Texas Pacific Land Trust (TPL) is a unique stock in many ways and merits a careful consideration. To understand this stock/company properly, one needs to review a little history behind it.
Origins of the Trust
Texas Pacific Land was formed in 1888 after the bankruptcy of the Texas Pacific Railway Co. The railroad had previously sold bonds to finance construction of a western line to connect with the Southern Pacific way out in West Texas. The railroad secured those bonds with land — about 3 million acres — that the state of Texas granted it as an inducement for the railroad to build the line. After the railroad went bankrupt, the land was placed into a trust — Texas Pacific Land Trust — and three trustees were appointed to manage it.
The trust today has 9 employees and still holds 913,190 acres of land. This land is spread over 19 counties in West Texas. It also owns 318 town lots in Loraine. Of this, the trust has nonparticipating perpetual royalty interest in oil/gas revenues as follows
- 1/16 interest in the revenues from the wells on 373,777 acres, and,
- 1/128 interest in 85,414 acres
With the oil and gas boom in West Texas, the trust is in no hurry to sell off the land and although the mandate is to sell the land and pay back the shareholders, no time period is specified. In the last 125+ years of its existence, the trust has sold about 2 million acres, and still holds close to a million acres of land. Every year, the trust sells a few thousand acres and at this rate it will take 20-30 years to liquidate the rest of its land holdings.
Trust Income and Returning Money to the Shareholders
The trust operates with very little expenses (just 9 employees, little to no SG&A, R&D, etc) and close to 60% net profit margins (more on this later). Income is generated in many ways
- Oil/gas royalties
- Land sales,
- Grazing leases, and,
- Easements and other income
Key to understanding the Trust operations is to realize that ALL the land is carried on the books at ZERO cost. Therefore practically all the land sales transactions are operating income. About 97% of the land is leased out on annual grazing leases and the trust generates oil/gas royalties on 50% of its holdings. Easements and other income are typically the income generated by the trust through fees it charges developers to place utilities and other structures through its properties. The trust also earns interest from the notes when some of the land it sells is purchased with seller financing.
Trust expenses include income taxes, property taxes which are minor due to the rural nature of the land, legal and other professional costs for sales, and payroll.
Other than carrying a healthy cash balance to fund the operations (currently around $14 million) the rest of the income is used to pay an annual dividend to the shareholders and buy back the trust shares in the open market.
Essentially, close to 40% of the revenues from the trust operations is returned to the shareholders every year
Valuation of the Shares
As you can suspect, you can’t use the normal ratio analysis to value an atypical company like this. What we will do is to attempt to place a value on the trust assets assuming an orderly liquidation, which is essentially what is happening here. The analysis will be broken up in two steps:
Step 1: Placing a value on the land assets
Currently the trust holds 913,190 acres of land. How much is this land worth in today’s market? Some clues can be found in the prices they have fetched with the recent land sales. For this I am using the sales made in 2011 and in the Q1, 2012.
2011 Sales: 31,446.46 acres sold for $11,873,112.00 at an average price of $377.57/acre
2012 Sales (Q1): 5,460 acres sold for $3,567,000 for an average price of $653/acre
Blending these together the weighted average of the price fetched is $418.36/acre.
This gives us the value of the remaining land at 913,190 x $418.36 = $382 m
The assumption is that the land sold and the land remaining are on average of similar type. This assumption is wrong because –no- oil/gas producing land was sold in the last 15 months, whereas we know that 50% of their remaining land is used for oil/gas production, and is likely worth more. So our estimate is likely on the conservative side. Also, if the property values rise faster then the rate of inflation (population growth, new developments, etc), the real value realized is likely to be much higher.
The 318 town lots in Loraine correspond to 315*5 = 1,590 acres (based on typical 1/5 acre per town lot). My quick search on the land prices in Loraine TX places the value at about $1000/acre which gives these lots a value of 1.6 m. Since these are marked for residential purposes, it may actually be worth a lot more.
Step 2: Placing a value on the oil/gas royalties income
Grazing leases, easements and sundries are a function of the normal land holdings and the price of the land calculated above includes these revenue streams. Oil and gas royalties are however not included and the land that is involved in these activities have incremental value. We will look at the net income generated through oil/gas royalties and attempt to place a value.
2011 oil/gas royalties: oil/gas revenues = $14.7 m. Contribution to net income = 14.7 * 0.4 = $5.88 m
2012 oil/gas royalties (Q1): Oil/gas revenues = $3.4 m. Contribution to the net income = 3.4 * 0.4 = $1.36 m
This gives us an average of $5.8 m/yr from oil/gas revenues in net income. Assigning a PE of 12 (Exxon Mobil trades at PE of 11, but with profit margin of just 10% compared to 40% for TPL), this income stream is worth $70 m.
This again I feel is conservative as the trust is adding new wells every year and bringing more supply on board. Last year, they added 75 new wells and only 4 were depleted and plugged. Even if the price of oil/gas falls in the next decade, the trust should be able to maintain the income stream or grow it modestly. The company does not have information on the reserves to properly estimate the future value so for now, this calculation will have to do.
Adding these up, the total value of the trust assets are about 382+70+1.6 = $454 m.
The company has another $20 m in net assets (cash, investments, receivables, etc less payables and other liabilities).
So the total value is $474 m. At 9.065 m shares outstanding, this implies a share price of $52.28 m
TPL is the largest holding in the Hodges Small Cap Fund and they estimate that the shares are currently worth $75. Our estimate of the intrinsic value is clearly conservative. For example, we have ignored the 50% growth in the oil/gas revenues year over year, since there is no reliable way to calculate how much growth is left (given the value of the reserves is not known).
With this sense of conservativeness, I recommend buying the shares at $53/share or below using a limit order. Allocate about 6% of your portfolio to TPL. There is no target sell price as it depends on the number of outstanding shares left but the target hold is 5+ years.
The trust buys shares back. They do have a dividend yielding 0.4% ($0.23/share) that is paid annually. They are not allowed to issue new shares or give stock options to their employees. There is no risk of dilution. On the contrary, the share concentration will continue to increase. I expect in 10-15 years, the shares left in the market will be very very valuable