You Cannot Grow an Acre

Right now, there are nine companies in the S&P 500 with market capitalizations over one trillion dollars: NVDA, AAPL, GOOGL, MSFT, AMZN, AVGO, TSLA, META, and MU. (SpaceX has not been added to the index.) These nine trade for 32 times earnings and throw off a 1.5 percent free-cash-flow yield on enterprise value. (All free-cash-flow figures here are net of stock-based compensation.)

We were wondering whether you could hide from this overvaluation elsewhere in the S&P index. The first, obvious thought would be to skip the top nine and own the other 491. They trade for 27 times earnings and throw off 2.6 percent on the same basis. Cheaper, but still expensive.

So we looked at various ways of slicing up SPY. We screened out every company with meaningful stock-based compensation, on the theory that the companies paying employees in stock also have the most overvalued shares. (This line of thought actually gave us a good Apple entry point in April 2024.) The low-SBC survivors yielded 2.1 percent, worse than the index, because the screen mostly caught the bid-up defensive complex: utilities, staples, telecom, the names people own for safety. We tried another screen, keeping only the companies that have shrunk their share count over the past five years. That group was the best of the lot at 3.2 percent, but it is not a number worth writing home about.

Put the four cuts together and the ladder of free-cash-flow yields runs from 1.5 to 3.2 percent of enterprise value. None of them are "cheap." Unfortunately, the 491 are not a bargain hiding behind the nine. They are slightly lower-quality businesses, on average, at a quality-adjusted price that is roughly the same. There is no secret cheap slice in the index, because the index as a whole is pretty expensive on the cash that actually reaches an owner.

One option would be to sit in cash and bonds and wait. If the correction doesn't come in a year, you'll be rooting for the world to end. Also, the U.S. federal debt to GDP and the deficit are both high enough that the government will be sorely tempted to inflate its way out, and a government that wants inflation usually gets it. In that world, cash and bonds hand you a negative real return after tax. 

That is the box. Stocks are expensive, but bonds are expensive too. We need a "third way."

There are two ways for a good business to slip through the cracks and be excluded from the passive, indexation bid. One is structure: a master limited partnership or other pass-through cannot go into the index, because the funds that track it cannot hold those companies without tax problems. The other is size: a company too small to move the index gets no meaningful flows. Either way the price is set by people doing valuation arithmetic rather than by a machine that has to buy. These have been called "orphaned securities."

Take Enterprise Products Partners. EPD is a partnership, so the index cannot own it, trades for 11x ttm EBITDA, which allows a 5.9% dividend that is largely tax deferred to be well covered. That is several times the owner yield of the index, for a toll road whose revenue is largely contracted. The standard objection is obsolescence: pipelines are a melting ice cube in an electrifying world. But a large share of EPD's business is natural gas liquids and petrochemical feedstock, and petrochemicals are a secularly growing market, not a shrinking one. Demand for plastics and chemicals rises with population and income whether or not anyone buys another gallon of gasoline. The terminal-value fear is priced as if the whole franchise rides on crude oil. It does not.

Or take a land base. Rayonier (RYN) owns timberland and trades below what the dirt would fetch in the private market. It is a real-estate trust, so in theory it could be indexed, but it is far too small ($6 billion market cap) for the popular indices. Natural Resource Partners owns mineral and royalty land and is orphaned twice over, a partnership and tiny (only $1.3 billion market cap). Neither one has factories to run or fashions to chase. They own real assets that throw off cash, with no large operating or capital budget to eat into the return. In a world where the currency is being diluted, a perpetual claim on an acre or a ton is exactly the thing to own. 

Something falls out of this search that we did not go looking for. The orphans are close to the perfect assets for a great inflation. In many cases they are inflation-protected bonds wearing equity clothing, and  the index-ignored corner of the market is not where you would expect to find them.

It is not a coincidence. A land or royalty asset returns its cash because there is nothing to reinvest in. You cannot grow an acre. That single fact is why it is the right thing to own in an inflation: a real claim paying a real coupon, with no plant or equipment whose replacement cost keeps climbing. And it is the same fact that orphans it. Cash that has nowhere to compound has no reason to sit inside a corporation paying the double tax, so the asset is wrapped in a partnership. An asset that never reinvests never swells into something the index notices, so it stays small. Return your cash and you are orphaned twice, by structure and by size.

So the index runs an inadvertent filter. It bids up the businesses that retain and reinvest, which is most of what is expensive, and it leaves alone the ones that pay everything out, which is where the yield is. That is the bargain. You collect a real yield on the assets best built for the world the deficits are inviting, and you collect it precisely because the largest pool of money in the market is forbidden to bid against you. The only thing asked of you is the willingness to buy what no one is forced to buy, and to hold it on the days when no one is forced to buy it back.

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.

Earnings Notes V (Q4 2023)

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

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

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

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

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

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

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

So the shares are pricey, but growth is good.

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

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

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

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

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

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

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

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

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

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

Earnings Notes (Q4 2023)

Freeport-McMoRan Inc. (FCX)
For Q4 2023, Freeport reported operating cash flow of $1.32 billion and capital expenditures of $1.36 billion, giving a free cash flow for the quarter of negative $42 million. Their quarterly copper production of 1.1 billion pounds was up 2% y/y, at an average realized price of $3.81 per pound. Their guidance for 2024 free cash flow is $1.2 billion (at $3.75 copper), which would be only a 2% yield on the current enterprise value of $57 billion.

FCX’s consolidated operating cash flows are estimated to approximate $5.8 billion (including $0.1 billion of working capital and other sources) for the year 2024, based on current sales volume and cost estimates, and assuming average prices of $3.75 per pound of copper, $2,000 per ounce of gold and $19.00 per pound of molybdenum. The impact of price changes on operating cash flows for the year 2024 would approximate $400 million for each $0.10 per pound change in the average price of copper, $180 million for each $100 per ounce change in the average price of gold and $120 million for each $2 per pound change in the average price of molybdenum.

Capital expenditures are expected to approximate $4.6 billion for the year 2024 (including $2.3 billion for major mining projects and $1.0 billion for the Indonesia smelter projects). Projected capital expenditures for major mining projects include $1.1 billion for planned projects primarily associated with underground mine development in the Grasberg minerals district and potential expansion projects in North America, and $1.2 billion for discretionary growth projects.

FCX’s financial policy is aligned with its strategic objectives of maintaining a strong balance sheet, providing cash returns to shareholders and advancing opportunities for future growth. The policy includes a base dividend and a performance-based payout framework, whereby up to 50% of available cash flows generated after planned capital spending and distributions to noncontrolling interests would be allocated to shareholder returns and the balance to debt reduction and investments in value enhancing growth projects, subject to FCX maintaining its net debt at a level not to exceed the net debt target of $3.0 billion to $4.0 billion (excluding net project debt for the Indonesia smelter projects).

They are quite leveraged to the copper price as you can see: $400 million additional operating cash flow for each ten cent increment in copper price. Yet even $4.75 copper would only give an additional $4 billion of operating cash flow which would be kind of lackluster on the $58 billion EV. They are crazy to be spending money on growth! They should demand contracts in hand for $6/lb before they spend a penny more on capex.

Barrick Gold Corp (GOLD)
For Q4 2023, Barrick reported cash from operations of $1 billion and capital expenditures of $861 million, giving a free cash flow for the quarter of only $136 million on an enterprise value of $25 billion. Gold production was up 1% y/y in Q4. Their cash cost was $982 per oz and their "all-in sustaining cost" was $1,364/oz. 

Like other commodity producers and miners, they are plowing it into capex: They produced 4.05 million ounces of gold in 2023, down from 4.1 million in 2022 and closer to 5 million in 2020. Cash cost has risen from $700/oz in 2020 to $960/oz last year. Operating cash flow for 2020-2023 (four years) totaled $17 billion but they spent $11 billion on capex. So only $6 billion of cumulative free cash flow ($1.5 billion per year) and production is in decline!

Remember that to recover an ounce of gold they have to process 28 tons of ore, and for every ton of ore, they have to also move 6 tons of waste.

Comstock Resources Inc (CRK)
Comstock produces almost 100% natural gas and sells it for the pittance of $2.50/mcf. They reported negative free cash flow for Q4 and FY 2023 yet they grew production 6% y/y. Although they may get some religion about lighting cash on fire now that natural gas is even lower:

"In response to weak natural gas prices, Comstock plans to suspend its quarterly dividend until natural gas prices improve. In addition, the Company plans to reduce the number of operating drilling rigs it is running from seven to five. Two of the five drilling rigs will continue to be deployed in the Company's Western Haynesville play. As a result, Comstock plans to spend approximately $750 million to $850 million in 2024 on its development and exploration projects to drill 46 (35.9 net) operated horizontal wells and to turn 44 (38.2 net) operated wells to sales in 2024. Comstock expects to spend $125 million to $150 million on its Western Haynesville midstream system, which will be funded by its midstream partnership."

Comstock has $3.4 billion of net liabilities and a $2 billion market cap. It is conceivable that the equity here goes to zero.

PrairieSky Royalty Ltd. (PREKF)
PSK reported revenue for 2023 of $380 million, generated $283 million of funds from operations (74% margin). They spend 13% of revenue on income tax, 9% on G&A expense, 3.4% on finance expense (interest), and about 1% each on production taxes and on exploration and evaluation. The $283 million of funds from operations is a 7% shareholder yield on the $4 billion market capitalization. (Based on Q4 would be an 8% yield.)

Horizon Kinetics wrote about PSK in the annual letter for their Inflation Beneficiaries (INFL) ETF:

"With today’s temporarily depressed energy prices, PrairieSky should be able to generate C$1.50 in FFO/share, which equates to a 7.5% yield. This could be viewed as a “base case” minimum return—assuming no improvement in energy prices, production volumes, or Canadian price differentials. Assuming modest improvement here, namely with pricing and volumes, it is reasonable to expect more than C$2.00/share of FFO, or a 10% yield. If prices rebound more fully, and volume grows even moderately, FFO could exceed C$2.50 share, nearly a 12% yield."

One big hope for PSK would be more export of natural gas from Canada. Their share of natural gas production for the quarter was 5.4 million Mcf of gas which was sold for only $2.19 per Mcf.

Intercontinental Exchange Inc. (ICE)
For the full-year 2023, ICE earned $3.05 billion of free cash flow on $8 billion of total revenue (less transaction-based expenses) for a royalty-like 38% free cash flow margin. The current market capitalization is $78 billion the enterprise value is around $100 billion, so at a 3% free cash flow yield, it is not cheap. Something else to note was FCF was flat from 2022 to 2023. Their M&A goals: "deepen moats, gain intellectual property, increase customer wallet-share".

Peabody Energy Corp (BTU)
The market capitalization of Peabody is now $3.35 billion versus $3.3 billion when we wrote about them last quarter. (It was $4 billion when we wrote about them in August 2022.) Total liabilities less current assets are now $335 million, so we would put the enterprise value at $3.7 billion now. For the fourth quarter of 2023, Peabody's adjusted EBITDA was $345 million, up from $270 million in the third quarter. Adjusted EBITDA for the full year 2023 was $1.4 billion which is about equal to the Q4 annualized figure. That puts the EV/EBITDA at 2.7x. Operating cash flow for the quarter was $282 million and $1,036 million for the year. Capital expenditures were $158 million for the quarter and $348 million for the year. So the free cash flow yield on enterprise value is 13% based on the most recent quarter or 19% for the full year.

Thoughts from Coal Trader: "If executed successfully, the Centurion and Shoal Creek organic investments should deliver extremely high IRR's and return significant free cash flow to Peabody in the coming years. Peabody’s team also found a way to further enhance the Centurion investment by acquiring the adjacent Wards Well deposit. These investments will pivot the company more towards the met market where the long term fundamentals are far more favorable compared to thermal. The long term prospects of the company have significantly improved with Centurion being the flagship of their portfolio in the years ahead. The average realizations of the met segment will improve significantly with the addition of Shoal Creek and eventually Centurion. This is probably something that will be overlooked by many analysts, but I believe the 'relativities' in the metallurgical coal market are something the sector if going to have to contend with for far longer than most believe. That is to say, the price spreads between high-quality coking coals relative to lower-quality coking coals may be here to stay..."

Seems cheap and everything, but would rather own coal royalties at current valuations.

Natural Resource Partners, L.P. (NRP)
No year-end results yet, but NRP put out an 8-K in January about a warrant settlement:

On January 29, 2024 (the "exercise date"), holders of Natural Resource Partners L.P.'s (the "Partnership's") warrants to purchase common units ("warrants") exercised 462,165 warrants with a strike price of $34.00. On January 31, 2024, the Partnership settled the warrants on a net basis with $10 million in cash and 198,767 common units. The 15-day VWAP ending on the business day prior to the exercise date was $97.62. Of the originally issued 4.0 million warrants, 1.08 million warrants with an exercise price of $34.00 remain outstanding.

As of the September 30, 2023 quarterly results, NRP had 2,190,000 warrants outstanding. An October purchase (8-K) brought them down to 1.54 million warrants. We had been wondering what they did with their Q4 cash - we won't know for sure for another few weeks until they report earnings, although they did aggressively tackle the warrants. Wonder if they were redeeming the preferred (12% liability) during the fourth quarter?

Exxon Mobil Corp (XOM)
XOM reported cash from operations of $13.7 billion and free cash flow of $8 billion (58% of CFO) for the fourth quarter of 2023. The market capitalization is $400 billion and the enterprise value is $420 billion so the free cash flow yield is 7.6% at current oil (and LNG) price. For the full year of 2023, shareholder distributions were $32.4 billion ($14.9 billion of dividends, and $17.4 billion of share repurchases) which is a 8% shareholder yield.

Imperial Oil Ltd (IMO)
We mentioned IMO last week. Production in the fourth quarter was up 8.5% versus the prior year, while capex for the quarter was down 34% versus the prior year. (See results. Full year capex was down 2% from 2022.) Free cash flow for the quarter was $667 million, which is about an 8.6% yield on the enterprise value. Imperial is a share cannibal. During 2023, they shrank the share count by 8.3%. 

Enbridge Inc (ENB)
Enbridge shares have been really weak, under-performing Enterprise Products, for example. (Also compare with EPD, NTG, and FEI over the past three years.) It's a $70 billion market capitalization company yielding 7.9% (dividend) which is quite high compared to what it has yielded historically. And it is a C-corp so you don't even get the annoying Schedule K-1 that you do from other midstream companies. From the Q4 call:

2023 showcased the predictability of our business amid continued geopolitical instability, persistent inflation and rising interest rates. This is as a result of the 98% of Enbridge's earnings being generated from either cost of service or take-or-pay contract assets. Our debt portfolio is less than 10% exposed to floating rate volatility. Our customer base is over 95% investment grade, and 80% of our EBITDA is earned from assets with protection against inflation. We are rated BBB+ by all rating agencies and remain committed to our long-held leverage target of 4.5x to 5x.

Half of the EBITDA is from their liquids pipelines. They've got the Mainline pipeline from the western Canada oil sands and then the Line 5 that takes it 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.")

A quarter of their EBITDA is gas transmission. They carry from western Canada to export, also to eastern U.S. Connects PA gas to 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 (utility). ("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.")

Allison Transmission Holdings Inc (ALSN)
We keep noticing ALSN on the daily all-time highs list. Per their website, Allison is the world’s largest manufacturer of fully automatic transmissions and hybrid propulsion systems for commercial-duty vehicles. 

On fourth quarter sales of $775 million, they did $170 million of net income and $186 million of adjusted free cash flow (24% free cash flow margin). On full year sales of $3 billion, they did $659 million of adjusted free cash flow (22% FCF margin). Revenue for the year was up 10% for 2022 and adjusted free cash flow was up 37%. They repurchasing $260 million of shares during 2023 (6 percent of outstanding). The market capitalization is $6.25 billion and the enterprise value is $8 billion, so the FCF yield is 8%.

Penske Automotive Group, Inc. (PAG)
Highlight from fourth quarter results:

For the three months ended December 31, 2023, total new and used units delivered increased 8% to nearly 117,400, and total retail automotive revenue increased 5% to $6.2 billion. Same-store new and used units delivered increased 9% to nearly 116,700, and same-store revenue increased 4%, including a 7% increase in service and parts revenue. Total retail automotive gross profit decreased 1% to $1.0 billion, including a 1% decrease on a same-store basis. Same-store service and parts gross profit increased 7%.

Revenue for the fourth quarter was $7.3 billion, gross profit was $1.2 billion, EBITDA was $357 million, and capital expenditures were $103 million. The current market capitalization is $10 billion. Net income was $190 million for the quarter and $1 billion for the full year.

AutoNation Inc (AN)
Highlight from fourth quarter results:

New Vehicle Gross Profit - Decreased $102 million reflecting gross profit per vehicle retailed of $3,653, compared to $5,633 a year ago, partially offset by an 8% increase in unit sales. Used Vehicle Gross Profit - Decreased $27 million reflecting gross profit per vehicle retailed of $1,455, compared to $1,847 a year ago and a 4% decrease in unit sales. After-Sales Gross Profit - $540 million, an increase of $61 million or 13% from a year ago.

Revenue for the fourth quarter was $6.8 billion, gross profit was $1.2 billion, and net income was $216 million. During the quarter, AutoNation repurchased 1.15 million shares of common stock (3% of shares outstanding at start of quarter) for an aggregate purchase price of $151 million. The current market capitalization is $6 billion. Net income was $1 billion for the full year.

Enterprise Products Partners LP (EPD)
Highlights from fourth quarter results:

Enterprise reported net income attributable to common unitholders of $5.5 billion, or $2.52 per common unit on a fully diluted basis, for 2023 compared to $5.5 billion, or $2.50 per common unit on a fully diluted basis, for 2022. Operational DCF was $7.5 billion for 2023 compared to $7.6 billion for 2022. DCF provided 1.7 times coverage of the distributions declared with respect to 2023. Enterprise retained $3.2 billion of DCF in 2023 to reinvest in the partnership, repurchase partnership common units, and reduce debt. Distributions declared with regard to 2023 increased 5.3 percent compared to those declared for 2022 and marked Enterprise’s 25^th consecutive year of distribution growth.

Steady as she goes. The real question will be, do the growth investments pay off? If so, earnings will rise and capex will go down, resulting in a lot more cash for distributions. (As we pointed out in October, the free cash flow per unit of Enterprise has grown substantially (3.3x) over the past five years.)

Altria, Inc (MO)
Highlight from fourth quarter results:

Smokeable products segment reported domestic cigarette shipment volume decreased 7.6%, primarily driven by the industry’s decline rate (impacted by macroeconomic pressures on ATC disposable income and the growth of illicit e-vapor products) and retail share losses, partially offset by trade inventory movements. When adjusted for trade inventory movements, smokeable products segment domestic cigarette shipment volume decreased by an estimated 9%.

Cigarettes volumes down 9%. Cigarette revenues down 2.4% y/y net of excise tax. They are not able to raise price of pack enough to maintain flat revenue. Operating income from cigarettes down 1.3% y/y.

Chipotle (CMG)
Highlights from fourth quarter results:

Total revenue increased 15.4% to $2.5 billion. Comparable restaurant sales increased 8.4%. Operating margin was 14.4%, an increase from 13.6%. Restaurant level operating margin was 25.4%, an increase of 140 basis points.

Market capitalization is $70 billion, they earned $282 million in Q4 on sales of $2.5 billion. Sixty times earnings is steep! Net income for fourth quarter was up 11% year-over-year.

Marathon Petroleum (MPC)
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, each with about 2 million barrels per day. Highlight from fourth quarter results:

“In 2023, the business generated $14.1 billion of net cash from operations, driven by strong operational performance and commercial execution,” said Chief Executive Officer Michael J. Hennigan. “This enabled the return of $12.8 billion of capital to shareholders. We believe MPC is positioned to generate strong through-cycle cash flow with the ability to deliver superior returns to our shareholders.”

That's on a market capitalization of $63 billion. 

Marriott International, Inc. (MAR)
We wrote about Marriott in November as a royalty-like business. Highlights from Q4 results:

Adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) totaled $1,197 million in the 2023 fourth quarter, a 10 percent increase compared to fourth quarter 2022 adjusted EBITDA of $1,090 million. The company repurchased 4.7 million shares of common stock in the 2023 fourth quarter for $965 million. For full year 2023, Marriott repurchased 21.5 million shares for $3.9 billion. 

In 2024, we expect another year of solid growth and significant shareholder returns. With normalizing RevPAR growth around the world, we anticipate a worldwide full year RevPAR increase of 3 to 5 percent and net rooms growth of 5.5 to 6 percent. We expect this should yield adjusted EBITDA of approximately $4.9 billion to $5.0 billion for the year and enable us to return $4.1 billion to $4.3 billion to shareholders after factoring in $500 million to purchase the Sheraton Grand Chicago.

That would be quite a nice shareholder return on the current market capitalization of $69 billion.

Warrior Met Coal Inc. (HCC)
The market capitalization of Warrior is now $3.2 billion. Their current assets net of all liabilities (ignoring deferred income taxes) are $660 million, so the enterprise value is $2.5 billion. For the fourth quarter of 2023 (release), Warrior's adjusted EBITDA was $164 million, up from $148 million the prior year. For the full year (2023), adjusted EBITDA was $700 million, down from $1 billion in 2022. That puts the EV/EBITDA at 3.8x using the fourth quarter (annualized) or 3.6x using the entire year.

They sold 1.53 million tons versus 1.45 million the prior year. The average price was $234/t and the average cash cost was $121/t. Cash from operations was $245 million for the quarter and they spent $182 million on capital expenditures. 

For the full year 2023, $700 million of cash from operations, but they spent $525 million on capex. No share repurchases, even though the stock was trading for 1.2x EBITDA earlier last year.

The price per ton of met coal averaged $219 in 2023 vs $304 in 2022. It seems insane to invest so much (~$1 billion for the new Blue Creek mine) in producing more of a commodity that does not have a firm price. There are some good pictures of it in the new investor presentation though.

Coal Trader tweeted: "It seems like they’re really struggling to move this coal. Maybe the transition to more HVA is hurting more than I figured, or maybe the spreads in the Atlantic basin are making it more difficult than I assumed. Prices in Q4 were terrible, and inventories increased A LOT."

That's so brutal. There really shouldn't be any question of being able to move the product if you are expanding production.

Occidental Petroleum Corporation (OXY)
From Q4 results, Occidental's oil volume (total U.S.) was down 2.2% in the fourth quarter (year/year). Their total U.S. production in BOEs though was up 1.3%. In the Permian specifically, oil was flat and natural gas was up 14%. The wells are getting gassier!

Total oil and gas capex in the second half of the year was up 4.5% versus the second half of 2022, but in the Permian was actually down 20%. (They really slashed Permian capex in Q4... in Q3 it was up 8% y/y so maybe we'll see volumes fall off more in Q1 2024.)

Their operating cash flow in Q4 was $2.5 billion with capex of $1.4 billion, giving free cash flow of only $1.1 billion. Market cap is $50 billion and the enterprise value is $80 billion. So EV/FCF is only 5.5%.

Truly no idea what Buffett sees here. 

 

Royal Gold Inc. (RGLD)
Reported results: cash from operations was $101 million for Q4 2023 and $416 million for the full year 2023, virtually the same as Q4 2022 and the FY 2022. There were no capital expenditures in Q4 and only $2.7 million for the full year. They spent $325 million on debt repayment and $100 million on dividends. So the shareholder yield is 5.8% on the $7 billion market capitalization. (Net debt is down to $151 million.)

Kraft Heinz Company (KHC)
Noticing from Q4 results that Kraft's North American volumes were down 5.5% despite 2.5% price increase, resulting in fourth quarter sales down 3%. (They're calling this "headwinds that were driven by ongoing consumer pressure".)

 

The market capitalization is $42 billion and the enterprise value $63 billion. Cash from operations for the full year was $4 billion; surprisingly they actually have $1 billion of capital expenditures, so free cash flow is only $3 billion. They spent $191 million on debt repayment, $2 billion on dividends, and $455 million on share repurchases.

Review of Material World: The Six Raw Materials That Shape Modern Civilization

Ed Conway is a journalist who has gotten interested, in Vaclav Smil fashion, in the materials that underlie our civilization and world. Hence his new book, just published in November: Material World. While Vaclav Smil has argued that the "four pillars of modern civilization" are cement, steel, plastics, and ammonia, Conway focuses on six raw materials that he thinks are underrated: sand, salt, iron, copper, oil, and lithium.

It's not entirely clear that "underrated" is Conway's organizing concept for choosing these six, and one thing we quickly see is that he is not as logically organized, thorough, or data driven as Smil. But his argument seems to be that these are underrated and overlooked since on the one hand they are so important, but on the other hand they are cheap relative to the value they create (copper is under $4 per pound), they are used in enormous volumes (big, bulky, yet overlooked flows), and because they are bulky, producing them requires displacing even more enormous amounts of overburden and ore. Tearing down mountains, and that sort of thing.

Another point that Conway raises is that these raw materials less fungible than the casual observer might realize. Sand, for example, comes in different varieties with important differences in grain size and shape and mineral composition. The sand that is needed for making high quality optical glass is different than the sand that is acceptable for use in making concrete. Sand is also turned into silicon for making semiconductors, but that has more to do with the refining and ingot producing process than the raw ingredient sourcing. If you have ever thought, "how can sand be rare, or important?," the answer is in these idiosyncrasies that make the different types non-fungible.

The iron chapters got our attention because we have been thinking quite a bit about iron, steel, and metallurgical coal. Conway observes that iron accounts for 95% of the metal that we produce and use, and that it is "so fundamental to our lives that it is just as good a measure of living standards as GDP." The most developed countries in the world have an installed base of steel of about 15 tons per capita. (As he puts it, "iron is the bones of our society.") The per capita figure for China is only about half as much. His back-of-the-envelope calculation is that if everyone in the world were to come up to the developed country amount of steel per capita, it would be an additional 144 billion tons - four times the amount that has been already produced in human history.

We had already been thinking lately that, if the GDP per capita of India keeps growing then their use of steel per capita (and oil too, of course) should as well. India is already the largest importer of U.S. metallurgical coal for making steel. India is the second largest steel producer but its per capita consumption and per capital installed base lag far behind the rest of the world. The straightest path forward would be for steel production to continue to grow, resulting in increasing demand for imported metallurgical coal. (Every ton of steel produced requires almost a ton of metallurgical coal to go in the blast furnace alongside the iron ore.)

The writer "Coal Trader" argued recently that "emerging markets appear to be approaching a level of self-sufficiency and mutual support. They no longer seem to rely heavily on the investment and consumer demand from major Western corporations." If Coal Trader is right and their economies are decoupling from the U.S. (the "training wheels are starting to come off," he says) we should see it in their GDP growth figures (e.g. India). And if they decouple it should make demand for these raw material commodities less volatile. (Coal Trader had an interesting observation: "I believe we need to invest as if our offices were in Singapore, or perhaps even Jakarta.")

If these countries continue to develop, they should soon begin consuming much more oil per capita too. Enough to make a big difference to total world oil demand. India is currently something like 5% of world oil demand with per capita usage that’s only about one-third of China. If India develops just to the level of China, it would cause incremental increased oil demand of around ten million barrels per day. An astonishing figure, it dwarfs any possible near-term savings from electric vehicles in richer countries, and the incremental demand would be almost as big as total U.S. oil production. And note that it will take machines built of steel to burn this oil.

People who are short commodities are betting against the up-and-to-the-right GDP trends of countries like China and India. Maybe those trends will continue and maybe they won't, but they are the status quo. Which brings up another point from the book. 

As we have elsewhere observed, there is a great tension between physics-based pessimism (Malthusian) about natural resources and economics-based optimism (some might say cornucopianism) about the ability to respond to higher prices with substitution and invention. As an example, the new lithium-iron-phosphate (LFP) battery chemistry seems like a major point in favor of the cornucopian, economist viewpoint. We would not have thought it possible a few years ago to make a battery with just lithium and iron. 

In the book, Conway points out that even as the ore concentration of copper has plummeted over the past century, the price has fallen in real terms. There have been huge fluctuations, having to do with the capital cycle in copper mining, but worse ore grades have not caused prices to rise. The Malthusian and Cornucopian forces have held in balance. (Perhaps the long-run destiny is for these forces to always remain in balance?)

It therefore seems prudent for an investor to make not highly leveraged bets ("torque") on much higher commodity prices, but rather to find ways of benefiting from the status quo of growth, development, and human invention.

So let us talk about ways to do this. As we have observed in the past, owners of royalties on natural resource production make money in status quo conditions, they do well if prices rise, but they can even benefit if the producers foolishly over-expand their capacity and drive down their commodity price (which they have a marked tendency to do throughout history), at least as long as they own a royalty on the new production too. 

The opportunity that we have seen is that these royalty interests in hydrocarbons are bond-like assets priced to give equity-like returns because of ESG investing and because of a brutal bear market, and subsequent investor disinterest, in natural resource production.

We have mentioned both Natural Resource Partners and Pardee Resources in past writing. NRP derives a significant portion of its revenue from royalties on metallurgical coal production, but also from thermal coal production as well as an interest in a soda ash business in Wyoming. While the partnership owns 13 million mineral acres, it does not own any surface acres. In contrast, Pardee owns about 155,000 surface and mineral acres, mostly in West Virginia, with active metallurgical coal production. 

The current market capitalization of NRP at $96 per share is $1.2 billion. NRP has a more complicated balance sheet, with debt, preferred stock, and warrants. (The liabilities keep going up as the share price goes up, because of the warrants.) Depending on the valuation assumptions you make, they probably have $371 million of additional liabilities, less around $80 million potentially earned during Q4, for an estimated current enterprise value of $1.5 billion. 

Assuming the recent level of $80 million of quarterly free cash flow, the FCF/EV yield would now be about 21%. Amazingly, this is higher than the FCF yield of the coal miners, who have to reinvest a significant portion of their cash flows back into production as capital expenditures. It is surprising that the royalty, which is the senior security in the capital structure of the mine, seems cheaper than the producers' equities. 

There is a slide in NRP's investor presentation showing annual free cash flow figures for NRP since 2015. For the year 2016, which was when the coal market crashed and most of the miners in the industry went bankrupt, the partnership 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 still be 5%.

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.

Then there is Pardee, which has a market capitalization of $164 million at $250 per share. Factoring in the end of year special dividend and estimated fourth quarter free cash flow, their enterprise value is probably now around $130 million. (That's $830 per acre of surface.) Pardee generated around $7.6 million of EBITDA in Q3, so that would be an annualized yield of 23% on the enterprise value.

The edge perhaps goes to Pardee at this point based on valuation, as well as the fact that it is "two-pillar" since it is trading (arguably) below the value of the surface. In fact, one thought experiment would be to consider that Pardee could theoretically sell the surface and timber for an amount in excess of the current enterprise value, while retaining the mineral rights (meaning coal royalties) as well as other assets. (Pardee is very unlikely to actually do this; it is just a thought experiment.) Not to say that the land is of exactly the same quality, but Weyerhaeuser just bought land for $2,685/acre in the southeastern U.S.. It is very difficult to find any land with timber in the U.S. for less than $1,000 per acre. Land prices of three digits per acre tend to be swamp or desert.

4/5.

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".

Natural Resource Partners L.P. ($NRP) - Q2 2023 Earnings

[Previously: Natural Resource Partners L.P.]

Natural Resource Partners L.P. (NRP) is a limited partnership that owns mineral rights throughout the U.S. (totaling 13 million acres) as well as a 49% minority interest in Sisecam Wyoming, a trona ore mining and soda ash production business located in the Green River Basin of Wyoming. 

NRP does not produce any minerals - they lease acreage to operators in exchange for royalties. The majority of their mineral rights revenues come from royalties on Appalachian coal production, with additional amounts from coal royalties in the Illinois Basin and the Powder River basin. They also derive revenue from minimum lease straight-line charges, wheelage charges, and oil and gas royalties.

The market capitalization of NRP (at $68) is $860 million. Total liabilities net of current assets and deferred revenue were $146 million at the end of the second quarter (10-Q). There are 121,667 units of Class A Convertible Preferred Units after the (significant) year-to-date redemptions. The terms governing the liquidation preference are:

The “liquidation value” will be an amount equal to the greater of: (1) (a) the per unit purchase price multiplied by (i) prior to March 2, 2020, 1.50, (ii) on or after March 2, 2020 and prior to March 2, 2021, 1.70 and (iii) on or after March 2, 2021, 1.85, less (b)(i) all preferred unit distributions previously made by NRP and (ii) all cash payments previously made in respect of redemption of any PIK units; and (2) the per unit purchase price plus the value of all accrued and unpaid distributions.

The partnership has been able to redeem 128,333 preferred units year to date for $128 million ($1,000 per unit). The partnership has some leverage in negotiating these repurchases because only 1/3 of the units can be converted in any 12 month period, and only when the unit price is above $51. We will use $1,000 per unit for the remaining units while realizing that the actual cost of redeeming the remaining units could vary (and be higher) than this. That puts the enterprise value now at $1.13 billion.

Royalty revenue for Q2 was $61 million compared with $76 million for Q1. Earnings from Sisecam Wyoming were $27 million, up from $19 million the prior quarter. Cash from operations was $73 million in Q1 and $81 million in Q2. So the YTD cash from operations of $154 million is a 27% yield on the enterprise value.

For the entire year-to-date, capital expenditures have only been ten thousand dollars. The partnership borrowed $14 million, paid $51 million of distributions to unitholders, paid $15 million of distributions to preferred unitholders, and paid $128 million to redeem preferred units. 

You'll notice that 81% of revenue was converted to cash from operations (YTD), and all cash from operations was used to either pay claims senior to the common unitholders or to pay distributions to the common unitholders. (The preferreds have a 12% cumulative coupon and the credit facility where the partnership borrowed to help repay preferreds has an interest rate in the 8% range.) Also, note that even though only $50 million has been distributed to unitholders year-to-date, a significant fraction of the $150 million of net income YTD is likely taxable and will be reported to unitholders via K-1.

If coal prices and production levels as well as earnings from the Sisecam interest hold up, then the partnership could pay off its remaining $268 million of net liabilities in just over three quarters from now. Paying off liabilities is management's stated intention - from this quarter's call which actually had some questions:

We intend to continue to pay down our preferred and debt as rapidly as we can to the extent we can borrow on our credit revolver at a lower cost than the 12% on the preferreds and to the extent that we can have the preferred holders waive the make-whole premium, which is called a MOIC, M-O-I-C, so that we're able to buy those bonds back at par.

If we can replace 12% obligations with something more like 7% or 8% obligations, we're going to do that as much as we can and then immediately begin paying down the revolver with cash that we generate as well. And our goal is to pay down the preferreds, the bank revolver and then of course continue paying down our private placement notes, which are on an amortization schedule and also by the time they settle in first quarter of 2025, settle our warrants that are outstanding. We're going to want to get rid of all of those obligations as soon as we possibly can. [...]

Our strategy is to eliminate all of these obligations we have the preferreds, the debt and settle our warrants before such time as we begin to raise the distributions or look at consider raising the distributions. And the reason for that is that we have learned firsthand that it would be imprudent for a company such as ours with our business profile to rely at all on sourcing capital from banks or from capital markets to fund our business in the future. So when you can no longer rely on rolling forward or refinancing your credit obligations, you have to assume that you operate with no permanent debt in your capital structure.

So we want to clean everything up, stay on the same path we've been on now for quite a while. And once we have the capital structure fully clean, then we will evaluate capital deployment strategies. It's not going to be too long in the grand scheme of things, we see light at the end of the tunnel. But early 2024, is too soon. Because remember even when we take out those preferreds, we're simply switching the obligation from preferred units to debt. So that's our philosophy. And when we look at it, we think in the long run on a risk-adjusted basis this is going to maximize value for common unitholders.

If we look out a year from now, assuming that cash from operations holds up, they are able to pay off these liabilities, and the unit price remains the same, then the same ~$300 million of annualized cash from operations would be available for distribution to common unitholders with a market capitalization of $860 million. Potentially a 35% yield, or $20+ per unit on the current $68 price.

The royalty model is just so superior to the producer model. When we looked at coal producer earnings this quarter, we see that they are cheaper on EV/EBITDA than NRP, but they have vastly larger capital expenditure requirements. (They are also more leveraged to the coal price, for better and for worse, since they have production cost and a royalty owner doesn't.) 

Something fantastic about royalty companies is that they can benefit if the producers foolishly over-expand their capacity and harm their commodity price. Here's the math: suppose that a producer making a 100% margin (cost is half of selling price) expands production by 25%. Their projection was that they would use the lower volumes to drive cost down by 20% thanks to higher volume, and so the greater amount sold at a lower cost would result in 50% higher profit, a huge return on the expansion capex. 

However, everybody else in the industry has the same idea and inflation causes the cost of production to stay the same (instead of the projected decrease) while at the same time the selling price falls 10% because of the increase in supply. The result is that profits are flat. The expansion capex was completely wasted.

But look what happens to the royalty owner: the selling price is down 10% but a 25% production volume increases results in a 12.5% increase in royalty revenue, since the royalty owner has no cost of production. And it happens with no capital expenditure on the part of the royalty owner. (Keep in mind, of course, that the selling price could fall more than enough to offset the production increase, whether because of the increased supply alone or because of other economic factors. But if that happens, the producers will really be hurting.)

If it is a tough call whether to invest in the royalty or producer based on valuation, the tie has to go to the royalty owner. The reason is that the royalty stands to benefit from the classic producer management mistake (expanding).

Natural Resource Partners L.P. ($NRP)

Natural Resource Partners L.P. (NRP) is a limited partnership that owns mineral rights throughout the U.S. (totaling 13 million acres) as well as a 49% minority interest in Sisecam Wyoming, a trona ore mining and soda ash production business located in the Green River Basin of Wyoming. 

NRP does not produce any minerals - they lease acreage to operators in exchange for royalties. The majority of their mineral rights revenues come royalties on coal production in Appalachia, the Illinois Basin, and the Powder River Basin. Production last year (2022) was split 55/45 between thermal coal (mostly from Illinois Basin) and met coal (mostly from Central Appalachia). Something nice from the investor presentation [PDF]: 

NRP owns the right to sequester CO2 underground in approximately 3.5 million acres located primarily in the southern United States – NRP currently has approximately 140,000 acres of pore space under lease with an estimated carbon storage capacity of at least 800 million metric tons. [...] We do not plan to develop or operate any carbon sequestration or renewable energy projects ourselves but lease our acreage to companies that will conduct those operations in exchange for payment of royalties and other fees to us.

The market capitalization of NRP (at $47.50) is $595 million. Total liabilities net of current assets and deferred revenue were $128 million at the end of the first quarter (10-Q). The liquidation value of the convertible preferred (which has a 12% coupon) is $200 million, so the enterprise value is $923 million. 

In 2022 (10-K), NRP had total revenue of $389 million and $317 million of adjusted EBITDA, with $294 million of adjusted EBITDA contributed by mineral rights, $45 million from the soda ash partnership, less $22 million of overhead.

For the first quarter of 2023, NRP reported adjusted EBITDA of $78 million. Mineral rights contributed $73 million, soda ash $11 million, and corporate overhead subtracted $6 million. The Q1 adjusted EBITDA annualizes to $312 million (running behind the 2022 figure) and would represent a 34% yield on the current enterprise value.

NRP has been working hard on deleveraging, getting out from under expensive debt and preferred stock. (Management talks about liabilities as "obligations remaining to be settled.") This is what they said in the fourth quarter 2022 earnings release:

"Early in 2023, one of the preferred holders exercised their right to convert $47.5 million of the preferred units into NRP common units. After considering our financial position, liquidity, and comparing the market value of NRP's common units to our estimate of intrinsic value, we elected to redeem the units with the payment of $47.5 million of cash instead of issuing NRP common units. After this transaction, the outstanding liquidation value of our convertible preferred units was reduced to $202.5 million."

"We remain focused on maximizing long-term free cash flow available to common unitholders and increasing our financial flexibility. We intend to achieve this by paying off all permanent debt, redeeming all preferred equity, and settling all remaining warrants. We also remain focused on becoming a key player in the transitional energy economy. During the year we made significant progress toward this goal with the execution of our first two subsurface carbon sequestration leases and our first geothermal energy lease, which have the potential to produce significant cash flow over the long term."

NRP continues to make great strides in de-levering and de-risking the partnership. In 2022, NRP fully retired its outstanding $300 million 9.125% Senior Notes due 2025, aiding in the sharp decrease in NRP's consolidated leverage ratio to 0.5x at December 31, 2022 from 2.7x at December 31, 2021.

And on the fourth quarter conference call:

I would like to begin by thanking our employees for their outstanding contributions, executing our strategy to delever and derisk the partnership. I'd also like to thank our equity investors, bondholders and banks for your enduring support. And a special word of appreciation is owed to our Board of Directors for its wise guidance and counsel.

When we embarked on our new strategy 7 years ago, the partnership was in a precarious financial position, with almost $1.5 billion of debt, representing more than 2/3 of our capital structure. Our bonds were trading at $0.65 on the dollar, and our free cash flow was negative. Our future looked bleak.

We responded by exercising extraordinary financial discipline to aggressively cut costs, eliminate capital expenditures and sell off underperforming assets with an incessant focus on delevering and derisking the capital structure. Today, I'm proud to say that the partnership is dramatically healthier and financially stronger than it was 7 years ago.

We have rightsized the business from 4 business segments down to 2. Both of which now earn returns on capital well in excess of their cost of capital. Our operating and interest expenses are each more than 70% lower than they were when we began. And our free cash flow, which had been negative, exceeded $0.25 billion in 2022, a record for the partnership.

Our debt, which has been almost $1.5 billion, had declined more than 80% to $169 million at year-end. The financial profile of today's NRP is so remarkably improved from that of 7 years ago that it would be hardly recognizable to anyone who hadn't followed the transformation.

I am especially proud that these results have been achieved without the use of sly legal maneuvers, debt forgiveness or bankruptcy. Let it be known that NRP keeps its promises, pays its debts and does exactly what it says it will do.

We have come a long way, but there's still more work to be done. Our goal remains to retire all permanent debt, redeem all of our 12% convertible preferred equity and eliminate all outstanding warrants. Taken together, these commitments currently total approximately $465 million.

If our business continues to generate free cash flow at the current run rate, I hope to reach this goal within 2 to 2.5 years. Once these obligations are eliminated, Free cash flow available for common unitholders will increase, most likely in a dramatic fashion.

Metallurgical coal prices reached historical highs and were the primary driver of strong segment performance. Numerous factors continue to provide support from net pricing as the post-COVID recovery continues.

Supply chain disruptions, labor shortages and years of underinvestment in new coal production capacity continue to undermine producers' ability to bring new production online to meet demand. While met prices have pulled back from the peaks reached last year, we continue to believe met prices will remain well supported for the foreseeable future.

Thermal coal prices also reached record highs in 2022, but have declined significantly in recent months due to usually warm weather in Europe and North America. Thermal prices traded at a premium to met for much of last year, even pulling lower quality met coal into thermal markets at times. That situation no longer exists as thermal coal now sells at significant discounts to met.

While we do not see thermal prices rebounding to last year's record levels, many of the factors that provide support to prices over the last year still exists. Boycotts of Russian coal continue to force European buyers to source coal from other regions, including the U.S. Operators will continue to be burdened by labor shortages, pressure from governments, regulators, activists and capital providers, which will limit ability to increase thermal production to meet demand. [...]

And with that, I'll turn the call back over to the operator for questions.

Operator

(Operator Instructions) It appears that we have no questions. I'll turn it over to Craig Nunez for any closing comments.

Interestingly, there were no questions on the fourth quarter conference call, despite the fact that the company trades at 3x EBITDA (with a pure royalty business model) and is committed to shareholder returns!

Some color from the Q1 conference call:

Metallurgical coal prices remained highly volatile, and while strong relative to historical price levels, they have declined significantly from the record levels reached last year. While we expect price volatility to continue, we believe the supply-demand balance for met coal will remain well supported for the foreseeable future, primarily due to the lack of industry investment in new metallurgical supply.

Thermal coal prices also remained strong but have weakened significantly in recent months as unusually warm weather in North America and Europe has impacted electricity demand. While weather will always pose unavoidable uncertainty with thermal coal demand, we believe the same constraints that have prevented met producers from adding capacity are also affecting thermal producers. The lack of thermal supply additions is likely to provide support for thermal coal pricing at levels that are relatively high by historical standards for the foreseeable future, albeit with continued volatility.

Soda ash demand growth continued to exceed new soda ash capacity in the first quarter of 2023. Consequently, international prices remained near record levels, which allowed Sisecam Wyoming to negotiate a strong domestic order book for 2023. Coupled with Sisecam Wyoming's global low-cost position, these robust prices generated a 29% increase in earnings versus the prior year quarter. We continue to believe that the long-term outlook for Sisecam Wyoming remains favorable due to its low-cost position and positive long-term demand characteristics for soda ash, driven in part by the ongoing increase in renewable energy, the electrification of the global auto fleet and urbanization.

Once again, there were no questions on the call.