Texas Pacific Land Corporation

Greetings and welcome to Texas Pacific Land Corporation second quarter 2021 earnings call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Sean Animi of Investor Relations.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's second 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 this call, we'll also be discussing certain non-GAAP financial measures. More information and reconciliations about these non-GAAP financial measures are contained in our earnings 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, Chris Stedham. Management will make some prepared comments, after which we will open the call for questions. Now, I will turn the call over to Ty.

Thanks, Sean, and thank you, everyone, for joining us today. I'll begin with an overview of our quarterly performance, and then I'll turn it over to Chris to discuss our financial results in more detail. Oil and gas royalties had a strong quarter supported by solid activity levels across the Permian Basin and higher oil prices. Production during the quarter averaged approximately 16,400 barrels of oil equivalent per day, which is roughly flat sequentially from first quarter 2021. In an effort to provide investors additional useful information, TPL has disclosed three stream production and realized pricing figures in our recently filed 10Q and earnings press release. For second quarter 2021, our production mix was 46% oil, 31% natural gas, and 23% natural gas liquids. Our oil price realizations during second quarter 2021 averaged $65 per barrel, which was 18% higher compared to first quarter 2021. CPL did not carry any commodity price hedges during the most recent quarter, so we benefited fully from the oil price rally, and we currently remain unhedged. As of June 30th, TPL royalty inventory included 565 gross drilled but uncompleted wells, or DUCs, and 474 gross permits. From our vantage point, producers remain disciplined, especially the publicly traded integrators and large independents. Though not at pre-COVID activity levels, these producers still remain active in developing their leasehold and based on trends with new permits and DUCs. we think TPL production in the second half of 2021 will be at least on par compared to first half of 2021. Next, for our surface leases, easements, and material sales, or SLIM, total revenues were about flat sequentially from the first quarter of 2021. We saw a nice uptick in pipeline easement and collegiate sales during the second quarter, which generally reflects healthy Permian activity levels. Turning to water, Produced water royalty revenues during the quarter were up over 20% sequentially from first quarter 2021. We benefited from a one-time catch-up payment from a customer. Although excluding this benefit, produced water revenues were still up nicely from last quarter. Produced water continues to provide stable, high-margin royalty cash flows without the direct exposure to commodity prices. Our source water sales were roughly flat compared to the first quarter 2021, Source water sales volumes were negatively impacted by four to five days of system downtime due to flash flooding. TPL continues efforts to electrify our water operations, and we expect to realize cost savings and reduce our emissions once completed. Before I turn it over to Chris, I'd like to summarize the uniqueness of our value proposition and the remarkable opportunity we believe TPL provides. We call ourselves the ETF of the Permian Basin because we can benefit throughout the entire lifecycle of a well, generating multiple cash flow streams through this value chain. Generally, before an operator begins development, they first call us for easements, surface leases, and colicci so they can start constructing and installing vital infrastructure. As development progresses, we often supply the water that is necessary for drilling the wellbore and fracking the shale reservoir. As a well begins producing hydrocarbons, it will also flow back water, and TPL collects royalties on most produced water that crosses or is disposed of on our land. We leverage this entire integrated value chain to incentivize timely and efficient development on our royalty acreage. And of course, TPL's royalty interests benefit directly from all the oil and gas production that flows from a well. Although there is uncertainty with the ongoing impact of COVID-19 on the global economy, and there is always uncertainty with future commodity prices, we are confident about our position in the Permian, and we believe the asset quality underlying our role as an extensive surface acreage footprint will create tremendous value over the long term. Now, I'll turn it over to Chris to discuss our financials.

Thank you, Ty. Beginning with our operating results. For the second quarter of 2021, we had net income of $57 million, or $7.36 per share. This compares to $27.6 million in net income, or $3.56 per share, in the same quarter of the prior year. The increase in net income and earnings per share in the second quarter is primarily due to an increase in oil and gas royalty revenue. and partially offset by a decrease in easements and surface-related income in the second quarter of 2021 compared to the second quarter of 2020. Total revenue for the second quarter of 2021 was $95.9 million compared to $57.3 million for the same quarter last year. Oil and gas royalty revenue increased 184% to $58.2 million as compared to the prior year quarter. Production volumes were approximately 16,400 BOE per day in the second quarter of 2021 compared to 15,700 BOE per day for the second quarter of 2020. The average realized price of oil was approximately $65 per barrel in the second quarter of 2021 compared to approximately $25 per barrel during the same period last year. Water revenue was $27.9 million in the second quarter of 2021 up from $21.5 million in the prior year. This increase was primarily due to year-over-year increases in both source water sales volumes and produce water royalty volumes. Easements and other surface-related revenue was $9 million, down from $11.7 million in the prior year quarter. This was primarily due to a decrease in pipeline easement income of $3.8 million. Moving to the expense side, Operating expenses were $24.7 million for the second quarter of 2021, up from $22.5 million in the second quarter of 2020. The increase was primarily due to $4.7 million related to severance costs, partially offset by a decrease of $1.5 million in legal expenses and professional fees. Adjusted EBITDA was $80.3 million compared to $40.6 million for the same period last year. Turning to our balance sheet, at the end of the second quarter, we had $329 million of cash and cash equivalents, and we continue to carry no debt. In the second quarter of 2021, capital expenditures were $2.2 million, which was spent primarily for electrifying our water sourcing infrastructure. Looking to the balance of 2021, we anticipate spending an additional $5 to $7 million of capital on our water sourcing infrastructure. On August 3rd, our board declared a cash dividend of $2.75 per share payable on September 15th to shareholders of record as of September 8th. Through June 30th, our year-to-date dividends total $5.50 per share. Under our recently authorized share repurchase program, we bought back 1,633 shares of stock at an average per share price of $1,533. As of June 30th, we have $17.5 million remaining on the current repurchase authorization. Finally, TPL recently joined the Russell 1000 Index. This is a great milestone for the company, and we're glad to be new members of the index. We look forward to engaging with a growing set of investors. With that, operator, we will now take questions.

Thank you. If you would like to ask a question, please press star 1 on your telephone keypad and a confirmation tone will indicate your line is in the queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question is from Chris Baker with Credit Suisse. Please proceed.

Hey, good morning, guys. Maybe one for Ty. Just would love to hear a bit more about the approach to capital allocation and where you guys see the most attractive opportunities today.

Yeah, Chris, thanks for the question. You know, look, we're always looking for deals. We're We're very picky. That's one of the benefits of being TPL. We don't have to buy to grow. So we can be very disciplined in our approach. But, you know, deal flows up and there's some attractive packages out there. So we're definitely looking.

And, Chris, I would just add, you know, the benefit that we have as well with, you know, strong cash balances, it just gives us a lot of optionality. So whether that's potential deals in the market, you know, increasing dividends. It just really allows us to pick and choose what's the best return at any given time. And we love that optionality.

That's great. And then just as a follow-up, you know, great to see the additional disclosure around volumes. You know, I know you guys said in terms of the near-term production outlook that you expect the second half to be, you know, at least flat with the first half. Do you have a sense of how many net wells you'd need to come online in sort of a maintenance scenario? I'm just trying to frame up that 7.9 net duck well backlog.

Sure. Yeah, I think, and I'm going to, when I refer to the net wells right now, I'm going to kind of refer to them on like a net normalized basis because what we've seen through time, right, is the lateral links have tended to increase. And so, again, If you just said an average net well is a mile and a half well, I think something like seven net wells would be enough for us to maintain our production. And maybe some simple math to think about is our base level of production, you may lose something like 6,000 BOE, so call it 35% to 40% over the course of the year. And for us, each one of those net wells that's, again, like a mile and a half of normalized well it probably does something like 800 to 900 boe per day on average through the course of the year so seven of those wells would would kind of replace that production you would see through the normal decline and the one other thing i would reference um you know if you use that same normalized basis our duct number is probably like nine net wells if you normalize it so the 7.9 is because on average those wells are a little bit longer than a mile and a half. So we've got a pretty robust level of current inventory that I think, you know, to Ty's point in the earlier comments, would certainly support us being able to hold production flat. And, you know, at the current rate that we've seen people bringing wells online in 4Q and 1Q and starting to get data coming in in 2Q, they'd probably be a little bit ahead of that pace.

Okay, great. Appreciate the comments.

Thanks a lot, Chris.

Our next question is from Hamed Korsand with BWS Financial. Please proceed.

Hey, good morning. Just a follow-up on the capital allocation. Would you be willing to go into debt if there was the appropriate or valuable asset that is available to you?

Hey Ahmed, this is Chris. You know, look, I think in general, we've always managed this business without any debt. And we even like having a very strong cash position. And so, you know, I would never say never, but I think we tend to err toward a very low leverage profile for TPL. And so I would say that in general, we would probably tend to capitalize with cash on the balance sheet or other ways. But if there was an excellent opportunity and it required a little bit of debt financing, we would consider that.

Okay. And my other question was, given the amount of attention in the headlines about the deals being out there, have you seen any kind of change in activity or posturing as far as potential new production or potential new customers for you? or is this purely being done with the price of oil?

Yeah, you know, I would say through a lot of the consolidation, we now have exposure to a couple operators. So, you know, that's been good for TPL. You know, we've gained a couple of really good relationships through some of the consolidation that's happened recently. Okay, thank you. Thanks, Matt.

Our next question is from Derek Whitfield with Stifel. Please proceed.

Thanks, and good morning, all.

Hey, Derek. Good morning.

Hey, Derek. Shifting back over to the organic growth side of the equation, could you speak to your expectations for activity based on what you're seeing in your latest permit scrapes? Based on Chevron's Q2 earnings commentary, the activity in your northern Delaware operating area is likely biased higher sooner than what we were expecting. I'd love to get your views on that.

Yeah, Derek, hey. I would say in general, when we look at the permitting activity, it continues to be really robust. It probably really started to pick up in one queue of 21. So we had a pretty robust level of new permits. Really, when we look at them though, Oxy was actually probably the biggest set of permits that we saw, especially in Q1. And then in the second quarter, fairly even level of permits across most of our operators. And so I would just kind of, again, also point back to when you think about the nets, right, the net permits that are coming online, it would continue to support kind of the level of new wells that we see brought online, new ducts that are getting drilled. It's probably something in the kind of mid-two net permits that are coming online each quarter. And so in general, I think it continues to be pretty robust and continues to kind of support the current pace of development that we've seen in the last two quarters, which has been encouraging.

Great. And then with my follow-up, moving over to the water side of your business, how are you thinking about the trajectory of your 2021 and 2022 capture rates for the SWD and source water businesses?

Yeah, you know, we've got pretty robust capture rates on both the source water and produce water side. You know, like we said in the prepared remarks, the produce water business just continues to show growth and be a strong business. You know, that thing has been steady even through 2020 and, you know, year to date this year, we just continue to see growth. A lot of that is from volume realization through existing contracts that our team has locked up. We've got very expansive long-term contracts across the majority of the northern Delaware basin, and the team's done a great job and continues to do a great job locking up additional contracts and bringing wells online into those systems that we have a royalty on. So very strong business, and I think it's going to continue to be strong for us.

That's great. Maybe one final question for me. With the understanding that you own a high margin, low capital intensity business with a pristine balance sheet, could you speak to your appetite to hedge your second half 21 and 2022 production profile to lock in your relatively strong oil and gas, really more specifically prices?

Yeah. Hey, Derek. You know, TPL, we've always managed this business without any hedges. And I think one of the benefits of, like you said, that we're fortunate to have a very high margin business is it can withstand the volatility that this industry sometimes brings forth. And 2020 was a great example of that. And despite the fact that we were unhedged, at the end of the day, it was one of our best years ever. And so I think You know, a lot of the folks that invest in TPL like the fact that we kind of provide that exposure. And, you know, one of the benefits of being unhedged was, you know, during this year, we've gotten the full, you know, exposure to these great recovery in prices really across the board. I mean, oil, gas, NGLs, everything is significantly up from last year. And so just given the nature of our business and our ability to weather the, you know, the storms that come, you know, I think we would continue to just remain unhedged. I think 2020 was a great showcase that this business will do just fine, even through some difficult times. And it's nice to be able to fully realize those good times when the commodity cycle turns the other way. And so I think we would generally continue that approach in the future.

Makes sense. And great update today. And thanks for your time.

Thanks, Derek. Thanks, Derek.

Thank you. There are no more questions at this time, and this will end today's conference. You may disconnect your lines at this time. Thank you very much for your participation, and have a great day.