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.

Mineral Royalty Owner Earnings ($DMLP $NRP $STR $RGLD $TPL $PREKF)

Dorchester Minerals, L.P.
The market capitalization of DMLP is now $1.11 billion (at $28 per unit) and the enterprise value is $1.08 billion. For the third quarter of 2023 (10-Q), the partnership earned $30 million of net income (compared with $34 million the prior year), generated $34 million of cash from operations (compared with $46 million the prior year), and distributed $26 million to unitholders. The CFO/EV yield is 12.6% based on the third quarter results, during which the average oil sales price was in the mid-$60s/bbl and the average natural gas sales price was around $2/mcf.

Yesterday, Dorchester announced that they had leased land in Reagan County, Texas for an $11.8 million bonus payment and a 25% royalty. That upfront payment amounts to $0.30 per unit, and the royalty payments will hopefully be substantial once the wells are drilled and go into production.

Natural Resource Partners L.P.
The market capitalization of NRP is now $872 million (at $69 per unit). The capital structure is complicated so it is worth discussing the assumptions that go into the enterprise value calculation. The partnership has $60 million of current assets (mostly cash and accounts receivable) and $52 million of current liabilities. We add back all deferred revenue including $6.4 million of the current portion which is a current liability. The partnership has $171 million of long term debt, $6.8 million of other long term liabilities.

After some significant repurchases of preferred stock and warrants during the quarter (see 1, 2, 3), there is now $72 million of preferred stock outstanding and warrants to buy 2.2 million shares. For our enterprise value calculation we use the difference between the current unit price and the warrants strike price of $34 to calculate a liability of $77 million. In the end it may cost more than this to settle them if the partnership unit price continues to appreciate.

That gives an enterprise value of $1.1 billion for the partnership. For the third quarter of 2023 (10-Q), free cash flow was $80 million. (For the trailing twelve months, it has been $304 million.) That gives a FCF/EV yield of 29% using this quarter's annualized number. 

There is a slide in the August 2023 investor presentation showing annual free cash flow figures since 2015. For the year 2016, which when the coal market crashed and most of the miners went bankrupt, NRP still had free cash flow of $76 million. If that were to happen again (a 75% decline from current level), the FCF/EV on the current valuation would be 6.9%.

Recently, the producers' cash cost per ton of met coal has been around $100 per ton, with Arch at $97/ton and Warrior at $114/ton. In 2016, the cash cost of met for Arch was only $53/t. With the producers' costs per ton having doubled since 2016, it ought to be difficult for the market-clearing price to drop as low as it did in 2016 (at least for a protracted length of time), and hence it ought to be difficult for free cash flow to drop that much again.

If coal prices and production levels as well as earnings from the Sisecam (soda ash/trona) minority interest hold up, and if the unit price stays the same, then the partnership might be able to pay off its remaining $312 million of net liabilities by the end of Q4 2024. Paying off liabilities is management's stated intention. (Q3 2023 call: "We continue to believe that aggressive retirement of debt, preferred equity and settlement of warrants, while maintaining common unit distributions is the right strategy to maximize long-term common unitholder value.")

If they achieve that deleveraging, then the current level of free cash flow (~$320 million annualized) would be a 37% shareholder yield on a $872 million market cap.

Sitio Royalties Corp.
The market capitalization of STR is now $3.7 billion (at $24 per share). Unlike many of the other oil & gas royalty investments, Sitio has a significant amount of debt: about $1 billion, consisting of $601 million on a revolving credit facility (floating interest rate, currently 8.42%) and $405 million of senior notes due 2026 (also floating rate, currently 11.29%). So the enterprise value is now $4.6 billion.

In the third quarter of 2023 (10-Q), Sitio earned only $275 thousand of net income, thanks to a $24 million hedging loss. If you add back $81 million of depreciation, depletion, and amortization for the quarter, you get an "adjusted-CFO" yield of 7% on the current enterprise value, or a 9% yield if you assume the hedging loss is "one time" and add that back too.

In addition to being highly leveraged (with expensive, floating rate debt), Sitio is the only royalty investment we follow that hedges. Sitio has a slide in their latest investor presentation that says "Sitio is able to drive down Cash G&A per boe with each large acquisition". It seems like their model is to use expensive debt to aggressively acquire properties and increase scale, and they then have to hedge the commodity price to reduce risk. Lots of moving parts, with the goal being to spread the overhead cost over more barrels.

Sitio reports their their G&A cost per BOE as $2.17 for this quarter. We might also look at it as $7.45 per barrel of crude oil. By comparison, Dorchester's G&A is $3 per BOE and only $4.57 per barrel of crude oil. Another way to look at it is that Sitio spent 7.6% of revenue on SG&A for the quarter and Dorchester spent 6.6%.

So, Dorchester is smaller yet operating more efficiently. Dorchester also managed not to bungle and blow the whole quarter's earnings with a hedging loss. The entire point (to us, at least) of owning royalties and the reason that they are first class assets is that you always make some money owning them. It may not be a lot some of the time, but you never lose money. Borrowing money at 11.3% and selling both puts and calls on commodity futures puts you in a position to lose money.

Royal Gold, Inc.
The market capitalization of RGLD (at $105 per share) is now $7.1 billion. They have $236 million of net liabilities (excluding deferred taxes) so the enterprise value is $7.3 billion. For the third quarter of 2023 (10-Q) they reported revenue of $139 million, operating cash flow of $98 million, and earnings of $49 million. The company is trading for 36x earnings (annualized) and an OCF/EV yield of 5.4%. 

Several developments negatively affected the quarter and made earnings and cash flows lower than they would have been. Newmont's Peñasquito mine in Mexico had a four month strike (although an agreement has been reached with the union), Centerra’s open pit Mount Milligan mine in British Columbia has also had some issues with ore quality resulting in guidance there being lowered, and there was also a delay to the ramp-up of Barrick’s expansion of its Pueblo Viejo mine in the Dominican Republic. 

There is upside to Royal Gold if those mines' issues can get fixed, as well as upside from mines that have already been funded but which have not gone into production. Something mentioned on the conference call is that their cash G&A costs remain are 5% of total revenue, which compares very favorably with Sitio and even Dorchester, as we noted above.

Texas Pacific Land Corporation
The market capitalization of TPL (at $1,650 per share) is now $13.5 billion. The company has built up quite a cash pile during the shareholder activism dispute, so the current assets net of liabilities are $747 million and the enterprise value is $12.75 billion.

In the third quarter of 2023 (10-Q), Production volumes for TPL (in BOEs) were down 6.6% for Q3 2023 versus the prior year. Royalty revenue was down 33% because of the lower production volume as well as lower commodity prices. (The price of natural gas in particular was much lower than last summer. Revenue for easements and other surface-related income, land sales, water sales, and produced water royalties were all up year-over-year.

Expenses were $27 million (excluding depreciation) versus $25 million the prior year. Thankfully legal fees were only $1.7 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 $127 million for the quarter, and if you add back $3.6 million of depreciation, depletion, and amortization, you get a cash flow-like number of $131 million, which would be an annualized yield of 4% on the current enterprise value.

PrairieSky Royalty Ltd.
The market capitalization of PREKF (at US$17.80 per share for the U.S.ADR) is $4.25 billion and the enterprise value (with $195 million of net debt) is $4.4 billion.

For the third quarter of 2023 (MD&A), PrairieSky's net earnings were $40 million (compared with $55 million the prior year) and earnings plus DD&A were $67 million (compared with $83 million the prior year). That's a "cash generation" yield of 6% on the current enterprise value.

Royalty production volumes averaged 25,469 BOE per day, an increase of 8% over Q2 2023 and 2% over Q3 2022. Quarterly oil royalty production averaged 12,084 barrels per day, a 4% decrease from Q2 2023 and a 6% increase over Q3 2022. The average realized price for crude oil this quarter was $67.55/bbl compared with $75/bbl the prior year.

With the cash generated from operations this quarter, the company spent $11 million on property acquisitions, $42 million on dividends (4% dividend yield), and $4 million on debt repayment. One odd thing disclosed was a "$13.3 million termination payment related to a leadership change in the quarter".

Dorchester Minerals and Texas Pacific Land

[Previously regarding Dorchester Minerals, L.P. and Texas Pacific Land.]

The big takeaway from the energy producer earnings results from the first quarter is that there were very large increases in capital expenditures which resulted in unimpressive production growth, and even declines. The two possible causes of that adverse trend would be cost inflation (more expensive labor and material inputs for a given result) and resource exhaustion (declining quality of rock requiring more effort to get the same result). 

Another takeaway from the quarter is that the producers' capital expenditure discipline is not as good as we would like. While they are (thankfully) spending less than half of operating cash flow on capital expenditures (which implies that we are still relatively early in the capital cycle), why spend anything to maintain production when Biden is hammering the oil price?

What is bad for producers can be good for royalty owners. We have been saying this for years and this quarter we are asking ourselves why we strayed from the first class assets. Rising costs are bullish for royalty owners. Undisciplined spending on production is very bullish for royalty owners.

The big uncertainty with the non-operating mineral owners is always: how much oil do they actually own and what will their lands produce over time? (As an example, see our past posts, "Is Dorchester Minerals LP Just a Depleting Asset?" and "Dorchester Minerals LP Retrospective".) The quantity that will be produced in the future is unknowable, since the decision whether to produce is no longer in the hands of the landowner once they have leased land to an operator. Also, unlike the royalty trusts which are in a pure runoff mode, the "operating" non-operators (like Dorchester Minerals, Sitio Royalties, and Texas Pacific) can increase reserves, production, and value per share or per unit by making acquisitions. Success or failure at these acquisitions can really only be judged in retrospect.

Let's do a five-year comparison of Dorchester Minerals' production volume per partnership unit, comparing Q1 2018 with Q1 2023. 

Dorchester uses partnership units (not cash) to make acquisitions of acreage. So the units outstanding have grown 19% total, or 3.5% per year, compounded. Production of oil has doubled, which means that oil per unit increased 71% per unit (11.3% compounded). 

The BOE metric in the table is based on the price equivalence of natural gas (currently a 20:1 ratio) not the energetic (always 6:1) equivalence. Total production of oil and natural gas, in price-equivalent BOEs, has grown 90% total or 60% per unit.

The formula of issuing units to acquire properties seems to be working. Production per unit (BOE) has grown almost 10% per year, compounded, over the past five years. What is great for unitholders is that they did not have to invest in drilling the wells that produced those hydrocarbons.  

By the way, since success or failure at acquisitions is difficult to judge except in retrospect, Dorchester Minerals has something of a barrier to entry against competition. If you were a landowner in an oil and gas basin looking to trade your mineral rights in a tax-free transaction for partnership units that were more diversified, more liquid, and professionally managed by an entity with a long track record of success, how many choices would you have?

The market capitalization of Dorchester is now $1.1 billion (at $28.63 per share) and the enterprise value is $1.04 billion. For the first quarter of 2023, they earned $28 million of net income, generated $39 million of cash from operations, and distributed $34 million to unitholders. The CFO/EV is 15% and the distribution yield is 12.4% (both using Q1 annualized). That was at an average oil price of around $70 and an average natural gas price in the $3 range.

Texas Pacific Land, formerly a trust, is now a C-corp. They are a pure play on the Permian Basin: they own almost 900,000 surface acres, complete with mineral rights, in West Texas. That's about 1,400 square miles; almost as big as Rhode Island. The market capitalization of $10 billion is around $11,000 per acre. When we see Occidental furiously drilling away in the Permian, it is to a large degree on land owned by TPL; Oxy is the single biggest operator on their land. 

Production volumes for TPL (in BOEs) were up 0.6% for Q1 2023 versus the prior year. Importantly, this was achieved with capital expended by Occidental, Chevron, Exxon, and others, and not TPL.

Oil and gas royalties were $80 million vs $104 million, because of lower commodity prices. However, water sales were up, produced water royalties were up, and easement income was up, with the result that total revenue was $146 million vs $147 million the prior year.

Expenses were $41 million versus $23 million the prior year. The biggest issue here is legal and professional fees for the quarter of almost $17 million. There is a battle for control of TPL between the hired help management and shareholders with major share ownership. There will undoubtedly (and unfortunately) be more cash burned fighting over this immense prize. But at the same time we would not expect the legal dispute to continue forever. It is being litigated in Delaware's Court of Chancery in front of the highly astute Vice Chancellor Travis Laster, and he seems sympathetic to the shareholders.

Adding the extra legal expense as well as depreciation back for Q1 would have resulted in after-tax net income of about $100 million. That's a P/E of 25, annualized based on the most recent quarter's lower commodity prices ($75 oil and $3.60 gas). In the higher commodity price environment ($95 oil and $6 natural gas) of 2022, TPL had adjusted EBITDA of $592 million which would be a yield of 5.9% on the current enterprise value.

One thing interesting that has come out in the litigation is that TPL's management wanted to make acquisitions using stock. They thought there were assets (like Brigham Minerals, which is now owned by Sitio) that were undervalued compared to their own shares. In July 2022 when TPL made the offer to Brigham (for $1.9 billion in all-stock consideration), TPL shares were trading for around $1,700 vs $1,300 today. In November 2021, TPL also expressed an interest in buying unspecified assets from Occidental that would have involved the issuance of over $1.5 billion of stock.

It is important to note that one of the shareholders fighting TPL is Horizon Kinetics. The investment in TPL has been a centerpiece of their marketing for years. They were really upset about the idea of issuing stock to make acquisitions. But as we have seen at Dorchester, if management has a good sense of relative valuation, it can create value for shareholders by using its stock as a currency to buy things that are cheaper.

Earnings Roundup Q2 2022 ($TPL $RGLD $DMLP $MRO)

In the "What I Would Buy Instead of Tesla" post back in October 2020 (almost two years ago), we mentioned Texas Pacific Land Trust as one investment idea:

Texas Pacific Land Trust (TPL) for $3.6 billion. At $460, the market capitalization is $3.6 billion and the enterprise value is about $3.3 billion. (They have a net cash position.) They get a royalty from their land in the Permian and do not do any production themselves. No debt and royalty ownership protects against the risk of ruin in the scenario where there is "deflation first" before an inflation. In 2019, they did $318 million of net income. In the 1H of 2020, they did only $85 million (which annualizes to $170mm). It's a higher quality asset than companies that are more expensive. I think it's a better inflation hedge than precious metals. The big question to me would be whether we overpaid if there's an extended period of deflation. But at least it would be far more likely to survive than something like XOM which has 3x its EBITDA in debt.

Texas Pacific Land has subsequently converted from a trust to a corporation, and has also greatly increased in price (increased 3.6x). The market capitalization is now $12.8 billion and the enterprise value is $12.3 billion. Second quarter 2022 net income was $118.9 million, or $15.37 per share, and adjusted EBITDA was $158.3 million. First half of 2022 net income was $216.8 million, or $28.02 per share, and adjusted EBITDA was $288.1 million. So the FCF/EV yield is 4.7% (based on first half results).

From their investor presentation: only about 12% of royalty acreage is developed with 20,000 gross undeveloped locations remaining. On their acreage, operators have 2,883 wells currently on production, 207 completed (but not producing), 452 drilled but uncompleted, and 480 that have been permitted. The 1,139 additional wells will drive quite a bit of cash flow when they come online. The company estimates that their acreage has 25 billion barrels of oil equivalent (gross). At a 4.4% average royalty, that would be 1.1 billion net barrels, an enterprise value of around $11 per barrel.

Another idea that we mentioned in that post was Royal Gold:

Royal Gold (RGLD) for $7.9 billion. A great business model - streaming/royalty interests on gold mines with no debt. Net income of $200 million for the past year is expensive, but it could/should grow as more mines come into production. (They have interests in 41 producing mines and 16 in development, plus more in the pipeline.) They do about 1 transaction a year but it's lumpy - they did none from 2006-2008 or from 2016-2018.

The market capitalization has actually fallen and is now $6.7 billion. They are debt free with cash of $280 million so the enterprise value is $6.4 billion. For the second quarter of 2022 they reported revenue of $146.4 million, operating cash flow of $120.2 million, and earnings of $71.1 million. On an annualized basis, the company is trading for 23x earnings (of $284 million) and an OCF/EV yield of 7.5%.

We mentioned Dorchester Minerals in that post too:

Dorchester Minerals LP (DMLP) for $358 million. They own producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests. They have no debt. Net income for 1H 2020 of $10 million vs $28 million for 1H 2019. Prices were obviously down during the covid crash, and operators also curtailed production. They bought back some of their own units during April.

The market capitalization is now $1 billion. For the year to date 2022, they have earned $68 million and over the past two quarters (i.e. not counting January) they have distributed $65 million to unit holders. That is a distribution yield of 13% on the current market capitalization. See our past posts, "Is Dorchester Minerals LP Just a Depleting Asset?" and "Dorchester Minerals LP Retrospective".

We mentioned Marathon Oil Corp in a blog post in May of this year:

Marathon is an independent E&P company, based in Houston, with operations in the Eagle Ford, Bakken, STACK/SCOOP and Permian. It's a bit smaller than our Canadian oil majors - the market capitalization (at $27) is $18 billion and the enterprise value is $21 billion. [T]hey repurchased 3% of outstanding shares in one quarter. They're trading at 6 times annualized, adjusted net income, and the FCF/EV yield based on guidance for 2022 is 21%.

The market capitalization is down to $15 billion now and the enterprise value is $18.3 billion. They reported second quarter 2022 net income of $966 million, operating cash flow of $1,678 million, and free cash flow of $1,323 million. Their projection is $4.5 billion of 2022 free cash flow, assuming $100/bbl WTI and $6/MMBtu Henry Hub. (A $1/bbl change in WTI is ~$60MM of annual CFO, which would imply $3.9 billion at $90 WTI.) 

So they are now trading for less than 4 times annualized net income, and the annualized FCF/EV yield is currently 29%, and is likely still north of 20% at $90 oil based on their projections.

They have returned over $1.7 billion of capital to shareholders year-to-date. Over the past 10 months (since October 2021) they have reduced share count by 15%, and year-to-date they have reduced it by 7.3%. 

A great comment from the conference call:

We're trading at a free cash flow yield more than 25%, one of the lowest trading multiples in the entire S&P 500. We continue to believe that our equity is fundamentally mispriced. And as long as that's the case, we'll aggressively repurchase our stock. As I've said before, it's the best acquisition we can make.

We notice that their sales volumes are down 1% year over year from 348k boe/d to 343k. In general, oil companies are responding to their distressed valuations by using their cash flows to buy back stock and pay dividends, not grow production.

Is Dorchester Minerals LP Just a Depleting Asset?

The average price per barrel of oil sold by Dorchester Minerals was $59 last year. Crude oil spent almost all of 2006 above $60. At year-end 2006, Dorchester's proved reserves were 3.8 million barrels of oil and 66 million mcf of natural gas, with 28 million units of the partnership outstanding. At the end of 2021, reserves were 9.2 million barrels of oil and 38 million mcf of natural gas, with 37 million units outstanding.

So the oil reserve per unit has grown but the natural gas reserve per unit has shrunk. But keep in mind that the price of natural gas was over $6 per mcf in 2006 and was under $3 last year, and that would decrease the reported natural gas reserves for 2021, other things being equal. (Normalizing for this is why we pick a date when the oil price was roughly the same, because reserve engineers give a higher estimate of recoverable hydrocarbon quantities when commodity prices are higher.)

Also, if you use a 20:1 ratio for the relative economic value of oil and natural gas (instead of the 6:1 energetic equivalence), then you have 7.1 million barrels of oil equivalent (boe) in 2006 and 11.1 million boe now. That is 0.25 boe/unit in 2006 and 0.3 boe/unit now. From 2007-2021, Dorchester paid $26.12 per unit in distributions, greater than today's price per unit, and managed to slightly grow the proved reserves of oil (equivalent) per unit.

If Dorchester were just a depleting asset, their sales of oil would result in a finite pool of oil shrinking over time. Since the reserves are growing, it means one or both of two things: the proved reserve metric understates the total amount of ultimately recoverable oil in their land, and/or the acquisition of new land using partnership units is having an accretive effect. But either way, the partnership was not just a "depleting asset" over the past 15 years.

So how would an investor have done owning Dorchester units over the past fifteen years, starting at the beginning of 2007? One interesting calculation to make is to look at the outcome if an investor had reinvested the quarterly distributions in more units of the partnership.

It turns out that the points in time where the dividend yield is high (when the prices of DMLP and/or oil are distressed) are very powerful in the compounding effect of distribution reinvestment. The reinvestment of the November 3, 2008 quarterly distribution grows your stake by 4.3%. The reinvestment on May 14, 2020 grows your stake by 4.7%.

The result of the compounding is that one partnership unit purchased in January 2007 grows to 3.5 units with dividend reinvestment over the 15 year period. Those 3.5 shares are worth $83.34 now on a starting investment of $21.50. That is an IRR of 9.35%.

This is particularly impressive since the valuation has fallen (the Dorchester distribution yield has increased) from 8.55% (annualized) at the start in 2007 to 10.8% (annualized) today. If the yield today matched what it was at the beginning of 2007, the price of a Dorchester unit would be $29.90 and the IRR would have been 11%.

Note that the time periods when Dorchester is richly valued actually lower the IRR that an investor following the long-term distribution reinvestment strategy earns. As an example, the highest price that an investor would have paid during the fifteen year period for units was $34.16 in July 2014, which was only a 5.6% yield on that quarterly distribution (annualized). If the units had instead been trading at the same yield as today, the unit price would have been $18.15, and an investor would have been able to buy more units, and so the IRR would have increased slightly to 9.4%.

These calculations seems like a good reality check of Dorchester's model of accretive land acquisitions using partnership units. They would also tend to show how the market does not ascribe enough value to the non-producing reserves of non-operating mineral owners.

Non-operating mineral investments (e.g. royalties) seem to trounce operating (exploration and production) investments. (The S&P Oil E&P ETF is down about 30% since 2006, not counting dividends.) This seems to come from poor capital allocation as a result of principal-agent conflict in the oil and gas business.

Dorchester Minerals LP Retrospective (2007 vs 2020)

We mentioned Dorchester Minerals in our October 2020 post, "What I Would Buy Instead of Tesla". This is a publicly-traded limited partnership that owns producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests in oil and gas. At that point the market cap was $358 million (with no debt) and net income for 1H 2020 had been $10 million vs $28 million for 1H 2019.

The stock is up almost 50% since that post - but oil is up 50% too (currently $60/bbl for WTI). The market cap is now half a billion dollars. They distributed $48.2 million to limited partners in 2020. Their average selling prices of oil were high $40s/bbl and for natural gas a bit below $2/mcf.

I looked at an old research report and saw that Dorchester's revenue in 2006/2007 was ~$75 million and ~$65 million with natural gas @ $7 and crude oil in the $60s/bbl. For 2019 and 2020 it was ~$79 million and ~$47 million. Kurt Wulff had a couple interesting observations in his 2007 report:

Normally we would expect a volume decline of about 11% a year for a reserve life index of 9 years. Instead, DMLP’s decline rate is hardly evident despite distributing all of cash flow to unitholders (see graphic from management presentation). The performance enhances the partnership’s status as the oldest and highest quality oil and gas production Master Limited Partnership (MLP) that we know at a time of renewed interest in the organizational format.

The main tax complication of DMLP is that taxable holders must report distributions as partnership income including the separate items furnished in what is known as a K-1 form. For new purchasers, most or all of income in the early years would be sheltered by cost depletion. For depletion purposes conservative reporting of reserves is an advantage because the implied higher depletion means earlier tax shelter.

The share count has increased by about 25% (acquisitions with stock are how they replace reserves) since 2007, but the share price is currently 38% lower, so the market cap is 25% lower. Revenue/mcap back 15 years ago was about 11% and now it's about 14% with crude oil slightly lower and natural gas way lower. Interestingly, at the time the report was written, DMLP was trading for ~$23 and from 2007-2020 it paid $26 in distributions. Currently trading for $14.

Dorchester's PV-10 of reserves at year-end 2020 was only $137 million. However, the PV-10 is based on the 12 month average oil and gas prices which were depressed in 2020. (Oil was $32.43 and gas was $1.)

Remember the most important quote from the book The Shipping Man:

"[H]e who is the most bullish on the market, or has the lowest cost of capital, or has some other personal motivation for doing a deal, or ideally all three, wins the ship. Everyone else does nothing but talk about the very good and rational reasons they have for not doing deals. The simple fact is that you must take a view on the market."

Dorchester is at a big premium to a reserve value - at much lower hydrocarbon prices. To buy it, I think you have to have the view that, while electric vehicle sales may continue to slowly grow, the worldwide ICE vehicle fleet is going to keep growing too. Plus petroleum is irreplaceable for diesel and kerosene prime movers. 

The result if you believe those premises is that oil (and many other commodities) will need a bull market here in order to recruit commodity investors to expand production again. 

Remember that U.S. explorers and producers lost an incredible amount of money over the past decade. They burned their debt and equity investors, and discipline will be restored by investors who force them to "accept life in a declining industry, slash costs and ramp up returns of capital to shareholders".

What I Would Buy Instead of Tesla

When I started this thought experiment, Tesla had a market capitalization of $460 billion. It traded around 300 million shares (around $140 billion in value!) at that valuation level. But it has declined and is now a ~$400 billion market cap. So with ~$400 billion in hand, here is the shopping list of what I would rather buy. We can see how this alternative portfolio does over time.

• Toyota Motor Corporation (TM) for $185 billion. Sell the worst automaker and be long the best. Earnings were $17 billion last year. Peak was $23 billion in 2018. Average from 2010-2019 was $13 billion annual. (They made money every year of the decade.) With a market capitalization of ~$185B that's 14x if we look at the ten year average like we do with the S&P as a whole. (Or, only 11x last year's earnings.) Pretty amazing that their net income is close to Tesla's entire revenue (maybe 2/3 of it), but Tesla's market capitalization is 2x higher. TM dividend yield is 3%.
  
• The two U.S. based tobacco companies, Altria (MO) and Phillip Morris (PM) for $72 billion and $117 billion. PM earned $8 billion last year and MO earned $2.3 billion (excluding the Juul write-down). That's $189 billion which is the same market capitalization as Toyota and 47% of Tesla. The P/E of the tobacco companies is about equal to the price-to-revenue of Tesla!
• Valero Energy Corporation (VLO) for $16.3 billion. The second largest oil refiner in the U.S. with 2.2 million barrels/d of capacity. They earned an average of $3 billion per year over 2018 and 2019. The hope here is that the oil refining industry will follow the path of the tobacco industry - a product still in demand but with concerns about the future that discourage entrants to the industry and additional capacity from being added. In this case, the electric vehicle mania is leading people to believe that gasoline demand is going away.
  
• Royal Gold (RGLD) for $7.9 billion. A great business model - streaming/royalty interests on gold mines with no debt. Net income of $200 million for the past year is expensive, but it could/should grow as more mines come into production. (They have interests in 41 producing mines and 16 in development, plus more in the pipeline.) They do about 1 transaction a year but it's lumpy - they did none from 2006-2008 or from 2016-2018.
  
• Texas Pacific Land Trust (TPL) for $3.6 billion. At $460, the market capitalization is $3.6 billion and the enterprise value is about $3.3 billion. (They have a net cash position.) They get a royalty from their land in the Permian and do not do any production themselves. No debt and royalty ownership protects against the risk of ruin in the scenario where there is "deflation first" before an inflation. In 2019, they did $318 million of net income. In the 1H of 2020, they did only $85 million (which annualizes to $170mm). It's a higher quality asset than companies that are more expensive. I think it's a better inflation hedge than precious metals. The big question to me would be whether we overpaid if there's an extended period of deflation. But at least it would be far more likely to survive than something like XOM which has 3x its EBITDA in debt.
  
• AerCap Holdings N.V. (AER) for $3.3 billion. They are an aircraft lessor. This is a covid nothingburger play. It's high risk but high potential reward. It is highly leveraged: they have $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. Current market cap is $3.2 billion, so very low P/B. The key question is whether the aircraft are worth their carrying values. This was trading for ~90% of book until covid hit. If air travel was going to take a multi-year hit, it would be conceivable that the airline lessees would go bankrupt, reject their leases, and the lessor would be stuck with planes that were worth much less than expected. But, for whatever reason, herd immunity seems to have kicked in far earlier than expected.The Boeing MAX problem is complicated, but if those planes are scrapped it would be bullish for the lessors because it would extend the economic life (and increase the residual value) of existing planes. They earned $246 million in Q2 2020 vs $331 million the prior year. So that is a double digit return on equity. And it makes the P/E about 3x! If lots of airlines go bankrupt, this is a zero. If things return to normal, it's worth close to triple.
  
• Dorchester Minerals LP (DMLP) for $358 million. They own producing and non-producing mineral, royalty, overriding royalty, net profits and leasehold interests. They have no debt. Net income for 1H 2020 of $10 million vs $28 million for 1H 2019. Prices were obviously down during the covid crash, and operators also curtailed production. They bought back some of their own units during April.

So instead of Tesla's $25 billion in annual revenue and no profit (in fact, a cash burn of maybe $5 billion a year), you get revenue of about $400 billion (1x revenue, how about that) and net income of maybe $30 billion a year and distributable (as opposed to reinvested) income that's greater than Tesla's revenue.