Earnings Call Transcript - TPL Q2 2021

Operator, Operator

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. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Shaun Animi of Investor Relations.

Shaun Animi, 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 Investors 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 risks 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 reconciliation 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 Steddum. 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.

Ty Glover, Chief Executive Officer

Thanks Shaun, 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-scenario production and realized pricing figures in our recently filed 10-Q 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. TPL 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 integrated 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 2021. Next for our surface leases, easements and material sales or SLEM, total revenues were about flat sequentially from the first quarter 2021. We saw a nice uptick in pipeline easement and caliche 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 continued 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 for the Permian Basin, because we can benefit throughout the entire life cycle of a well, generating multiple cash flow streams through this value chain. Generally, when the operator begins development they first call us for easement, surface leases and caliche, 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 the 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. Finally, 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 royalties and extensive surface acreage footprint will create tremendous value over the long-term. Now, I'll turn it over to Chris to discuss our financials.

Chris Steddum, Chief Financial Officer

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 produced 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 million to $7 million of capital on our water sourcing infrastructure. On August 3, our Board declared a cash dividend of $2.75 per share payable on September 15 to shareholders of record as of September 8. Through June 30, our year-to-date dividends totaled $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 30, we had $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.

Operator, Operator

Our first question is from Chris Baker with Crédit Suisse. Please proceed.

Chris Baker, Analyst (Crédit Suisse)

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

Ty Glover, Chief Executive Officer

Yes, Chris, thanks for the question. Look, we're always looking for deals. 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 deal flow is up and there are some attractive packages out there. So we're definitely looking.

Chris Steddum, Chief Financial Officer

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

Chris Baker, Analyst (Crédit Suisse)

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

Chris Steddum, Chief Financial Officer

Sure. Yes. When I refer to the net wells right now I'm referring to them on a net normalized basis, because what we've seen through time is that lateral lengths have tended to increase. If you assume an average net well is a 1.5-mile well, I think something like seven net wells would be enough for us to maintain our production. Some simple math to think about is our base level of production you may lose something like 6,000 Boe, call it 35% to 40% over the course of the year. For us each one of those net wells, that normalized 1.5-mile 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 replace that production you would see through the normal decline. And the one other thing I would reference, if you use that same normalized basis, our DUC 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 1.5 miles. So we've got a pretty robust level of current inventory that I think to Ty's point in the earlier comments would certainly support us being able to hold production flat. And 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.

Chris Baker, Analyst (Crédit Suisse)

Okay. Great. Appreciate the color.

Chris Steddum, Chief Financial Officer

Thanks a lot, Chris.

Operator, Operator

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

Hamed Khorsand, Analyst (BWS Financial)

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

Chris Steddum, Chief Financial Officer

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

Hamed Khorsand, Analyst (BWS Financial)

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?

Ty Glover, Chief Executive Officer

Yes. I would say through a lot of the consolidation, we now have exposure to a couple operators, so that's been good for TPL. We've gained a couple of really good relationships through some of the consolidation that's happened recently.

Hamed Khorsand, Analyst (BWS Financial)

Okay. Thank you.

Ty Glover, Chief Executive Officer

Thanks Hamed.

Operator, Operator

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

Derrick Whitfield, Analyst (Stifel)

Thanks and good morning all.

Ty Glover, Chief Executive Officer

Hey Derrick, good morning.

Chris Steddum, Chief Financial Officer

Hey Derrick.

Derrick Whitfield, Analyst (Stifel)

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 modern Delaware operating areas may be higher sooner than what we were expecting. I'd love to get your views on that?

Chris Steddum, Chief Financial Officer

Yes, Derrick. In general when we look at the permitting activity, it continues to be really robust. It probably started to pick up in the first quarter of 2021, so we had a robust level of new permits. When we look at them, Occidental was actually probably the biggest set of permits that we saw, especially in Q1. In the second quarter there was a fairly even level of permits across most of our operators. When you think about the nets, the net permits that are coming online continue to support the level of new wells that we see brought online and new DUCs that are getting drilled. It's probably mid-single-digit net permits coming online each quarter. In general I think it continues to be pretty robust and continues to support the current pace of development that we've seen in the last two quarters, which has been encouraging.

Derrick Whitfield, Analyst (Stifel)

Great. And then 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?

Ty Glover, Chief Executive Officer

Yes. We've got pretty robust capture rates on both the source water and produced water side. Like we said in the prepared remarks, the produced water business just continues to show growth and be a strong business. That business has been steady even through 2020 and 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. The team has 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, it's a very strong business and I think it's going to continue to be strong for us.

Derrick Whitfield, Analyst (Stifel)

That's great. Maybe one final question for me. With the understanding that you own a high-margin, low capital intensity business with a very strong balance sheet, could you speak to your appetite to hedge your second half 2021 and 2022 production profile to lock in your relatively strong oil and gas prices?

Chris Steddum, Chief Financial Officer

Yes. TPL has historically managed this business without hedges. One of the benefits of having a very high-margin business is it can withstand the volatility that this industry sometimes brings. 2020 was a great example of that. Despite being unhedged, it was one of our best years ever. Many of our investors like the fact that we provide that direct commodity exposure. Being unhedged allowed us to fully realize the recovery in prices this year across oil, gas and NGLs. Given the nature of our business and our ability to weather industry volatility, we would generally continue to remain unhedged. 2020 showcased that this business will do just fine even through some difficult times and it's nice to be able to fully realize the good times when the commodity cycle improves. So I think we would generally continue that approach in the future.

Derrick Whitfield, Analyst (Stifel)

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

Ty Glover, Chief Executive Officer

Thanks Derrick.

Chris Steddum, Chief Financial Officer

Thanks Derrick.

Operator, Operator

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.