Texas Pacific Land Corporation

Good morning and welcome to Texas Pacific Lands Corporation First Quarter 2021 Earnings Conference Call. This conference call is being recorded. I would now like to introduce your host for today's call, Mr. Chris Stedham, Vice President, Finance and Investor Relations. Please go ahead, sir. Thank you. You may begin.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's First Quarter 2021 Earnings Conference Call. Yesterday afternoon, the company released its financial results and filed its Form 10-Q with the Securities and Exchange Commission. These documents are available on the Investor section of the company's website at www.texaspacific.com. As a reminder, remarks made on today's conference call may include forward-looking statements. Forward-looking statements are subject to risk and uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our forward-looking statements in light of new information or future events. For a more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and to our most recent SEC filings. During the call, we will also be discussing certain non-GAAP financial measures. More information about these non-GAAP financial measures and reconciliations to the most directly comparable GAAP financial measures are contained in our earning release and SEC filings. Please also note we may at times refer to our company by its stock ticker, TPL. This morning's conference call is hosted by TPL's Chief Executive Officer, Ty Glover, and Chief Financial Officer, Robert Packer. Management will make some prepared comments, after which we will open up the call for questions. Now, I will turn the call over to Ty.

Thanks, Chris, and thank you, everyone, for joining us today. Since this is our first quarterly earnings call, I'd like to begin with some background for those who are new to TPL. Then I'll cover our business strategy, our performance during the first quarter, and our plans for the road ahead. Lastly, I'll turn it over to our CFO, Robert Packard, to discuss our financial results in more detail. Texas Pacific was formed as a trust in 1888 to manage the checkerboarded land assets of the former Texas and Pacific Railway Company. We have been listed on the New York Stock Exchange since 1927, and in the first quarter of 2021, we completed our reorganization from a trust to a corporation. Today, we own over 880,000 acres across 19 counties in western Texas, with a majority located within the Permian Basin. We are very unique in that although we are a pure play Permian-focused company, we are not an oil producer or exploration company. Rather, we have three core revenue streams. oil and gas royalties, surface management, and water solutions. And our customers include nearly every major EMP and midstream company operating in the Permian. We believe this provides exceptionally diversified exposure to best-in-class Permian operators across multiple facets of their operations, with added value in the form of our vast and largely undeveloped royalty acreage, our core surface positioning, and our sizable market share in the sourcing and produced water aspect of our water solutions business. We'll walk through each of these three core revenue streams in turn. Our oil and gas royalties accounted for 59% of our revenues in the first quarter. We own approximately 530,000 gross royalty acres, with the vast majority leased for oil and gas development, which entitles TPL to a certain percentage of revenue interest based on oil and gas production. Our average royalty per acre is 4.4%, which translates to about 23,700 net royalty acres on an eight-eighths basis. Our oil and gas royalties are perpetual real property rights that require no capital expenditure from us for continued development, making this a very high margin business. Fundamental trends in the Permian have been highly supportive for royalties, with daily average well production of 150% from 2018 through 2020. At March 31st, 2021, Texas Pacific had a robust inventory of 541 drilled but uncompleted wells, or ducts, and 488 permits, providing clear visibility into future royalty earnings. New ducts grew from 91 in the fourth quarter to 152 new ducts in the first quarter, providing line of sight into future production. New permits grew from 139 in the fourth quarter to 176 in the first quarter, As of March 31st, 17% of all Permian rigs were located on TPL drilling spacing units, or DSUs, up from 11% of Permian rigs as of December 31st. In terms of spud count, TPL DSUs accounted for 18% of total spuds across the Permian during the first quarter. 14% of all permits approved by the Texas Railroad Commission in the first quarter intersect TPL DSUs. Importantly, most of our net royalty acres are concentrated within the northern Delaware region and core of the Midland Basin. This diverse exposure represents a significant competitive advantage for TPL. Overall, our oil and gas royalties are only 10% developed, with the Delaware Basin being less developed than the Midland Basin. Within the Texas portion of the Delaware, TPL accounted for 49% of all SPUDs during the first quarter. We believe this gives us more runway to grow our royalties over time compared to our peers, as the Delaware should continue to support a high pace of growth and production. In addition to our oil and gas royalties, we also have surface ownership of our land. Over the past decade, technological advances in exploration and development have unlocked a tremendous amount of additional reserves, contributing to a rapid build out of oil and gas infrastructure across the basin. These activities and others provide TPO enormous optionality to generate additional cash flows utilizing our surface assets. We call this part of our business SLEM, or SLIM, which stands for Surface Leases, Easements, and Material Sales. We earn income from uses ranging from easements for pipelines, power lines, and utilities, agriculture, wind farms, access roads, material sales, and various other infrastructure projects. Most of our surface revenues come from pipeline infrastructure, demonstrating our ability to capture value all along the oil and gas supply chain from production to midstream. Surface leases and easements are typically 30-plus year contracts with recurring payments every 10 years, providing stable cash flows along with escalated renewal fees. Our material sales primarily consist of caliche, which is calcium carbonate used in construction for energy companies and TxDOT infrastructure development. This is another way in which we provide services to the operators beyond just land, helping to relieve their pressure points and further solidify our customer relationships. Out of our SLIM contracts in the first quarter, 64% were for upstream activities and 36% were for midstream, further demonstrating our diversification along the value chain. SLIM accounted for 10% of our revenues in the first quarter of 2021, with renewable energy revenue acting as a hedge against the Texas winter storm as our wind revenue increased $2 million from Q4 2020 due to increased pricing. Similar to our royalties business, SLIM can achieve organic cash flow growth through new leasing without any additional capital or operating expenditures, meaning margins are effectively 100%. Lastly, our water solutions business accounted for 31% of first quarter revenues. We provide brackish water sourcing and disposal and treatment solutions, which are essential to oil and gas development. A major barrier for other water companies in the Permian is highly fragmented land ownership, which limits their ability to move around. They often need to negotiate agreements with multiple landowners for pipeline right of way to transport their product to a desired end user, significantly increasing their cost per barrel. Texas Pacific is unique that we own strategically located surface assets, allowing us to provide water services without needing costly leases to transport our product and the ability to move water across the vast majority of the northern Delaware basin. In addition, our surface assets, with emphasis on our state line ownership, also play a crucial role in capturing produced water volumes. Although TPL does not operate any saltwater disposal wells, we have agreements covering over 460,000 acres within Texas where the characteristics of Delaware bedrock produce a high water to oil ratio. These long-term contracts, combined with volume stemming from New Mexico, provide immediate revenue with tremendous upside from future development. Our contracts are structured so that TPL is paid a fixed fee per barrel royalty for produced water being disposed of on TPL land or for produced water being transported across TPL's surface. These factors enable us to capture a large market share in Permian water solutions at low cost, and we believe we can continue to grow our water business organically with limited CAPEX requirements. The water business also creates direct synergies with our oil and gas royalties and surface management business. As we continue to provide water solutions into areas where they were previously unavailable, we enable further development by operators, which in turn drives our royalties and SLIM revenue. This increased development drives more demand for water sourcing and disposal, continuing this virtuous cycle. To summarize, we believe there is no other company that provides the kind of differentiated exposure we provide to the Permian with low risk and low earnings volatility. We are diversified across multiple revenue streams. Our customers include numerous blue chip energy operators. We have exceptionally low capital requirements across our high margin businesses, and we operate at a scale that gives us significant cost efficiencies. We capitalize on all stages of the development process from exploration and production to midstream, and the synergies among our business lines will help drive further organic growth. Next, I'll discuss our recent performance and outlook. Robert will go into details shortly, but I'll provide a few high level thoughts. Oil and gas markets have continued to normalize after the volatility brought on by COVID-19. Through it all, we continue to generate positive operating results, and in fact, 2020 was our second largest revenue year in the company's history. I think this highlights the premium quality of our assets. First, we're diversified. While our royalties are tied to oil prices, we're also anchored by steady cash flows from multiple business activities. Second, we have no debt. Many of the energy companies that ran into trouble last year and at similar points in past cycles were over-levered. We enjoy high margins and have minimal capital needs in order to generate organic growth, and we continue to benefit from our pristine balance sheet. The result is that we're even better positioned to capitalize on the oil and gas recovery that is now taking place. In the first quarter, oil prices returned to $60 per barrel. As I mentioned, we have an inventory of 541 ducts and 488 permits, and current market fundamentals are supportive of getting those in-process wells converted into producing wells and contributing to our royalties. Next, I'd like to touch on the impact of the winter storm in February. First and foremost, our thoughts go out to all of those who are still dealing with the long-term effects of the storm. At TPL, we were fortunate to be in a position to help support the energy grid at a time of high stress. As I mentioned before, we have some wind energy exposure within our slim business that acted as a hedge against the disruption to production activity. But I'd like to focus on the steps we took to mitigate the storm's impact. On the royalty side, we had an estimated five to six days of production loss due to the storm or about 6% of the quarter. As mentioned, we recognize higher than average swim revenue from our wind leases. The storm was more impactful to our water business where our downtime was 10 and a half days or about 12% of the quarter. We fortunately had preventative steps in place well ahead of the storm, including emergency protocols, winterization efforts, and initiatives to protect our infrastructure. As a result, aside from the downtime, we did not incur material cost or damage to our assets from the storm. Texas Pacific Water Resources was the final remaining source of water for producers in the Northern Delaware as the storm hit and the first to resume production. In the first quarter, we are very pleased to have completed our reorganization from a trust to a corporation. We feel this enhanced corporate governance structure better aligns the interests of management, the board, and shareholders. It also allows us to become eligible for certain indexes, which opens us up to a broader base of investors. We view this as a starting point rather than a finish line for continuing to improve our corporate governance, and to that end, we are engaged in implementing a formal environmental, social, and governance policy later this year. We look forward to discussing our ESG efforts with you in future messages. Looking ahead, we are focused on increasing efficiencies in our existing business lines and continuing to grow our market share. We may also take advantage of opportunities for bolt-on acquisitions that align with our core revenue streams. As noted, while E&P is dominated by larger players, we operate within a highly fragmented segment of the Permian ecosystem. Historically, we have funded our acquisitions through our cash flow and we expect this to continue. However, at the end of the day, there is a tremendous amount of value embedded in this portfolio, and we do not need to chase acquisitions in order to achieve outsized growth. We will remain opportunistic, and we have extensive relationships across the Permian which provide us with unique visibility into M&A deal flow. Now, I will turn it over to Robert to discuss our financials. Thank you, Todd.

Beginning with our operating results, For the first quarter of 2021, we had net income of $50.1 million or $6.45 per common share. This compares to $57.4 million in net income or $7.40 per sub-share certificate in the same quarter of the prior year, a decrease of $7.3 million or $0.95 per share. For clarity, when the reorganization was completed in January of this year, We converted these sub-share certificates to common shares on a one-to-one basis, so the number of shares outstanding for each period is identical. The decrease in net income and earnings per share is primarily due to a $14 million decrease in water sales revenue, which I'll detail shortly. This decrease in water sales revenue was partially offset by an increase of $7.2 million in oil and gas royalty revenue in the first quarter of 2021 compared to first quarter of 2020. Now moving to revenue detail. Total revenue for the first quarter of 2021 was $84.2 million compared to $96.6 million for the same quarter last year. Oil and gas royalty revenue increased 16.9% to $49.5 million as compared to the prior year. This increase was due to an $8.8 million increase in gas royalty revenue, primarily driven by a 121% increase in the average realized price in the first quarter of 2021 as compared to first quarter of 2020. Water sales revenue was $13 million in the first quarter of 2021, down from $27 million in the prior year. This decrease was primarily due to an approximately 41% decrease in the number of sourced and treated barrels of water sold in the first quarter of 2021 as compared to our record level of sales in the first quarter of 2020. This is a direct result of the decreased pace of development employed by operators as they manage their capital allocation following the onset of COVID-19 and the disruption caused by OPEC Plus decisions in the first quarter of last year. Produced water royalty revenue was $12.5 million for first quarter of 2021 and 2020. Please note that beginning this quarter, produced water royalties are shown on a separate line on the income statement to give clarity to the readers of our financials. They were previously included in the easements and other surface-related revenue line item. Produced water royalties were impacted by the winter storm, with February volumes down 27% compared to January. Easements and other surface-related revenue was $9 million, down from $13.8 million in the prior year quarter. This was primarily due to a decrease in pipeline easement income of $4.9 million, which is again related to the decreased pace of development in first quarter 2021 compared to first quarter of 2020. The decrease was partially offset by a $2 million increase in wind revenue year over year as a result of the higher electrical rates during the winter storm. Moving to the expense side, Our largest cost savings were on water service related expenses, which were $3.3 million, down from $6.8 million in the prior year's quarter, a decrease of 51.4%. This decrease was primarily a result of the lower water sales volumes previously discussed. In addition, we continue to see cost savings due to our capital spend on electrifying our water sourcing infrastructure. The use of electricity in lieu of diesel-powered generators reduces costs for equipment rental, fuel, and maintenance and repairs. Salary and related employee expenses were $10 million, down from $10.6 million in the prior year. G&A expenses were $2.8 million, down from $3 million in the same quarter last year. These contributed to a total reduction in operating expenses from $26.1 million in the first quarter of 2020 to $22.1 million in the first quarter of 2021. Lastly, cash flow from operating activities for the first quarter was $52.4 million. Now, turning to our balance sheet, as of the end of the first quarter, we had $310.7 million of cash and cash equivalent an increase of $29.6 million from year-end 2020. We continue to carry no debt, as Ty mentioned previously. We did not purchase or sell any land or oil and gas royalty interest in the first quarter. In the first quarter of 2021, we invested $2.7 million in capital to maintain and enhance our water sourcing assets. As discussed previously, The bulk of the investment was on electrifying our water sourcing infrastructure to further reduce our water sourcing and transportation costs. Looking forward for the balance of 2021, we anticipate spending an additional $7 to $9 million of capital on our water sourcing infrastructure. With regard to the dividend, for the first quarter, our board has declared a cash dividend of $2.75 per common share payable on June 15 to shareholders of record as of June 8. The Board will continue to evaluate additional dividends in the future. We did not repurchase any common stock in the first quarter. However, on May 3, our Board of Directors approved a stock repurchase program to purchase up to an aggregate of $20 million of our outstanding stock through December 31st, 2021. We plan to enter into a 10b-5-1 trading plan that would generally permit the company to repurchase shares at times when it might otherwise be prevented from doing so under securities laws. In conclusion, we will continue to evaluate our options and be disciplined in our capital decisions in order to maximize shareholder value through distributions, share repurchases, and select investment activity. Now back to Ty.

Thanks, Robert. Before we go to Q&A, I want to conclude by thanking Robert for his years of outstanding service to TPL as CFO. As previously announced, Robert will retire at the end of May and will be succeeded by Chris Stedham, our Vice President of Finance and Investor Relations. We will miss Robert greatly, and we know that Chris will continue to build on the achievements that Robert has helped us realize. With that, operator, we will now take questions.

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 to remove your question from the queue. For participants using speaker equipment, it may be necessary for you to pick up your handset before pressing the start keys. One moment while we poll for questions. Our first question comes from the line of Derek Whitfield with CIFL. You may proceed with your question.

Good morning, all, and congrats on a strong quarter and update. It's certainly a nice start for your first call.

Thanks, Derek.

With my first question, I wanted to focus on your return of capital strategy and thinking about your share buyback announcement and your strong cash position. Could you speak to your long-term strategic view on return of capital and what's the right balance between stock repurchases and dividends?

Yeah. Hey, Derek. This is Ty. Thanks for the question. To give you a little bit of color on that, TPL has increased its dividend consistently over the last 17 plus years. We've paid a dividend much longer than that. I mean, ultimately those decisions are made at the board level, but we're very confident that our board is focused on making the best capital allocation decisions for our shareholders.

And as my follow-up, and perhaps focusing it with you, Ty, shifting over to growth, regarding the potential outside growth opportunities referenced in your press release and prepared comments, could you speak to your appetite for acquisitions and the parameters you would use to assess such opportunities?

Yeah, for sure. Look, we're definitely going to evaluate assets across all of our revenue streams, you know, oil and gas, the slim business, the water company. I think there's going to be opportunities across all three of those. I mean, ultimately, you know, we're focused on core Permian assets. We want exposure to tier one operators because we feel like those assets perform best through the cycle. You know, our focus is on assets that have good visibility to development timing and fit in well with our existing portfolio of high-quality Permian assets. You know, historically, we've funded these types of transactions through our cash flow. But I think, you know, we're in a very unique position where we don't need to chase acquisitions, you know, in order to achieve growth. So we're going to remain opportunistic and stay very patient and disciplined.

Certainly makes sense. And shifting over to production visibility, could you share your thoughts on your production profile for the balance of the year based on your current duckback, clog, and rig activity? And additionally, perhaps comment on your permits and if they support a sustained level of rig activity.

Hey, Derek, this is Chris. I'll take that question. You know, as I look back, Starting in September, we probably started to see about 50 completions happening every month. And that, you know, continued definitely through January. With the February storm, it probably slowed down a little bit. But if you kind of think about our duck inventory, which is a little bit above 500 ducks, you know, that certainly is enough to get you through the end of the year at that pace if the operators wanted to continue. And, you know, to Ty's point, when you think about the permitting pace, I think we saw something like 170 new permits over the course of the first quarter. And so, again, that would definitely support kind of the pace that we'd seen at the end of the year. So we feel really good that given the current duck count and permit count, we've got good visibility for them to continue on kind of the pace that we saw at the end of last year. Yeah.

Great. And then as my final question, really more housekeeping in nature, could you offer your production split by product for Q1 and comment on the winter storm year impact on royalty production?

Yeah, sure, Derek. This is Chris again. For Q1, we saw our oil production was probably about 43% to 44% of the total production. Gas was just slightly above 30%, and NGLs were the balance. And I think when you think about the impact, you know, as Ty had said in his prepared remarks for February, for most of the operators, I think five to six days of downtime in terms of production is kind of what we've tended to see. You know, if you look at our produced water royalties as another good analog, it was down about 27%. And that would translate to about six or seven days. And so I think across the board, when you think of that kind of five to seven day window of downtime for production, I think that's probably what expectations should be for February.

That's great. Thanks for your time and thoughtful responses.

Thanks, Derek.

Thanks, Derek. Thank you.

Our next question comes from the line of Chris Baker with Credit Suisse. You may proceed with your question.

Hey, good morning, guys, and thanks for the host and the call. Derek covered most of it, but I was just hoping that since this is the sort of first public call, you could reflect a bit on, you know, the different pieces of the portfolio, how they performed last year, you know, given 2020 was pretty challenging, but just any color around sort of the different moving pieces there would be helpful.

Yeah, you know, as I mentioned, this is Ty. As I mentioned earlier, you know, 2020 was actually our second best year in the company's history. So, you know, as a whole, our asset performed pretty well. You know, one thing that we saw that I would highlight was the produced water royalty side of the business. You know, that side of the business actually saw, you know, roughly 30% over the year. So it was actually a very nice hedge for some of the other businesses that didn't perform quite as well. You know, and then like we mentioned earlier, the win revenue in February, I think just a lot of the hidden value in TPL and the natural hedges that are built into the business are, you know, a huge highlight and competitive advantage for TPL over some of the others in the industry.

That's great. And just as a follow-up, We'll look forward to getting the formal ESG report later this year, but could you just maybe expand on how you guys are thinking about ESG? You know, I think relative to EMPs, at least from my view, you know, the lack of Scope 1 emissions is a pretty clear differentiator, but just wondering how you guys are thinking about that potential opportunity.

Yeah, look, again, this is Ty. I mean, we see it as a big opportunity for us. We're very excited about it. I think the reduction in flaring that we've seen as a percentage of our production, just with the infrastructure that we've helped to plan and get built out on our property has been a big win for us over the last few years. A great opportunity for us to work with our operators and kind of be a problem solver there as well and just increase that relationship So again, yeah, I look forward to getting that message out there and super excited about it.

Great. Thanks, guys.

Thank you. Thank you.

Ladies and gentlemen, we have reached the end of today's question and answer session. This does conclude today's conference. You may disconnect your lines at this time. Thank you for your participation and