Texas Pacific Land Corporation

Ladies and gentlemen, good morning and welcome to the Texas Pacific Land Corporation fourth quarter 2023 earnings conference call. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and zero on the telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Sean Amini, Finance and Investor Relations. Please go ahead.

Thank you for joining us today for Texas Pacific Land Corporation's fourth quarter 2023 earnings conference call. Yesterday afternoon, the company released its financial results and filed its form 10K with the Securities and Exchange Commission, which is available on the investor section of the company's website at .texaspacific.com. As a reminder, remarks made on today's conference call may include for looking statements. For looking statements are subject to risk uncertainties that may cause actual results to differ materially from those discussed today. We do not undertake any obligation to update our for looking statements in light of new information or future events. For more detailed discussion of the factors that may affect the company's results, please refer to our earnings release for this quarter and our most recent SEC filings. During this call, we will also be discussing not 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 toxic or TPL. This morning's conference call is hosted by TPL's Chief Executive Officer Ty Glover and Chief Financial Officer Chris Dedham. Management will make some prepared comments after which we will open the call for questions. Now we'll turn the call

over to Ty. Good morning everyone and thank you for joining us today. TPL ended 2023 with the best quarter we had all year. Performance was led by old and gas royalty production of approximately 26,300 barrels of oil equivalent per day, which represents 20% sequential -over-quarter growth and a new company record. We also received excellent contributions from our surface and water related businesses as they accounted for over 40% of quarterly consolidated revenues. For produce water, we generated a royalty fee on 2.7 million barrels per day during the quarter, also a record. On source water, we recorded 517,000 barrels per day of sales volumes, of which 62% were off of our footprint as demand for both brackish and treated water remain elevated. Our surface leases, easements, and materials segment, which we refer to by its acronym SLIM, generated 19 million of revenues representing 5% growth sequential -over-quarter. Performance for full year 2023 highlights the virtues of TPL's unique business model, especially during periods of volatile commodity prices. Despite oil prices falling by 18% -over-year and natural gas prices declining by 64%, our water and SLIM businesses collectively grew revenues by 30%. For fiscal year 2023, our source water revenues grew by 32% -over-year, produce water royalties grew by 17%, and SLIM grew by 48%. This strong performance from our water and surface endeavors helped to substantially offset the negative impact from lower commodity prices. Overall, TPL's business continues to operate efficiently with fiscal year 2023 adjusted EBITDA on free cash flow margins of 86% and 66%, respectively. As we look ahead to 2024, TPL is well positioned to benefit from ongoing activity in the Permian Basin. Our land and water teams remain busy, and thus far, customers have indicated intentions to maintain strong levels of development on our royalty and surface acreage. Supermajor operators in particular continue to execute on robust, growth-oriented development pacing. This is especially relevant for TPL as these large operators account for a majority of the development on TPL's royalty acreage. With respect to recent commodity price volatility, it's important to remember that TPL's royalty and surface acreage overlaps with some of the most highly economic shale within both the Delaware and Linden Basin and North America more broadly. Should we see prolonged period of weak commodity prices, we would expect operators to maintain healthy development levels across their core Permian leaseholds while triaging other parts of their non-Permian portfolio. Should oil prices remain supportive at current levels or higher, then we'd expect activity levels to support higher production. We're optimistic and encouraged by what we see so far, and we're looking forward to maximizing our opportunities for this year. Chris will have more to share later on our outlook for the Permian as a TPL's business into 2024. I would also like to spend some time this morning reiterating and elaborating on TPL's capital allocation priorities. First, our North Star is maximizing shareholder value. That's always been the goal, and that dictates everything we do here. On that point, we believe the key to maximize TPL's shareholder value is to maximize free cash flow per share. Cash is finite. Over the long term, what a company can pay in dividends, repurchase in shares, and invest in itself are fundamentally limited to the cash it generates. Thus, if we can expand free cash flow on a per share basis, and not just near term, but also long term productive capacity for future free cash flow per share, then we'll be able to sustainably and consistently increase our capacity to return greater amounts of capital back to shareholders. The more cash we can ultimately return to shareholders, the more valuable the enterprise. If maximizing free cash flow per share is the goal, the question then becomes, how do we achieve it? Our primary options are to invest in organic opportunities, buy back our stock, acquire external assets or pay dividends, or some combination thereof. Each one of those options contains an economic and strategic reality. Our job is to determine the long term returns for each option and then allocate capital accordingly. If we can do that well, we create shareholder value. In practice, there are no simple answers, but we try and solve these items with a fundamental bottoms up intrinsic value approach. Let's quickly go through our capital allocation options, deconstruct how we evaluate returns, and where those returns and priorities stand today. Starting with organic investment. Here we look at what opportunities are available to leverage the company's existing assets, people, and expertise to expand its business. Potential organic investments are predicated on generating double digit returns on capital while also balancing our preference for high margins and a capital wide business model. Our investment into the water business serves as a great case study. For most of TPL's long history, going as far back as the 19th century, there was basically zero organic investment. In 2017, that changed as we began to take advantage of TPL's unique ownership of both royalty and surface acres. Without diving too deeply into the commercial and competitive dynamics that drove why we structured the individual pieces that make up the water business, namely an operated source water business and a contracted throughput royalty for produced water, The key takeaway is that each business was deliberately and carefully commercialized to provide the optimal balance between generating high returns on investment, moderating capital requirements, enhancing the overall business profile, and ultimately maximizing long term free cash flow per share. Since 2017, we have cumulatively invested approximately 140 million of capital into the water business. The water business and returns generated about 470 million of cumulative after-tax cash flow, and that does not include any of the significant benefits we derived both from sourcing water for operator completion activities or from facilitating essential produced water solutions for oil and gas wells on TPL royalty acres. For fiscal year 2023, our water services and operations segment closed with a net PP&E balance of about 84 million, from which we generated 99 million of net income during the year, resulting in excellent returns on capital. As it stands today, we have developed the largest source water network in the broader northern Delaware basin. We invest approximately $5-10 million annually towards various growth and cost savings initiatives, with each project individually assessed to determine economics as we continue to explore various opportunities and ideas to enhance our business. Overall, the growth of the water business has provided us with substantial free cash flow growth to the overall enterprise. With that growth and free cash flow over the years, TPL has been able to pay out increasingly larger dividends and execute on larger buybacks, all the while maintaining high cash flow margins, low capital intensity, and a net cash balance sheet. Beyond water, we are also searching for new opportunities to leverage our surface ownership. Many fan lines we have discussed in the past are a good example. Consistent with our current makeup, the overwhelming preference is to commercialize new projects in a capital-wide, -cash-flow margin manner. To the extent there is a project that can provide both exceptional returns and is strategically critical within the context of the overall enterprise, then we have the wherewithal to strategically deploy capital just like we did for the water business. Next, let's discuss share repurchases. When you buy back company shares, you are basically still buying assets. It's just that these assets are already owned by the company. The question is, what is the return generated by buying back your own shares? We look at share buybacks in a similar manner as we look at purchasing external assets. If buying back TPL stock, we are buying a claim on over 20,000 net royalty acres on an 8-H basis and nearly 1 million surface acres. Those assets generate a cash flow stream. What we do is go piece by piece and evaluate the full cash flow potential over the life of each asset. After aggregating the various components of the business, we can measure that value against the price to acquire. That price for a buyback is our publicly traded share price. There is just as much art assigned to this given all the various inputs and we do our best to generate reasonable assumptions. We run various scenarios sensitizing important factors, commodity prices of course being a major item. We have reservoir engineers on staff to assess resource potential track by track for our royalty acreage. We run a bottoms up life cycle analysis across our water and swim businesses. We also own a forever land asset that we are actively working to monetize and that is basically an option value for future revenue potential. So we account for that. After aggregating everything, we have an internal appraisal of our intrinsic value. We can then measure that against the stock market's appraisal of those exact same assets. If we can generate a double digit IR at a mid-cycle oil price of approximately $75 oil and $3 gas, then buybacks become an extremely attractive option to deploy significant capital. We still have over $200 million remaining on our current buyback authorization, so we have the tools in place to quickly execute a robust share repurchase program. Beyond just these opportunistic parameters, we do anticipate maintaining some level of buybacks throughout the year. There are still benefits to buying more of the assets we know so well and to just being in the market support and stock. We have a long history of repurchasing shares. We recognize that has been an important element of the TPL story through the years and that's something we want to reinforce. On that point, we receive feedback from some investors on why TPL doesn't just stick to what it did in the past and just use all of its cash to buy back shares. After all, that strategy was a core factor in driving some phenomenal returns through the decades. It's a fair point and it's worth diving into the buyback strategy of TPL of yesteryear versus the buyback strategy today. For most of its existence, when TPL was effectively just a liquidating trust, the strategy back then was to take the modest cash it generated from some vertical oil and gas wells, raising leases and asset sales, and to use those proceeds to repurchase shares. With the benefit of hindsight, those buybacks worked incredibly well because few knew or understood that one day modern horizontal drilling and hydraulic fracturing would unlock the ocean of oil that was locked in a shell lying underneath the trust roll-tree. Thus, you were buying back assets that would later become some of the best shell assets at a valuation that only reflected some minor ancillary operations. It was quite a deal. Today, the extent and quality of the shell resource on TPL land is widely recognized, so much so that our stock trades at a meaningful premium appears. That's also become evident recently with nearly $100 billion of Permian lease operator acquisitions occurring just in the last few months. Although we resolutely believe TPL has a unique, irreplicable set of assets and an outstanding team that justifies a premium, buying back our stock today isn't the same steal that it was decades ago, not to say that it isn't a good deal today. By that economics from decades past aside, we will not hesitate to aggressively ramp buybacks when the opportunity arises. Furthermore, if returns across organic capbacks, M&A, dividends, or buyback were all equivalent, our preference would be to lean into buybacks. Our bias is buybacks. Turning to external acquisitions, over the last few years, we've been candid in our interest in evaluating potential opportunities. We have a huge surface and realty footprint. We have a talented team of industry professionals. We have capabilities to monetize land like few others can, and we have the technology and systems to efficiently scale. It's for all of those reasons why we believe we're in a prime position to consolidate high quality Permian surface and realty assets. We approach M&A similar to buybacks. We evaluate each asset from a bottoms-up intrinsic value approach. The same assumptions we use to value our own assets, whether it's commodity prices, -by-track resource potential, or surface and water opportunities, we use to analyze third-party assets. Again, the goal here is to generate at least double-digit IRRs and invested capital and incremental free cash flow per share. For any package that's of meaningful interest to us, in addition to extensive financial analysis, we also perform significant asset and operational due diligence. Because TPL already owns great assets, we have no interest in diluting down our asset quality, our growth prospects, or our unique business model. For any deal, the economics have to work, it has to make us a better enterprise, and it has to enhance shareholder value. It's a very high bar, and we'll keep it high. And finally, if the company only has modest opportunities to deploy capital towards organic or external growth, and if buybacks are relatively less attractive, then dividends are another effective way to return capital back to shareholders. A good example was back in May of 2022. WTI crude was over $100, net gas over $7, both basically at highs over the last decade. Valuations then for external assets were based on essentially peak commodity prices and peak multiples. Buybacks during this time were also relatively less attractive, given this above-cycle commodity price. We had modest capital needs for our organic endeavors. Without great options to use the capital ourselves, we paid a $20 per share special dividend and gave that cash back to shareholders. We find ourselves in a similar situation in the future, that large special dividends are readily available. Our capital allocation strategy will adapt as industry and market fundamentals evolve. Our cash balance at year end has grown to $725 million as we've harvested cash flows over the last couple of years during this period of relatively high commodity prices, and as we've held back on large, pro-sickle spending. Today, commodity prices are lower, and we have an opportunity to deploy substantial capital countercyclically as weaker competitors pull back as valuations fall and as opportunities grow. Or, if commodity prices rise, our business will benefit tremendously. We're very much in a position of strength, and the company will excel in most any environment. With that, I'll turn the call over

to Chris.

Thanks, Ty. Consolidated revenues during the fourth quarter of 2023 were approximately $167 million, representing 6% sequential -over-quarter growth. Adjusted EBITDA was $151 million, and free cash flow was $116 million. Free cash flow for the quarter grew 15% on a -over-year basis driven by higher royalty production, sourced water sales, produced water royalties, and slim revenues, and partially offset by lower oil, natural gas, and NGL prices. Since Ty has already reviewed some of our other highlights for the quarter and full year 2023, I'll spend some time now on how we're thinking about things for 2024. As it relates to development and the overall Permian, our general view is that if oil prices stay around or above $75 per barrel, that is generally constructive for continued growth. If oil prices weaken to $70 or less for an extended period of time, we would expect overall Permian activity levels to slow and overall production volume to flatten. Specific to TPL, our business overall tends to be dominated by super majors and large independents, which tend to maintain development plans even during times of sideways commodity prices. Over 50% of our current drilled but uncompleted wells, otherwise known as ducks, are held by super majors Chevron, Exxon, Conoco, BP, and Occidental. 80% of our current ducks are held by operators with an enterprise value of at least $15 billion. Although rig counts have fallen in the overall Permian compared to a year ago, we have seen rig counts on our acreage remain stable. New spud activity on a net basis in the fourth quarter was a company record, and our overall near-term well inventory remains robust. We are seeing persistent, strong activity and loving in northern Culberson and in the central Midland subregion. In addition, continued operator efficiencies have condensed permit to production pacing, even despite wells with increasingly longer lateral lengths. Our water team today is just as busy as last year, and indications that they've received from operators is that development activity will remain at high levels. Our land agents also remain active as demand for pipeline easements, surface leases, well bore easements, and caliche is strong. As we've previously indicated, we believe that TPL royalty production can grow at a level that exceeds overall Permian growth. Although, like we've experienced over the past year or so, short-term, -to-quarter performance can be somewhat volatile due to greater co-completion developments, operator short-term development patterns, specific net revenue interest for various tracks, and check-stub timing. To conclude, TPL is in a great spot today. Our balance sheet arguably has never been stronger. The business still maintains strong cash flow and profitability margins. TPL still remains unhedged on commodity prices, so we capture the full upside if commodity prices improve, and if commodity prices weaken, then we have ample means and multiple ways to take advantage. And with that,

operator, we will now take questions.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you would like to ask a question, please press star and

1

on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star and 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. Ladies and gentlemen, we will wait for a moment while we poll for questions. Our first question is from Hamid Kholsan with BWS Financial. Please go ahead.

Hey, good morning. So, first off, could you just talk a little bit more about the water business and what you're doing there as far as the cost structure goes? I noticed that if I combine both water line items on the sales side and then look at your cost basis, the cost is more than outpaced the sales growth. So,

if you could just comment there on what your expectations are. Hey,

Hamid. This is Chris. You know, I think as Ty had said in his prepared remarks, you know, at the end of the day, what we are trying to do is grow our free cash flow. And, you know, last year was a bit unique. There was a few times where, you know, depending on where that water was moving and some of the contracts, it was a little bit more expensive. As we continue to reach out further into the basin, some of the expenses to get water to the further reaches of the Permian have increased. You know, on the flip side, we continue to electrify a lot of the operations, which helps, you know, regulate and even bring down some of the cost through the ability to automate systems, have less personnel required to run them. But at the end of the day, you know, the cost to deliver some of that water as we expand has come down. But I think the good news is, is that still leads to increased cash flow for the business.

Okay. And then my other question was, as far as the oil side of the business goes, oil and gas, is there any supply chain issues that you can see that, you know, could hamper production or are you just seeing that production can stay steady with, you know, whether electricity

is permitting?

I think most of the supply chain issues that we've seen over the

last few years have been worked out. You know, obviously, there's still a lot of infrastructure build out that needs to be done in the Permian. But talking to our operators and midstream operators as well, I think infrastructure planning is going well and companies seem to be making, you know, the right moves to prevent those bottlenecks in the future. So, I think most of those issues overall have been worked out.

And then last question is on your easement side, is there anything of a one-time nature there this past quarter that won't repeat in Q1

or in 2024?

I

mean, for the most part,

you know, big part of that is pipeline easements, material sales have increased as well, but those should be ongoing. You know, like I said, talking to our midstream operators, there's still a lot of infrastructure build out that they have planned for 2024. Material sales continue to be strong. We're growing our sand royalties as well. So, I would anticipate that staying strong through 2024 and really over the next few years.

Great. Thank you. Thanks, Ahmed. Thank you. Our next question

is from Nate Pendleton with Stiefel. Please go ahead.

Good morning and congrats on this strong quarter. Starting with production, coming off a strong Q4 and understanding that historically production has been lumpy, how should we think about the production trajectory heading into Q1 versus full year?

Yeah, hey, I think what you said is right. You know, we still expect that production is going to kind of remain lumpy through time. Just the nature of how the wells get completed, you know, the big co-completions, the way that operators are, you know, moving around and which pads they select can have a lot of impact quarter to quarter as to what our production looks like. But again, I think we would just, you know, reaffirm a couple things that Ty had mentioned in the prepared remarks. One would be we still think overall, over the long term, we've got a good chance to outperform the overall Permian in terms of production. And, you know, when we look at 2024 and we look at kind of our current backlog of net wells, it looks really strong. We've seen a big build of ducks occurring. And so all of those things would lead us to believe that at least over the course of the year, there's going to be plenty of inventory to continue to deliver strong production results. But as to whether that happens each quarter, like clockwork is always a more difficult thing to predict. And so I think there is going to be some lumpiness when exactly that occurs. It's hard to know, but the overall trend, we still feel really good about. And I think, like we said, if we have a supportive commodity price environment this year, we would expect a continued strong production performance.

Got it. Thanks. And then staying on the activity trends with your net well inventory that you mentioned, with that around 17 net wells in various stages of development entering 2024, can you provide a rule of thumb for the number of net wells that would need to be turned in line to hold production flat all else equal?

Yeah, you know, I think in the past, we probably said that that number was something like eight net wells. But obviously, as your production base grows, you know, that number is going to trend up. So I think we would tell you now that something in the neighborhood of probably nine net wells is going to roughly be your hold flat number that you need. But as you stated, you know, with 17 right now in the backlog, that certainly feels pretty good to us as far as having plenty of inventory available to, again, support strong production.

Got it. Thanks for that. And then shifting over to the water business, looking back at some of your acquisitions over the past year, can you provide any color on how you see the A&D market for additional SWD infrastructure and what opportunities there are to further expand your leading position there?

Yeah, you know, most of our focus

on the produce water side has been acquiring additional pore space. You know, so you saw a couple of surface acquisitions of pore space easement that we did last year. And so we just want to make sure that we stay out in front of our operators' needs, you know, and have the appropriate amount of pore space available to meet those needs. So that's kind of how we view, you know, our part in that business is just, you know, continuing with the same business model, being a pore space owner and using our network and relationships to put people together to make sure that, you know, that water has a place to go and, you know, just support the overall development of the basin.

Got it. Thanks. And then you mentioned pore space, so staying on that for just a second and taking the CCS angle. Now that the US EPA has started approving Class 6 permits and there are some operators injecting CO2 for storage today in Class 2 wells that qualify for the same credits, can you provide any updates on how you are viewing that opportunity given your expansive ownership? Yeah,

I mean, we've talked a little bit about it in the past. We think it's a great opportunity for us as well. You know, we view it similar, you know, in business model to the produce water, you know, where we'll continue to be a pore space owner. No real interest in building out any infrastructure in that space. But, you know, leasing on our pore space for a royalty, I think it's a great opportunity for the company. And so, you know, I think anytime we can add pore space, whether it be for produce water or carbon sequestration, you know, it just continues to add more runway to our business long term. Got

it. And the last one for me, is there any update you can provide regarding the status of the appeal related to the stockholders agreement litigation?

Not

too

much other than oral arguments were yesterday. So, at this point, we're just waiting on a decision from the court.

Got it. Appreciate you taking my questions. Thank you. Thanks.

Thank you. Ladies and gentlemen, as there are no further questions, that concludes the conference of Texas Pacific Land Corporation. Thank you for your participation. You may now disconnect your lines.