Texas Pacific Land Corporation

Greetings and welcome to the Texas Pacific Land Corporation third 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. It is now my pleasure to introduce Sean Amini, Vice President of Finance and Investor Relations Thank you. You may begin.

Good morning. Thank you for joining us today for Texas Pacific Land Corporation's third 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 will 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. 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.

Thank you, Sean, and good morning, everyone. Third quarter 2021 was a tremendous quarter. TPL set quarterly records for consolidated adjusted EBITDA and royalty production. This was our second best quarter for revenues in our water business, and what a difference a year makes. Compared to the same quarter last year, our total consolidated revenues are up 66%, royalty daily production is up 24%, total water revenues are up 51%, and total consolidated free cash flow is up 60%. Although the past 18 months have been among the toughest we've seen in the industry, TPL's vertically integrated business model, high margin cash flows, and strong balance sheet allowed us to successfully navigate through the downturn. One metric we focus on and prioritize and I think demonstrates the resiliency and quality of our overall business, is our consolidated adjusted EBITDA margin. For the first half of 2021, our adjusted EBITDA margin was 83%. Amongst members of the S&P Oil and Gas Exploration and Production Index, which includes TPL, our first half 2021 adjusted EBITDA margin was the highest of the group. If TPL were a member of the S&P 500, our adjusted EBITDA margin would have been in the top 10 for the same period. For this most recent quarter, our adjusted EBITDA margin has improved even further to 87%. Today, with higher commodity prices and continued growth in the Permian Basin, combined with years of hard work by the TPL team in developing and executing our vertically integrated business model, We're pleased to be in a position to fully capture the value from our asset base. Our active management approach has taken our legacy asset base, which was both ideally situated, yet raw and underdeveloped, and created multiple high-quality cash flow streams. To this point, today I want to highlight and elaborate on our water business. Our water business is a clear example of the benefits of our active management approach. Prior to active management, TPL had minimal revenues outside of its legacy production royalty interest, despite owning close to a million surface acres in the Permian. As drilling and completion techniques continued to improve over the last decade, the vast resource potential underlying our royalty assets became increasingly viable. However, development here is not without challenges, especially in the western part of the Permian, generally known as the Delaware Basin. where a majority of our high-interest royalties reside. On the Delaware side of the Permian, the geography tends to be much more arid and just generally inhospitable compared to the eastern flank of the basin. In fact, Loving County in Texas, which is considered to be part of the core of the Delaware Basin, is the least populated county in the contiguous United States. Reeves and Culberson counties sit to the west of Loving, and these counties are no less desolate and arguably even more arid than Loving. These geographical features are relevant because water is scarce in this part of the Delaware, and well development would be impossible without tremendous amounts of water. Completing a horizontal well, otherwise known as fracking, requires approximately half a million barrels of water. This lack of water availability was a major reason development in the Delaware Basin initially lagged behind the development in the Midland Basin. That's why in 2017 we formed Texas Pacific Water Resources. This represented a departure from the legacy way of doing business at TPL, which up to that point was mostly passively run with just a handful of employees. We went out and hired a talented and experienced team of professionals from some of the best companies in the industry to execute our plan. From there, we developed two general sides to our new water business, the first being source water and the second being produced water. Starting with source water, this is where we provide brackish groundwater and, to a lesser extent, treated produce water to oil and gas operators for use in their well development activities. As surface owners, TPL has the unique right to water aquifers on our land and across our 880,000 surface acres. We have a handful of locations with productive aquifers. Over the last few years, we've invested approximately $105 million in developing aquifer wells, laying transfer pipelines and pumps, and constructing frack water storage ponds. We strategically selected and developed this water infrastructure throughout our acreage footprint to efficiently service the greatest number of oil and gas wells across the Permian Basin. In order to maximize capital efficiency and margins, we generally require producers to come to our frack water ponds to take delivery of our water. From there, the operators take responsibility for developing the infrastructure and managing the logistics, transferring water from our frack ponds to their well pads. It's worth noting that today, operators generally develop multiple wells simultaneously on a single development pad. Operators have also become more efficient in completing multiple frack stages for multiple wells in an increasingly condensed amount of time. Laterals are also getting much longer. Thus, operators often need millions of barrels of water delivered over a course of just a few days, which is no easy task if you're trying to source water from multiple small sources. At TPL, we've sized and developed our source water infrastructure to accommodate the needs of the most demanding producers. The outcome of this very deliberate effort is that our source water business was instrumental in enabling and incentivizing production on our royalty acreage in the Delaware. Although development in the overall Delaware has grown tremendously over the last five years, production on our acreage has grown even more. Additionally, we often sell water for wells that may not be located on our acreage, so our water has been vital for well development in the Delaware even outside of our footprint. And this also drives additional surface revenue for TPL. During this most recent quarter, over 70% of our source water sales were for wells that were located off of TPL's surface, which is directly attributable to the industry relationships our team has. Historically, we estimate that our market share has been approximately 30% of Northern Delaware source water volumes. We have capability to deliver over 800,000 barrels of water per day without meaningful additional capital expenditures. This past quarter, we delivered 42 million barrels of water to our customers. I'm confident that without our source water business, oil and gas production in the Delaware overall and production on TPL's royalty specifically would be meaningfully less than what it is today. Our water is vital for Permian producers to develop their acreage, and we actively leverage our source water and our surface rights to drive more production onto TPL's royalty acreage. Today, we have an extremely talented group of people that focus exclusively on serving our customers, to encourage production on our land, and to make sure that we are a reliable partner in delivering water. That's worth noting because our source water is an operated business, and as such, our cash flow margins are understandably lower than our oil and gas royalties business. Our source water assets still generate strong cash flow margins and profitability, and our investment in the water business has generated meaningful free cash flow. Later on, the additional impact of using our water to incentivize development onto TPL's royalty acreage and our source water business has generated tremendous value for our shareholders. The other side of the water business is referred to as produced water royalties or also referred to as saltwater disposal royalties. This is where we charge a fee for water from a producing oil and gas well that is disposed of on or crosses our land. As many are already aware, oil and gas wells in the Delaware are unique in that these wells produce a disproportionately high amount of water along with the oil and natural gas volumes compared to other basins. This associated water is referred to as produced water. And generally, the water must either be injected into a saltwater disposal well or treated for reuse elsewhere. Unlike our source water business, our produced water business requires no capital investment from us. Whereas we operate our source water assets so that we can control our own destiny towards incentivizing development, our produced water royalties leverage our expansive checkerboarded surface footprint to create value. Our customers are generally either operators that own their own infrastructure or water midstream companies that specialize in handling produced water on behalf of operators. Because we don't develop, own, or operate saltwater disposal wells or the logistics pipelines, our produced water royalties are high margin, fee-based cash flows that require no capital expenditures. And because producing wells are almost never shut in outside of rare circumstances, the volumes are very stable. 2020 was a great example of the resiliency of this business. Despite one of the worst down cycles this industry has ever seen, And with severely depressed commodity prices, our produce water revenues in 2020 were 30% higher than in 2019. Again, our produce water business is a testament to our active management approach. Prior to active management, our produce water royalty cash flows were minimal and little time and effort was spent on maximizing its value. Today, TPL's management and water teams dedicate a tremendous amount of time and effort in forcing our surface rights negotiating fees at fair value, and monitoring compliance. In summary, over the last 12 months alone, our water business has generated approximately $113 million in revenues and $50 million in net income. And since 2017, when we started the business, we've generated over $445 million in revenues and $210 million of net income. The water business generates robust free cash flow and requires relatively modest amounts of maintenance capital, approximately $10 million annually. Our investment in people and capital has been a highly profitable endeavor, and we expect our investment to continue generating strong free cash flow and value for our shareholders. We're extremely proud of the business we have built. We're focused on making it better and more profitable every day, and we're glad that our shareholders have reaped those rewards. With that, I'll turn the call over to Chris.

Beginning with our operating results, for the third quarter of 2021, we had net income of $83.8 million, or $10.82 per share. This compares to $46.3 million of net income or $5.97 per share in the same quarter of the prior year. The increase in net income and earnings per share in the third quarter is primarily due to an increase in royalty and source water revenues compared to the third quarter of 2020. Total revenue for the third quarter of 2021 was $123.7 million compared to $74.4 million for the same quarter last year. a 66% year-over-year increase. Adjusted EBITDA was $107.6 million compared to $62.3 million for the same period last year. Oil and gas royalty production volumes were approximately 19.5 thousand barrels of oil equivalent per day in the third quarter of 2021 compared to 15.7 thousand barrels of oil equivalent per day for the third quarter of 2020. Production this quarter benefited from the increased activity on our royalty acreage and from production associated with periods prior to the beginning of the most recent quarter. We were able to fully benefit from rising oil, natural gas, and NGL prices as we were completely unhedged during the quarter and we currently remain unhedged today. At the end of the third quarter 2021, TPL's royalty acreage had 7.3 net well permits, 7.8 net drilled but uncompleted wells, 1.9 net completed wells, and 45.5 net producing wells. Water revenue was $36.9 million in the third quarter of 2021, up from 24.5 million in the prior year. This increase was primarily due to year-over-year increases in both source water sales volumes and produced water royalty volumes. Moving to the expense side, operating expenses were $20.5 million for the third quarter of 2021, up from $17.6 million in the third quarter of 2020. Turning to our balance sheet, at the end of the third quarter, we had $373 million of cash and cash equivalents, and we continued to carry no debt. In the third quarter of 2021, capital expenditures were $6.6 million, which was spent on electrifying our sourcing infrastructure and investments in corporate assets. Looking to the balance of 2021, we anticipate spending an additional $3 to $5 million of capital on our water sourcing infrastructure. On October 28th, our board declared a cash dividend of $2.75 per common share payable on December 15th to shareholders of record as of December 8th. Through September 30th, our year-to-date dividends totaled $8.25 per share. Under our recently authorized share repurchase program, we bought back 6,179 shares of stock at an average price per share of $1,406 during the current quarter. As of September 30th, we have completed $11.2 million of share repurchases and have $8.8 million remaining on the current repurchase authorizations. In August, TPL released its inaugural ESG disclosure. We believe this is a reflection of our existing commitments and priorities surrounding sustainability, social responsibility, and governance. We look forward to building upon these objectives, and we believe TPL is uniquely positioned to provide collaborative opportunities with customers and companies that operate on our land to drive sustainability and ensure that our industry benefits all stakeholders. With that operator, we will now take questions.

Thank you. We will now 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 tool will indicate your line is in the question queue. You may press star 2 to remove yourself 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 your questions. Our first questions come from the line of John Annis with Stifel. Please proceed with your questions.

Good morning, all, and congrats on a strong update. My first question is around activity. Good morning. Based on Q3 commentary from Chevron regarding increasing activity in the Permian and the rig ads from Privates, could you frame up how you see activity trending in Q4 and into 2022 based on your latest permit scrapes?

Yeah, sure, John. Hey, this is Chris. Thanks for the question. So, yeah, we definitely have seen and continue to see strong permitting activity. You know, just as reference, in the first quarter, that probably on a net permit basis remained the best quarter that we saw so far this year. The second quarter was a little bit slower, but then we saw another big uptick in the third quarter. And Chevron, for instance, was one of the companies who filed quite a few permits in 3Q and was definitely up from their level of permitting activity on TPL during the first half of the year. And so with the backlog of permits that we see today, I think we view that as a very positive indication for fourth quarter and continuing on into 2022. Great.

And then for my follow-up, perhaps for Ty, Given the increase in commodity prices, could you speak to the A&D market and the current opportunity set, and then perhaps touching on your appetite to pursue potential opportunities?

Yeah, sure. Thanks for the question. You know, we've looked at quite a few deals lately. You know, as we've said, our bar, you know, just for TPL is pretty high. And the bid-ask spread on those high-quality deals has been a little wider in the past, but we're starting to see that narrow with commodity prices where they're at. We've seen a lot more deals start to come on, hit the market last couple of months, so that's a big positive for us. We've seen a lot of competition on the smaller deals, but starting to see some bigger deals hit the market, so we feel really good about it.

Perfect. Thanks for the color. And if I could squeeze one last question in, thinking about your strong cash position, could you speak to your view on the progression of your return of capital strategy as we look forward in time?

Yes. Again, I think like Ty said, when you think about TPL's capitalization, for one, because we carry no debt and no RBL funds, maintaining a healthy cash balance has always been, and to the extent that that remains the case, will always be a big part of our strategy. And so, as Ty has alluded, I think when we think about that cash balance, from our perspective, it provides a lot of optionality and value to us to be able to utilize that in the near term And so when we think about it, we think that with the opportunity set in front of us, we like having that large cash balance to be able to utilize if the right opportunity comes along.

Thank you. Our next questions come from the line of Hamad Korsant with BWS Financial. Please proceed with your questions.

Good morning. I just wanted to see, given that the dynamics of the players involved in the Permian is changing, how does that change your business in any way as far as elongating the negotiations for royalties? you know, maybe the new players aren't well worse than how the industry works in the Permian?

Hey, this is Ty. I mean, I would say most of the consolidation that we've seen has been between, like, legacy Permian operators, most of whom we, you know, have existing relationships with. We have gained a couple of, you know, new additional strong relationships through some of the consolidation. But I think overall for us, it's been, you know, positive across all of our business lines. You know, just with where our acreage sits, the relationships we have, you know, it prioritizes some of our acreage that may not have been previous to some of this consolidation. So I would say overall it's been very positive for TPL.

And my other question was, do you expect an increase in your Delaware Basin acreage use in 22? And how much, if you can talk about how much that would look like?

Yeah, I mean, as Chris alluded to earlier, we saw strong permitting from our top three were Chevron, EOG, and Simerex. And third quarter, you know, that's all Delaware Basin. You know, Oxyshell and Exxon were four, five, and six. You know, vast majority of that's Delaware Basin as well. So, yeah, I think, you know, everything that we're seeing indicates stronger activity in the Delaware going forward.

Okay, great. Thank you. Thanks, Matt. Thanks, Matt. Thank you.

Our next questions come from the line of Chris Baker with Credit Suisse. Please proceed with your questions.

Hey, good morning, guys. Thanks for taking the questions. I just wanted to follow up on the strategic outlook. You talked about wanting to retain cash for the right opportunity, which makes some sense. I mean, if I think about the inventory depth today, it's already well ahead of peers. And, you know, clearly between that and the robust growth this quarter, could you maybe just talk about the kind of opportunities and what's sort of at the top of your punch list when it comes to, you know, potentially deploying that excess cash?

Yeah, you know, like I stated before, our bar is pretty high. So we're looking for, you know, very similar quality to what we already own. We like the vertically integrated nature of our assets. So, you know, always interested in, and integrated assets going forward, something where we can buy the surface, the minerals, it's got a water component. I don't think our focus has changed any from what we've talked about in the past. Like I said, on those really high-quality assets, the bid-ask spread has been a bit wider in the past, but we're starting to see that narrow, so we feel really good about the opportunity set and our ability to transact in the near term, and that's You know, as Chris alluded to, that's why we're going to hold on to some dry powder.

Great. And then, you know, just in terms of in the sort of potential for that bid-ask spread to remain wider than you'd like, could you maybe talk about the potential for either a special dividend or perhaps an expanded buyback authorization as a way to return cash that you're not able to deploy? Yeah.

Hey, Chris. Look, certainly at some point, if it becomes clear that the opportunity set, for whatever reason, bid-ask spread or other, isn't materializing, then I think both of those are on the table, and, you know, our board would certainly take a look and see of those two which makes the most sense, or it could be an increase in both of those as a way to return the capitals at the shareholders, and so, you know, but in the near term, we see a lot of opportunity, and so I think, you know, we'd like to to continue to retain some of the cash. But certainly, at some point, the right thing to do would be to return it to the shareholder base.

Okay, great. And then just as a follow-up, you guys have talked a bit today about the, you know, the value of active management, which is great to hear. You know, I was just hoping if you could kind of frame up the next-gen wind and solar opportunity just in terms of extrapolating what looks like a small wind power gen exposure today to, say, 20 or 30% of the unused surface position. Is it possible just to get some rough goalposts around how large a cash flow stream that could grow to over time?

Yeah, you know, I don't know if we give you goalposts today, but what I can say is we've got a team dedicated to, you know, renewable and next-gen opportunities. They're having some really good conversations right now, you know, regarding things like solar, wind, Bitcoin mining, carbon capture, microgrids. So a lot of conversations with our operators right now, you know, around working together on some of these opportunities. So, you know, it just, again, reinforces the importance of the relationships our team has with our operators in the broader industry. So thanks for the question.

Thank you. There are no further questions at this time. We appreciate your participation. And with that, that does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.