Downgrading Texas Pacific Land On Valuation, Despite Oil/Gas Bull View

seekingalpha07-30

Texas Pacific Land has been a top gainer in the energy sector over the last 12 months, trading close to all-time highs at $818 per share.However, the current share price is overvalued with a very high...

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View\n</h2>\n\n<h4 class=\"meta\">\n\n\n2024-07-30 09:21 GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4707803-downgrading-texas-pacific-land-on-valuation-despite-oilgas-bull-view><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>Texas Pacific Land has been a top gainer in the energy sector over the last 12 months, trading close to all-time highs at $818 per share.However, the current share price is overvalued with a very high...</p>\n\n<a href=\"https://seekingalpha.com/article/4707803-downgrading-texas-pacific-land-on-valuation-despite-oilgas-bull-view\">Source 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Pacific Land has been a top gainer in the energy sector over the last 12 months, trading close to all-time highs at $818 per share.However, the current share price is overvalued with a very high P/E ratio and low dividend yield, posing the investment risk of limited gains to potentially large losses into 2025.My suggestion is to sell/avoid Texas Pacific Land and consider other investment opportunities in the oil and gas space.   artplus/iStock via Getty ImagesI mentioned Texas Pacific Land Corporation (NYSE:TPL) as a buy idea in late 2020 and again last summer around $400 per share. Following suit, this massive land holder in Texas, leasing water, ground, and oil/gas rights has been a top gainer in the energy sector over the last year, with price now around $818 per share (close to all-time highs). My July 2023 article here, successfully made the argument that price was too low vs. historical trading valuations. Seeking Alpha - Paul Franke, Texas Pacific Land Article, July 3rd, 2023However, I think the share quote is a little ahead of itself with a trailing P/E of 43x and dividend yield of just 0.6%. Even if oil/gas prices shoot higher unexpectedly, an equivalent rise in interest rates (from the newly pumped inflation on rising energy) may mean Texas Pacific's share quote will be stuck in neutral for a year or two (or longer). Conversely, assuming oil/gas prices actually slide the rest of 2024 and into 2025 on a global economic recession, TPL's price may get stuck in a downtrend over the next 6-12 months. Essentially, the prospect for a stagnant range between very limited gains to potentially sizable losses in a severe recession argues the risk/reward equation has tilted against material gains during the next year. So, I feel it prudent to suggest owners lock in some profits, while readers researching this selection as a buy idea might want to avoid it until lower prices appear. My honest opinion for a 12-month outlook, therefore, is to downgrade Texas Pacific Land to Sell/Avoid. There are plenty of alternative oil & gas names with better investment profiles, set up to take advantage of future advances in the energy market. Texas Pacific Land - May 2024 Investor PresentationTexas Pacific Land - May 2024 Investor PresentationTexas Pacific Land - May 2024 Investor PresentationValuation Getting Stretched Looking at basic ratios of underlying fundamentals, Texas Pacific is expensive, but far from its worst valuation over the last several decades. Price to trailing earnings of 43x, sales of 29x and cash flow of 42x are in the 70th percentile for a valuation average over the last decade.   YCharts - Texas Pacific Land, Basic Fundamental Ratio Analysis, 10 YearsHowever, the oil patch in general is selling at far lower-than-normal valuations, highlighting TPL as an outlier pick. Why do you want to invest in a slower-growth business sporting one of the highest valuations in the sector? I have graphed the stretched P/E problem below vs. royalty and producing peers focused on Texas. This sort group includes Permian Basin Royalty (PBT), Kimbell Royalty (KRP), Sabine Royalty (SBR), Cross Timbers Royalty (CRT), PermRock Royalty (PRT), Permainville Royalty (PVL), Vital Energy (VTLE), Riley Production (REPX), EOG Resources (EOG), and Devon Energy (DVN).   YCharts - Texas Pacific Land vs. Texas Royalty and Oil/Gas Production Peers, P/E Ratio, 3 YearsAnother issue that has gotten dramatically worse on the near double in Texas Pacific's quote over the 12 months is the earnings yield (P/E flipped) of 2.3% is dramatically lower than risk-free cash yields in the 5% area. Why not invest in a 1-year Treasury Bill and take the better yield with almost no downside risk to your upfront capital? The -2.5% \"relative\" earnings yield to cash alternatives is the worst reading since 2008, following which the stock quote underperformed the oil/gas sector for several years, while only besting the S&P 500 by a minimal amount into 2012.   YCharts - Texas Pacific Land, Earnings Yield vs. 1-Year Treasury Rate, Since 1987When we include TPL's stellar balance sheet, regularly managed with more cash than total liabilities, the valuation picture doesn't improve at all. Using enterprise value as our theoretical takeover worth, with zeroed-out debt and net cash subtracted from the equity capitalization, ratios on earnings and sales remain quite high. In fact, EV to EBITDA (34x) and Revenues (27x) jump into the 90th percentile vs. long-term valuation readings.   YCharts - Texas Pacific Land, Enterprise Valuations, Since 1987Perhaps of more concern is the EV valuation vs. peers. While Texas Pacific has a history of being one of the most expensive names in the oil patch, it is a standout overvaluation today. The 34x ratio on EBITDA is dramatically higher than other royalty picks in the 10x area, and an amazing multiple vs. oil/gas producers around 5x.   YCharts - Texas Pacific Land vs. Texas Royalty and Oil/Gas Production Peers, EV to EBITDA, 3 YearsWhat about the dividend yield from this royalty focused company? You would expect a dividend yield approaching cash-investment rates. Nope, the 0.55% trailing yield is a complete failure vs. other royalty picks above 5%, and producers averaging 6%.   YCharts - Texas Pacific Land vs. Texas Royalty and Oil/Gas Production Peers, Dividend Yield, 3 YearsThe whole valuation setup is getting an \"F\" Quant Valuation Grade from Seeking Alpha's computer-sorting formula. When you look at a slew of fundamental data points and compare them to TPL's 5-year history and current valuations from peers in the oil/gas industry, waiting for a drawdown in the share price sounds like a reasonable proposition. Seeking Alpha Table - Texas Pacific Land, Quant Valuation Grade, July 26th, 2024Final Thoughts I do like the general prospects for oil/gas over the next year or two. I have explained in past articles how crude oil and natural gas prices are incredibly low today, after adjusting for CPI inflation in the overall economy. Plus, geopolitical trouble in the Middle East and/or with Russia (perhaps even China) could ignite a rally in energy without any warning. Truth be told, a spike to US$150 crude oil and $4 natural gas by 2025 will become an increasing possibility if the Federal Reserve eases monetary policy before a recession hits, or overruns the world with paper/electronic dollars after a mild recession. Unfortunately for Texas Pacific Land shareholders, given a major climb in energy commodity pricing, other royalty plays on Texas oil/gas should see earnings and dividends rise at a faster clip, on investments starting at a much lower valuation level. My current view is substantially stronger upside leverage is available in other names from the U.S. oil patch. A final concern is Texas Pacific Land spiked in price on its addition to the S&P 400 midcap index during June. The extra buying interest from index-related funds appears to be a one-time event many long-time shareholders have decided to sell into. The clear peak in momentum indicators during June (circled in blue) is a testament to this fact, with non-confirmation signals everywhere after the multi-year price highs of July. StockCharts.com - Texas Pacific Land, 13 Months of Daily Price & Volume Changes, Author Reference PointsAs a consequence of all of these factors, I have decided to downgrade my outlook for Texas Pacific Land to Sell. It's a solid business with a 5-star balance sheet and asset holdings. Yet, the valuation is too rich for my tastes. I suggest looking at hundreds of other energy industry choices if you are bullish on oil/gas.  Thanks for reading. Please consider this article a first step in your due diligence process. 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