show Warrior's current assets less total liabilities (ignoring deferred taxes) were $422 million which puts the enterprise value at $2.89 billion now.

For the first quarter of 2024, Warrior's adjusted EBITDA was $200 million (up from $164 million the prior quarter) which puts the EV/EBITDA at 3.6x. Warrior sold 2.1 million tons of met coal in Q1, up from 1.9 million tons in Q4. They got $234/t for met coal versus $258/t the prior quarter, and the cost per ton was down slightly to $133/t versus $147/t.

Cash from operations was $104 million and capital expenditures were $102 million for the quarter. There was an adverse change in working capital (mostly paying down trade accounts receivable) that negatively affected cash from operations by $87 million. If you add that back, free cash flow would have been $89 million, which is a 12% yield on the enterprise value.

The company paid $31 million of dividends and did not buy back any stock, making the shareholder yield 3.8% (annualized). It seems like it would be a good idea not to be expanding production, as we have previously observed.

Arch Resources
The market capitalization of ARCH is now $2.8 billion (at $156 per share), down about 15% from the all time high in March. Results for March 31st (10-Q) show Arch's current assets less total liabilities (ignoring deferred taxes) at negative $104 million which puts the enterprise value at $2.9 billion now.

For the first quarter of 2024, Arch's adjusted EBITDA was $103 million (down from $180 million the prior quarter) which puts the EV/EBITDA at 7x. Arch sold 2.2 million tons of coal in Q1 (both met and thermal coal), down from 2.3 million tons in Q4. They got $166/t for met coal versus $196/t the prior quarter, and the cost per ton (both met and thermal combined) was up to $94/t from $87/t. Note that the cash margin per ton was thus down one-third just from the prior quarter.

Cash from operations was $128 million and capital expenditures were $45 million for the quarter, resulting in $83 million of free cash flow, an 11% yield on the enterprise value. The company paid $44 million of dividends and bought back $14 million of stock, making the shareholder yield 8.3% (annualized).

Peabody
The market capitalization of BTU is now $2.8 billion (at $22.50 per share). Results for March 31st (10-Q) show Peabody's current assets less total liabilities (ignoring deferred taxes) at negative $263 million which puts the enterprise value at $3.1 billion now.

For the first quarter of 2024, Peabody's adjusted EBITDA was $161 million (down from $345 million the prior quarter) which puts the EV/EBITDA at 4.8x. Peabody's seaborne thermal earned $94 million of EBITDA for the quarter, the seaborne met earned $48 million, Powder River Basin earned $16 million, and other U.S. thermal earned $46.5 million.

Cash from operations was $120 million and capital expenditures were $68 million for the quarter, resulting in $52 million of free cash flow, a 6.7% yield on the enterprise value. The company paid $10 million of dividends and bought back $83 million of stock, which resulted in a 3% share count reduction.

Natural Resource Partners
The market capitalization of NRP is now $1.16 billion (at $90 per unit) and as of March 31st (10-Q) the partnership has $175 million of long term debt and $72 million of convertible preferred stock, for net liabilities of $220 million. The enterprise value is thus $1.39 billion.

NRP generated $72 million of free cash flow in the first quarter of 2024 and $312 million of free cash flow over the trailing twelve months. The first quarter figure, which annualizes to $288 million, is a 20.7% yield on the enterprise value.

After the end of the first quarter, NRP settled the remainder of its warrants and bought back more than half of its convertible preferred units. Our best guess now is that the partnership has an enterprise value of $1.35 million. Assuming an annualized free cash flow of $280 million, that would still be a yield of greater than 20% on the enterprise value. Also, it would mean that estimated remaining net liabilities of $175 million could be paid off in about 2.5 quarters, which would mean the end of this year. The stated intention of management is to begin distributing cash to shareholders once all liabilities are paid off. That would indicate a possible annual distribution of $20, which would be a 22% yield on the current unit price, assuming that current level of free cash flow holds.

Pardee Resources
Pardee is interesting because it owns a huge amount of land in West Virginia, both the surface with timber and also the mineral rights. The current market capitalization (at $250 per share) is $166 million and the company reported $35 million of current assets net of all liabilities at March 31, which gives an enterprise value of $131 million. That is $845 per acre, which seems quite low compared to what timberlands are worth, not to mention the mineral rights and other assets.

Pardee earned $5 million of EBITDA in the first quarter, which was down 17% y/y. The coal royalty per ton was down (because of lower commodity prices received by their lessees), but the lessees' production levels were up. That gives a yield of 15.5% on the enterprise value (annualized).

Beaver Coal
Beaver Coal is a partnership that also owns land in West Virginia (only about one-third as many total acres as Pardee) and unlike Pardee is also getting ground lease income from real estate tenants, in addition to coal royalties and timber sales. At $2,750 per unit, the market capitalization of the Beaver partnership is $68.4 million. Subtracting the $6.6 million of net current assets, the enterprise value is $61.8 million. 

Beaver's coal royalties were $8.9 million in 2023 vs $9.6 million in 2022. Total revenue was $12.9 million vs $14.4 million. Expenses were $2.3 million vs $2.1 million. Operating income was $10.5 million vs $12.1 million. The enterprise value is $1,246 per acre and the OCF yield on the EV (ignoring working capital changes) is 17%. Shares are trading for under 7x net income.

The partnership has had a cash build from $5.2 million (YE 2022) to $6.1 million (YE 2023), which is an increase of $34 per unit. There has been a net current asset build from $5.1 million to $6.6 million, now standing at $266 per unit of current assets net of all liabilities (excluding deferred revenue).

They had $889k of proceeds from sale of property and equipment (also had $511k expenditure for purchase of property and equipment). The financial statements do not say what the sale or purchases were. This will perhaps be explained in the shareholder letter when they mail the annual report.

Tuesday, May 14, 2024

Tuesday Night Links

  • Government can be seen, in a fallen world, as the necessary submission to a monopoly of violence to prevent random and unstructured violence. It is no different than paying protection money to a local mobster, often necessary in failed, semi-sovereign states. That monarchs, with their honest and straightforward exercise of power, can demand less protection money than the manufactured consent of democracy is a bug, not a feature, from the perspective of government (though a feature for the tiny minority of rational subjects). Democracy, then, is a superior technology of government that allows greater extraction of resources from the host population by elites, through the farce of voting. The downside is that instead of an honest elite based on the honest exercise of power, it breeds a rather amoral elite who compete on the basis of propaganda and manipulation of irrational voters. Morally, it is inferior, but as an extractive technology, it is superior. Democracy is like fracking applied to elite rentier efficiency. People would rather give half of their resources in taxation if they feel they have a voice than a tenth otherwise. The advent of fiat currency, as a form of stealth taxation, represented a further technological advance in the ability to exploit the productive. [The Tom File]
  • Why are solar PV panels so cheap? Solar panels are essentially large sheets of glass containing a thin layer of silicon configured so that light will push electrons through in one direction, generating electricity with no emissions, no fuel, no noise, no dust, and no moving parts. Built in factories refined continually for the last 50 years, solar panels have followed a similar cost curve to Moore’s Law for computers: ever greater volumes at ever lower prices — and no end in sight. Last year, the world installed about 437 GW of solar electricity, or roughly one acre of panels every 10 seconds. Earlier this year, panels fell to a record low of just $0.12/watt, and that record is certain to fall before long. In just the last decade, solar has fallen in price by a factor of 10. No other energy source has ever gotten that cheap that fast — and all indications are that both deployment and cost declines are accelerating. Fresh water production is just one of dozens of industries being upended by cheap solar, but the general rule applies. If it’s possible to use lots of cheap energy to make something, then sooner or later solar will be cheap enough to bring that product to a particular market at scale. For water in the US Southwest, that time is now. Solar can deliver power for about $0.02/kilowatt-hour (kWh), batteries for 24-hour utilization increase this to $0.12/kWh, meaning that the 1.8 kWh required for each cubic meter of water costs only $0.20 — and this is falling about 15% per year. [Casey Handmer]
  • On May 8, 2024, Natural Resource Partners L.P. (the “Partnership”) executed a negotiated transaction with holders of the Partnership's Class A Preferred Units ("preferred units") pursuant to which the Partnership repurchased an aggregate of 40,000 preferred units (the “Subject Units”) for $40,000,000 in cash, plus any accrued and unpaid distributions in respect of such units. Following the repurchase, the Subject Units were retired and are no longer outstanding, and all rights of the holders thereof have ceased with respect to the Subject Units. Of the originally issued 250,000 preferred units, after giving effect to this redemption and all prior redemptions, 31,666 preferred units remain outstanding. As a result of this negotiated transaction, holders of the remaining preferred units have waived their right to convert up to 33% of the outstanding preferred units for six months from the date of the negotiated transaction. [Natural Resource Partners L.P.]
  • Watching the slowly-developing advance of Russian forces across the line in Ukraine I've been brought back in mind of an excellent book I've read several times - Military Power by Stephen Biddle. Using mathematical modeling, Biddle predicted that future wars would move slower at the tactical level than we were used to from the experience of WWII.  This was due to technological trends in the range and effectiveness of modern weaponry forcing armies to operate in a more dispersed, methodical fashion so as to minimize their exposure to fire in a sort of neomodern reversion to the conditions of WWI.  He also predicted that failures to do so would be punished with increasing severity as anything that could be discovered by increasingly omnipresent battlefield surveillance could be engaged effectively with precise and deadly weapons. His recommendation on the optimum rate of advance for an army attempting to break through an enemy front line under modern conditions was a mere one kilometer per day; similarly he recommended that reserves be moved into position quite slowly to block such an advance to avoid their destruction by interdiction fire.  Only once that breach in the front is slowly levered open can forces then mass into fast-moving columns to strike into the enemy's lightly-held rear areas. [Armchair Warlord]
  • This bank just confuses me. I think that’s as succinctly as I can put it. To start with they have branch/office locations in California (the wealthy areas), Texas, Nevada, Hawaii, and Florida. And while this sounds fun (especially for exec PJ travel) and I understand catering to the wealthy, I have rarely seen this kind of geographic spread work for a small bank. They also tout a wealth department with AUM/AUA at $6.6b, which is admirable but small all things considered. I know zero about their platform, but in the RIA shuffle going on right now I don’t know what their differentiator is above and beyond a Raymond James type (great platform) or a PE buyout (higher payout). Their M&A move into Florida hurt EPS but then so did rates up and seemingly very little balance sheet management. Their NIM is in the low 1s and their COF in the mid to high 6s. Their L/D ratio is pretty bad too although to be fair their California Multi Fam loans have been performing really well. All in all, it all just feels confusing or maybe distracted. Like they’re trying to do a lot of things all at once, and maybe none of them great. Like Bruce Lee said, “I fear not the man that has practiced 1000 kicks, but rather the man that has practiced one kick 1000 times”. Oh, and I recently found out their COO spends at least some of his time with a YouTube channel and talks about his T levels on X while promoting some supplement company. [Victaurs
  • The bank isn’t even doing terribly on their mortgage book thus far, but they evaluate the decision in terms of EV. Most recreational gamblers associate having an edge with being up or down. How can you not have an edge if you’re winning? Or at least that’s how they think. So I like that the movie focuses on EV. They make a decision that’s unhindered by their prior errors and also unconstrained by convention. I mean wouldn’t that be a great way to go through the world? We should all be so lucky to be able to do that. Instead we often double down on errors and act within the confines of what might seem like reasonable approaches. The scene highlights the conflict between these approaches, and the clear decision making prevails. [Risk of Ruin Podcast Newsletter]
  • I talked with Jeremy Siegel. We reminded each other that the Value Line index was a geometric index. We remembered that the equation for the pricing of stock index futures contracts on a geometric index required an additional term to accommodate the peculiarities of the geometric computation. But what was this other term? We asked Krishna Ramaswamy of Wharton and Suresh Sundaresan of Columbia, both of whom had been partners in The Free Lunch Club. Sundaresan had coauthored an article on the pricing of stock index futures (Modest and Sundaresan, 1983). They pointed out that the appendix gave a formula for pricing a futures contract on a geometric index. We looked at the formula. The missing term was 1/2{average unique risk} of the stocks in the index. How much was this? A typical unique risk is about 10% per year. So one-half of this is 5% per year. Holy Smoke! I had a multi-million dollar position in a futures contract that the market was pricing using the wrong formula, and now the market was moving towards pricing it using the correct formula that includes the extra term! Instead of (1 + r - div) being +3%, (1 + r - div - (1/2{average unique risk }) is -2%. So instead of the theoretical basis being +1.78, it should be -1.21. By this time, five days had gone by, and I had already lost $25,000. And the basis had moved only one-third of the way towards its new theoretical value, so I stood to lose another $50,000 if I couldn't unwind my position. There was only one problem with unwinding our position. The positions that Jeremy Siegel and I had were 100% of the long positions in the March contract. The only party on the other side had obviously figured out the correct formula, and this party wasn't about to let us out at the "market" price. We had discovered what an "illiquid" position meant. [Jay Ritter]
  • We mailed letters to non-existent business addresses in 159 countries (10 per country), and measured whether they come back to the return address in the US and how long it takes. About 60% of the letters were returned, taking over 6 months, on average. The results provide new objective indicators of government efficiency across countries, based on a simple and universal service, and allow us to shed light on its determinants. [Andrei Shleifer]
  • Joe Biden is about to slap 100% tariffs on Chinese-made electric vehicles. A 100% tariff is an absolutely huge tariff. It means that Chinese EV makers would have to sell their EVs in the U.S. at half the price of EVs manufactured elsewhere in order to be competitive. That just isn’t going to happen. A 100% tariff will probably be enough to keep essentially all made-in-China EVs out of the U.S. The Rhodium Group recently came out with a report called “Ain’t No Duty High Enough”, arguing that Europe would need 40-50% tariffs to keep Chinese EVs out. [Noah Smith]