Texas Pacific Land: A Former Great Buy, But Not Anymore

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TPL's current share price of $818.85 is unjustifiably high based on its financial ratios and historical performance.Detailed analysis using comparable companies, dividend history, and discounted cash ...

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href=https://seekingalpha.com/article/4708379-texas-pacific-land-former-great-buy-but-not-anymore><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>TPL's current share price of $818.85 is unjustifiably high based on its financial ratios and historical performance.Detailed analysis using comparable companies, dividend history, and discounted cash ...</p>\n\n<a href=\"https://seekingalpha.com/article/4708379-texas-pacific-land-former-great-buy-but-not-anymore\">Source 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As a value investor, I will focus primarily on whether the company is undervalued, and not whether it is a good company with good management. $818.85 for Texas Pacific Land Corporation (NYSE:TPL) is utterly ridiculous. How on Earth could anyone think this is a reasonable share price for this company? TPL might’ve been a good buy when the price was $500-$700, but there’s no way to justify its current valuation. Don’t get me wrong, TPL is a strong company with many things going for it. It has no debt, a stark contrast to its highly-leveraged peers, it has strong and consistently positive free cash flows (FCFs), it has high-margins, and there’s a lot of potential in its ongoing efforts to invest in water desalination technologies. But there are many reasons why you absolutely should not buy TPL at its current price. Company Overview & Qualitative Insights I'll say it up front: the main reason, but far from the only reason, that I think TPL is overvalued is because of what my financial models tell me. Although there are qualitative aspects favorable to TPL, in my opinion, none of these comes even close to justifying its current high price—never mind that there are also qualitative aspects that do not bode well for TPL as well. Texas Pacific Land Corporation is a real estate operating company headquartered in Dallas, Texas. It owns over 880,000 acres of land in the Permian Basin, making it one of the largest private landowners in the state of Texas. Its sources of revenue include oil and gas royalties, accounting for 56.6% of revenue in FY 2023, water sales, accounting for 17.8% of revenue in FY 2023, produced water royalties, accounting for 13.3% of revenue in FY 2023, easements, which alongside other surface-related income accounted for 11.2% of revenue in FY 2023, and land sales, which alongside operating revenues accounted for 1.1% of revenue in FY 2023. Its competitors include Permian Resources Corporation (PR), Sabine Royalty Trust (SBR), EOG Resources (EOG), Coterra Energy (CTRA), and EQT Corporation (EQT). TPL stands out among the competition primarily for having a strong balance sheet with no debt, a fact it likes to often point out. It also stands out for its high margins, boasting a 64% net income margin, with its Land and Resource Management division and Water Services and Operations division having net income margins of 71% and 50%, respectively. The company has been developing an energy-efficient method of produced water desalination, leveraging a process known as fractional freezing. I acknowledge that there is a lot of potential with this. TPL's May 2024 Investor Presentation But in my opinion, none of these strengths seem substantial enough to justify its current high price. Moreover, with these strengths come weaknesses. One of the main things to worry about is geographic concentration risk. While TPL's laser-like focus on the Permian Basin may provide them with a unique competitive advantage in the market, this same exposure may potentially put the company at risks attendant with geographic concentration. Indeed, any bad development in this single region could potentially annihilate TPL's business. TPL could reduce this risk by expanding to other regions. Another risk is the dependence on commodity prices; low commodity prices may have an adverse effect on royalty income and thus overall profitability. TPL's revenues have been increasing due to favorable oil prices, but in turn, this further highlights TPL's dependence on this variable. TPL also must navigate regulatory challenges. TPL's operations, particularly in the oil and gas sector, are subject to stringent environmental regulations. These include laws governing water usage and disposal, air emissions, and land reclamation. The inability to anticipate and/or properly respond to changes in the regulatory environment could negatively impact TPL. Changes to legislation or regulation related to a tax on production volumes, GHG emissions, or other environmental elements could lead to increased operating costs and/or reduction in profits. Overall, TPL boasts a strong balance sheet, high margins, and strong potential with its innovative water desalination technologies, but is greatly prone to risks relating to its geographic concentration, dependence on commodity prices, and regulatory landscape. Why You Shouldn't Buy TPL at >$800 First of all, there’s a reason why its valuation grade is an “F” according to Seeking Alpha.   Seeking AlphaTPL’s EV/EBITDA ratio currently stands at 31.647x, its P/E ratio stands at 43.427x, and its P/B ratio stands at 16.772x. There are sectors where such insanely high ratios would be justified, but the energy sector is not one of them. To give you an idea of how absurdly high these ratios are in the context of the energy sector, the energy sector median EV/EBITDA, P/E, and P/B ratios are 6.41x, 12.04x, and 1.64x, respectively. Of TPL’s main peers, the highest EV/EBITDA, P/E, and P/B ratios excluding TPL itself stand at 8.845x, 29.270x, and 1.466x, respectively, none of which are even close to being as high as TPL’s ratios! I conducted comparable companies (comps) analysis using CTRA, MRO, EQT, PR, and OVV as TPL’s peers. This selection was based on the peer classification of TPL provided by Seeking Alpha. Using the median and mean EV/EBITDA ratios of TPL and its peers, TPL’s implied share prices are $188.06 and $290.24, respectively, both of which are substantially lower than its current price of $818.85 and therefore indicate substantial downside. Likewise, the median and mean P/E ratios yield implied share prices of $350.91 and $399.34, respectively, also indicating substantial downside. And finally, the mean and median P/B ratios yield implied share prices of $67.06 and $190.79, respectively, indicating extreme downside. Author's CalculationsModel sources: Refinitiv for market caps, TPL’s latest four 10-Qs for TPL’s EBITDA, net income, and book value, and Yahoo Finance for everything else. Please note that the EBITDA and net income figures used to calculate the EV/EBITDA and P/E ratios for each company are for the trailing twelve months (TTM). Look at how ridiculous TPL’s ratios look next to those of its peers! To be fair, TPL does stand out for not having any debt in contrast to its debt-heavy peers, which explains why TPL is the only one with a market cap higher than its enterprise value. But this does not even come close to justifying such dramatically higher ratios. And it’s not like TPL compensates for this by consistently beating EPS estimates each quarter by a substantial margin. TPL’s record is mixed in this regard. In the past 18 quarters, it has beat EPS estimates in 10 quarters by an average of $0.51, and it has missed EPS estimates in 8 quarters by an average of -$0.41, according to Seeking Alpha. Seeking AlphaMaybe these high ratios could be compensated for with strong and consistent dividends, but TPL doesn't offer this either. Their dividends are highly volatile and unpredictable, not to mention also not being as high as you would like. In 2024, TPL has paid $14.67 in dividends so far, distributed as follows: $10 on July 15, $1.17 on June 17, and $3.50 on March 15. In 2023, the total dividends amounted to $9.75, with payments of $3.25 on December 15, June 15, and March 15 each. The year 2022 saw a higher payout of $32 through five payments: $3 on December 15, $3 on September 15, $20 on June 15, and another $3 on March 15. In 2021, TPL provided a quarterly dividend of $2.75, totaling $11 for the year. The 2020 dividends totaled $16, paid in two installments: $10 on December 17 and $6 on March 16. In 2019, only one dividend payment of $1.75 was made. Even their highest annual dividend ever of $32 in 2022 was not particularly impressive given that the share price that year ranged from $1075 to almost $2600 (this was pre-stock split), resulting in an average annual dividend yield of roughly 1.7%. Although this yield is not bad, it’s also an anomaly unlikely to be repeated. Considering the company's cost of equity at 13.27%, even if TPL paid dividends of $32 annually for the next five years with a 3% perpetual growth rate, the dividend discount model would only value the stock at $284, which is significantly lower than the current price of $818.85. Given the total 2023 payout of only $9.75, it is unlikely TPL will pay $32 annually in the foreseeable future for even one year, let alone for five consecutive years. The following table shows TPL’s dividend history: TPL's dividend history (nasdaq.com)To further prove TPL’s overvaluation, I conducted comprehensive discounted cash flow (DCF) analysis on the company. The company’s free cash flows (FCFs) have been strong and consistently positive over the years. They generated roughly $395.8M, $406.7M, $253.1M, $197M, and $289.9M in FCF in 2023, 2022, 2021, 2020, and 2019, respectively. The following table shows TPL’s unlevered FCF history since 2013: TPL's financial statementsAlthough these FCFs are high, they are simply not high enough to justify TPL's current valuation. Using this historic data and Prophet, a forecasting tool build by Facebook data scientists, I forecasted TPL’s EBIT, taxes, D&A, capex, and change in NWC for each of the next five years and used these forecasts to estimate its future FCFs. This resulted in FCF projections of $358.7M, $429.8M, $499.3M, $567.1M, and $516.9M, which seem spot on. With a beta of 1.64, TPL has a fairly high cost of equity of 13.27%, which, fairly or unfairly, drags down its intrinsic value. Nevertheless, to be extra lenient towards TPL, in calculating the terminal value, instead of using the average of the FCF projections or the last year’s FCF projection, I used the highest FCF projection ($567.1M). Despite this, my model calculated an intrinsic value of $239.47 per share, indicating a staggering $579.38 (-71%) downside compared to TPL’s current price of $818.85! Author's CalculationsFurthermore, if for some reason you think that the FCF projections used are too pessimistic (which they clearly aren’t), for the model above to calculate an intrinsic value equal to the current share price of $818.85, the original FCF projections would have to be increased by 285%, from $358.7M-$567.1M to $1.4B-$2.2B! And even with such a gargantuan increase, TPL would still not be undervalued (but rather just fairly valued)! The highest annual FCF TPL has ever generated in its history is $406.7M, so it is basically impossible that the company will suddenly begin generating billions in annual FCFs for each of the next 5 years. Moreover, if you are concerned about the results being unfairly skewed against TPL by seemingly arbitrary assumptions such as WACC and perpetual growth rates, my sensitivity analysis demonstrates that TPL remains significantly overvalued for just about all WACC-perpetual growth rate combinations within the realm of plausibility. Even with WACCs as low as 6%-9%, which are virtually impossible given TPL’s ~1.6 beta, the analysis still indicates downside for most perpetual growth rates! Author's CalculationsNOTE: Cells higher than TPL’s current share price of $818.85 are highlighted in green, and those lower than $818.85 are highlighted in red. And in addition to all of this, the price has already seen a significant rally. After accounting for the 2024 stock split, TPL's price has surged from under $500 in January to over $800 by July. Its current price of $818.85 is close to its all-time high. The last time the price was this high (accounting for the recent stock split) was in November 2022, when it nearly reached $900 before plummeting to just over $400 in the following months. Given how fundamentally overvalued TPL appears, it seems likely we are witnessing a repeat of November 2022: the price might continue to rise for a little while longer, but the market will soon correct itself, and a decline seems inevitable. And it’s not just my opinion. According to Alpha Spread, the average forecast for TPL among Wall Street analysts is $755.89. Similarly, Yahoo Finance reports an average analyst price target of $741.06, with a low estimate of $565.13 and a high of $917. TradingView.comMy Recommendation If you don’t own any shares of TPL at the moment, now is not the right time to buy. However, if you already have TPL in your portfolio, I wouldn’t rush to sell all your shares just yet. There's a chance the price could climb a bit more, potentially hitting around $900 in the next few weeks. In this case, it might be wise to gradually sell portions of your holdings if the upward trend continues.  That said, it seems inevitable that the price will eventually start to decline, much like it did in 2022 when it reached a similar high. With this in mind, I recommend selling your entire investment within the next couple of months. As a value investor, I cannot endorse a company that appears so grossly overvalued based on its fundamentals. While some tech startups or established dividend kings might justify high valuations or low DCF valuations, TPL doesn’t fit into either category. For these reasons, I would rate TPL as a “SELL.”","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2455900125"}