In this episode of Industry Focus: Energy, Nick Sciple and Motley Fool contributor Luis Sanchez take a look at two of the biggest landowners in Texas and Florida and the opportunities they provide to investors. Over their more than 100 years of history, these companies have seen it all. Today, they provide a compelling opportunity to invest in emerging trends, like U.S. oil and gas production and the exodus of workers from cities.
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This video was recorded on December 10, 2020.
Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. This week, we're looking at two companies that own huge tracts of land, both of which trace their histories back to before the Great Depression. Texas Pacific Land Trust (NYSE:TPL) is one of the largest landowners in Texas, providing an interesting way to invest in U.S. oil and gas production. Meanwhile, St. Joe (NYSE:JOE) is one of the largest landowners in Florida offering coastal homes on the Florida Panhandle.
Motley Fool contributor, Luis Sanchez, joins the podcast to share his thoughts on how these companies are positioned as we head into 2021. Luis, great to have you back on the podcast.
Luis Sanchez: Great to be back, Nick.
Sciple: So, before we jump into Texas Pacific Land Trust and St. Joe, let's talk about investing in companies that own land, in general. Both of these companies, just to put it simply, own a big chunk of land. How do you size up a business like this? What are the factors you look at?
Sanchez: It's really interesting if you look at land companies, because they have a ton of book value on their balance sheet just with the land, and that is certainly one valid way to figure out what a company is worth that has a lot of land, but there's other things that you might want to take into account, like, does the company have earnings that are generated other than the land, are those earnings recurring, and what are, kind of, the other secondary factors that are driving the value of the land or driving the earnings?
Sciple: Yeah, and we'll talk about some of those secondary factors with the companies later on the show. Clearly, this huge rise in fracking has been helpful for a company like Texas Pacific Land Trust, that is a realty company in oil and gas. But before we drive into that company, Texas Pacific Land Trust really has an interesting history, Luis, going back to the nineteenth century, can you tell us about that?
Sanchez: Yeah, for sure. So, to understand where Texas Pacific Land Trust came from, you have to really go all the way back to the days of the Transcontinental Railroad, and it's really interesting, if you look at the history of finance, that periodically we have these bubbles in various industries. And in the 1800s one of the big bubbles was the railroad bubble, where there was a lot of capital chasing these railroad companies that were connecting the U.S. and connecting other parts of the world. And in Texas Pacific's case, the predecessor company was provided land that would be used to connect Texas to California. So, its own, kind of, intercontinental railroad there. And to their credit they built about 900 miles of track before the company eventually went bankrupt in the late-1800s.
And Texas Pacific Land Trust was actually a liquidating trust formed to oversee the disposition of all the land that the railroad owned over time to the benefit of shareholders. And it was formed in, I believe, 1888, and it actually went public on the NYSE in 1927 and is, I believe, the second-oldest NYSE listing that's still on there. So, it has this really incredible history [laughs] going all the way back to the Transcontinental Railroad.
And of course, over the last 100 years times have changed, and especially over the last 10 or 20 years that land maybe is not so valuable as a railroad track, but now it's become valuable as a place to produce oil.
Sciple: Yeah, you mentioned the history of this company, Luis, when we were talking about, as we were prepping for the show, you can find old clips from Warren Buffett in, like, the 1960s talking about Texas Pacific Land Trust and, kind of, the thesis for the company. But you mentioned, the investing thesis for the company today is probably significantly different than from when Warren Buffett was talking about in the 1960s, predominantly because of this huge rise of fracking in West Texas and The Permian Basin.
Sanchez: Yeah, absolutely. So, you know, the key assets of the company, they own 900,000 acres of land in West Texas, and that's The Permian Basin essentially. And The Permian Basin has been around for a long time. Actually, it's been repurposed in the last 10 years. So, before, from about the 1970s until about the mid-2000, the rate of oil production in The Permian Basin was on the decline. But then 10, 15 years ago there was a lot of innovation in the oil and gas sector and techniques like horizontal drilling and hydraulic fracturing has made extracting oil and gas from The Permian Basin a lot more achievable and affordable. So, Texas Pacific has [laughs] been a beneficiary of the oil and gas fracking boom. And in the last 10 years has really taken on a whole new life, and the value of their land has increased quite a bit.
Sciple: Right. And you mentioned that the value of the land comes from a few different things, you've got these royalties, so that means, when oil gets pulled out of the ground on the land that they have royalty rights on, Texas Pacific receives income, and this is obviously incredibly high margin income, you don't pay any of the cost of production, but you get this royalty stream that comes in. They also have other land rights that are significant for oil and gas production as well, talking about easements and things like that, do you want to talk about that, Luis?
Sanchez: Yeah. So, the business model can get a little wonky, and there's a lot of very specific things that they are doing to take advantage and to monetize their land holdings, but to really boil it down, to like the one-sentence explanation of what Texas Pacific is, is they own a bunch of land in West Texas. And if you want to extract oil from their land, you have to pay them one way or another, [laughs] right? So, they basically have four different ways to monetize their land.
The first is what's called, like, surface access rights. So, if you build a pipeline that goes over their land, you have to pay them a toll. If you build a drilling rig on their land, you're going to have to pay rent on that drilling rig. And they also have a little over 20,000 acres of oil royalty rights. And that entitles them to a percentage of the income generated from selling the oil. So, a small percentage of the income from the oil rigs. And then finally, they also, in 2017, established a subsidiary that sells water to the producers. So, water is used as a part of hydraulic fracturing. So, you know, [laughs] if you want to do some hydraulic fracturing, you might want to buy water from them too, so that's been another interesting area for them to make money. And finally, occasionally, they sell land and they also buy land and they do a little bit of land speculation there.
Sciple: Right. And so, they've got access to these important rights in an area where significant oil production is taking place. A stat from one of their investor presentations is, 25% of the hydraulic fracturing rigs in the U.S. are all located in the Delaware Basin, which is where Texas Pacific land is predominantly located. Another important thing to point out is, a lot of their customers are some of these big operators like Exxon, Chevron, so they have exposure to some pretty significant strong business. Now, granted, obviously these companies have struggled, but they're continuing to produce oil in The Permian Basin.
So, Luis, like, when we look at Texas Pacific, it really has a different quality of earnings relative to what you would expect from these traditional oil and gas businesses.
Sanchez: Yeah, it's interesting. So, if you look at how a traditional oil and gas business works, they have to spend a bunch of money to explore for oil, they have to spend a bunch of money to build their rigs, and they have to spend money to produce the oil. And then when they have produced the oil, then they're subject to the price of oil at market. So, it's a very capital-intensive process and there's a lot of exposure to commodity prices. And what ends up happening is, a lot of these oil and gas companies have a lot of debt. And in good times, when the price of oil is really high, [laughs] they make a lot of money. In bad times, when the price of oil crashes, a lot of these companies get wiped out and go bankrupt.
So, oil and gas investing through conventional exploration and production companies tends to be a bit risky, but Texas Pacific has a different tact, right? So, they're essentially like an asset-light way to play oil and gas exploration in The Permian Basin. So, they have the land and they provide the land and they contribute the land, but they allow the oil and gas exploration companies to invest the capital. So, the oil and gas companies are spending all the money and drilling the rigs and taking a lot of the risk, but Texas Pacific has the upside, because if these rigs actually generate a lot of oil and become quite productive then activity on their land will increase and they'll collect more revenue in the rent that they're taking out from the easement. But then they also get a cut of the oil that's sold at market.
And if you look at Texas Pacific, they have no debt, they're not super capital intensive, although they do have to invest capital in the water business. But it's nothing like what you're seeing with a company like Exxon or Chevron, who are spending tons of money on CapEx and taking a lot of risk on various projects that may work out well or may not work out well. And you could also see that just in -- you know, I think the bottom-line is really just looking at the way that Texas Pacific's stock price has performed. And if you believe the notion that they have a higher quality business model compared to a more traditional E&P company; well, it's definitely reflected in the price performance. And over the last 10 years, they've really outperformed the oil and gas peers. So, just going back to 2015 to today, at the end of 2020, the stock has been more than a 3X. Now, I would challenge you to find me another company in the oil and gas space who's seen their stock 3X from 2015 to 2020, it's going to be tough, especially a mid-cap or a larger cap company like Texas Pacific.
And that trend continues even this year. They're roughly flat on the year despite the terrible environment that we've seen for these commodity producers.
Sciple: Right. I mean, you see that, yeah, that over the past five years [laughs] quite many oil and gas stocks that performed well. And one of the things we were talking about as we were prepping for the show is, Texas Pacific as someone who gets a little bit of a cut of the oil that's produced on the land. Well, one of the things we talk about on the show a lot with these exploration and production companies, is sometimes there can be incentive structures with them that aren't the most favorable to shareholders, whereas you'd want managements to be rewarded based on earnings per share or return on invested capital or something like that, oftentimes you'll see pay packages where there's incentives based on increased production. So, that's bad if you're a shareholder of an exploration and production company, that every barrel of oil they pull out of the ground results in losing, you know, a little bit of money, that's great if you're a Texas Pacific Land Trust, because they get paid more and more, the more production takes place on their land.
So, if you're someone who thinks, you know, oil men are always biased, their solution is always to drill more oil, maybe Texas Pacific is an interesting play on that. I'll tell you, I would be much more excited to invest in Texas Pacific than most other oil and gas companies, just because of the asset structure of the business and just their control of assets that aren't going to go down in value. So, some of these oil companies may go bankrupt -- sorry, assets that are going to hold value over time, whereas some of these oil and gas companies might go bankrupt, that oil in the ground still carries some value.
So, you know, we lay out the, kind of, the cost structure of the business, its performance historically, and how it seems attractive as a way to invest in oil and gas, where could that go wrong?
Sanchez: Sure. So, at the end of the day Texas Pacific owns a bunch of land in the middle of nowhere in West Texas. [laughs] And if this land isn't valuable for producing oil, it's not very valuable. [laughs] So, you know, the extreme bear case would be that, if oil and gas production ceases completely, and especially in The Permian Basin if it becomes unviable, then Texas Pacific is going to really suffer from that. And you have to then really look at what's the downside, what's the land worth, and it's probably worth a fraction of what it would be worth if it's a viable oil and gas production facility. [laughs]
Sciple: Right. Yeah. So, there's risk that oil and gas production goes down, and then of course, that would take away some of their potential moving forward. I think one mitigating factor there is you've seen, obviously, lots of conversation this year around oil and gas companies reducing investment. Exxon, one great example, recently announced they're going to writedown $20 billion in assets. A lot of that travels back to their XTO Energy acquisition that's heavily in natural gas.
However, we've seen Exxon say that, you know, as they refocus their production around their highest profitability assets, The Permian Basin is in that group, so -- and you can look at projections from across the industry, is this idea that they expect The Permian to come back the quickest among the shale plays, because of its cost structure and that some of these others to take much longer. So, their exposure to The Permian gives them a little bit, I guess, a stronger likelihood that things are going to bounce back relative to if they were positioned elsewhere.
Last thing on -- go ahead, Luis.
Sanchez: Well, I was going to say, like, one more pushback I could see people saying is, well, you know, this stock has way outperformed companies like Exxon. So, therefore, if you really want to play oil and gas, isn't there more upside from investing in something that has been beaten up more. And I think that's a fair point. But I do believe that if you do believe in the long-term viability of The Permian Basin, there's still definitely upside in Texas Pacific. So, they claim, in their investment materials, that less than 10% of their royalty acreage has been developed. So, right, [laughs] like that, just kind of shows you that there is a multi-decade opportunity there.
The other thing that they point out is that they have a little bit less than a 100 rigs that were in operation on their land at the end of last year, but they have a few hundred wells that they refer to as drilled, but uncompleted. So, that's just all to say that, yeah, like, the stock has done well, but if you really believe that The Permian Basin is going to be a strong area of oil and gas production, well, Texas Pacific has the land and they have the runway to facilitate that.
Sciple: Yeah. So, last thing before we move on to Texas Pacific Land Trust. We mentioned off the top they were a trust formed after the original railroad company went bankrupt back in the 1800s. They're now moving toward converting to a C-Corporation here at the beginning of 2021. Does this change the thesis for the stock at all?
Sanchez: It is interesting. And you know, I think some people might view this as like a technical catalyst, right, to when a company converts from, like, an obscure legal structure, like a trust, into a conventional one, like a Delaware C-Corp. that Texas Pacific is doing, it potentially opens up the door for a larger class of investors to come in. And what I mean by that is, there's a whole host of mutual funds and ETFs who have rules that they can't buy anything other than, like, a Delaware C-Corp.
So, if all of a sudden, you know, Texas Pacific converts to a C-Corp., perhaps there's some incremental buying from some institutional investors or from some ETFs that suddenly view this as an attractive candidate for their holdings.
Sciple: All right. So, that's Texas Pacific Land Trust. Let's turn now to St. Joe, this is another company that has a history [laughs] going back to another speculative bubble, can you tell us about that?
Sanchez: Yeah. So, I think the theme today is, we're kind of hung in the loop connecting different bubbles. [laughs] St. Joe also goes back more than 100 years ago to in the early 1900s, the famous industrialist, Alfred du Pont. He was speculating on the Florida real estate boom in the early 1900s, and eventually that bubble popped, and he formed St. Joe, I believe in the 1930s as a place to put his real estate and to figure out what to do with it.
Over the last 100 years, the company has had a few different lives. It was primarily a paper company. At one point it was a sugar manufacturer. It was also a forestry operation, and it still does some forestry. And then, [laughs] finally about 15 years ago, it became a hot stock again because it got caught up in the most recent housing bubble in Florida, and then it also [laughs] got burned from that.
But in the last 10 years, the company has really narrowed its focus. And today it is primarily developing land in the Panhandle of Florida, in Bay and Walton counties in Florida, so that's primarily land around Panama City Beach, Florida.
Sciple: Right. So, what's the investing thesis today then, Luis, around those, kind of, Panama City assets?
Sanchez: Yeah. So, if you're not from the area, you might not know this, but it's sometimes referred to lightheartedly as, like, the Redneck Riviera or also known as the Emerald Coast. The Panhandle of Florida and that area in the Gulf, there's really beautiful beaches. There are actually very nice homes, very expensive homes. It's a regional hub for retirees, vacation rentals, second homes. And you know, I'm based in New York, so in a way I kind of think of it as, like, the Long Island or The Hamptons of those areas around Florida or Georgia.
And you know, the thesis is essentially that Joe has approved a masterplan in the Bay and Walton County areas to build up to 170,000 residential units, over 9,000 hotel rooms. And you know, they have the land. So, similar to Texas Pacific, Joe has 170,000 acres of land in Florida. And they have this asset-light business model, where they're contributing the land, they're developing it into lots, they've already gotten it approved by the local governments of those areas, and they're partnering with homebuilders, who then buy the lots from Joe. The homebuilders will put the capital in, develop the homes and then use their own salesforce to generate demand. So, like I said, it has similarities to Texas Pacific, it's asset-light, they're relying on other companies to do a lot of the capital-intensive part of developing the residential communities there.
But then, you know, an interesting thing about Joe is that they also have this recurring revenue business that they're starting to churn up. And one aspect of that is, they have what's called club membership. And in all these different communities, remember, some of these communities are really nice, very expensive. They have resort-like amenities, like, golf courses and pools, and little clubs. And Joe sells membership packages to these clubs. And if you join the club, if you're a member of one of these communities and you join a club, you're paying a couple of hundred dollars a month to stay in that club, so that's recurring revenue that Joe can count on.
And then Joe has also developed some hotels, some commercial leasing spaces around, like, shopping centers, as well as, affordable apartment units, which it rents out. And you know, a lot of these other developments are still under construction and are certain to come online over the next couple of years.
Sciple: Yeah. So, I find St. Joe interesting, because I always, kind of, vacation in that Emerald Coast area of the country. So, I grew up in Mobile, Alabama and I would go to Destin all the time. And I do think those areas are incredibly undervalued or underappreciated as, kind of, national vacation destinations. There's lots of folks from, you know, the South and the Midwest that head down there. But I would say, if you go to Destin, Florida, there aren't any nicer beaches in the whole country that I've ever seen. Which makes this area an interesting place to think that there could be continued growth as more and more people relocate.
Is one important trend here for these folks, this move away from cities here, in 2020?
Sanchez: Yeah. So, that's definitely been an interesting trend this year. I think, you know, if you look at the bigger picture trend, if you could go back several years and you can look at the long-term demographic trends, I think it does support this idea of people moving to the Southeast, people moving to areas, like, you know, retiring in Florida, moving to a nice area that's on the beach, like some of the communities that Joe is developing.
But then, of course, with COVID-19, it accelerated some of those trends. And you know, [laughs] you've seen a lot of people really abandon cities and move into vacation rentals for like, use them as more permanent residences and work remotely. And Joe has certainly been a beneficiary of that trend.
Sciple: Absolutely. So, Luis, we talk about this, kind of, continued trend of maybe toward moving to the beach or maybe some of these assets have some value. Similar to what I asked on Texas Pacific, what could go wrong with this company?
Sanchez: Yeah. So, I think one thing that comes to mind is, Joe has a very narrow specific geographic concentration with the Panhandle. And there's benefits to that, but there's also very specific risks. So, if a big hurricane comes and wipes out the Panhandle, that's going to hurt Joe, I'm sure they have insurance for that, but that's not going to be a good thing for their business, you know. So, natural disasters impacting their region won't be great.
I think the big picture thing is, you really just got to believe in that long-term trend of people continuing to move to Florida. And the company has certain targets that it set -- it refers to them as milestones. It wants to get to a point where it's selling 1,000 homes per year over the next couple of years. And they are also trying to develop 1,400 apartment units, a certain number of hotel rooms.
And they've taken this, kind of, "built it, and they will come" approach. So, if they build all this great stuff, but no one wants to live there, no one wants to go there, well then, they're not going to earn a very good return on the investments they've made. And with 2019, and what we mentioned about COVID, you know, I think the market has taken a cue that this could be a beneficiary, and the stock price has run up more than 50%. And now the valuation is a little bit more challenging than where it was a year ago. So, you really have to believe that it's going to hit its milestones, so that it could grow into its valuation.
Now, we could also, you know, they're definitely benefiting from people, from interest in the Southeast right now, but what if we get on the other side of this pandemic and people realize, hey, like, I actually don't want to live in the suburbs, I actually do like cities and I want to move back. You know, that could put a damper on the demand for their housing.
Sciple: Yeah. So, just context on maybe some of how things have been pulled forward this year. In their most recent quarter, they had a 72% year-over-year increase in home site sales. So, obviously, a significant boost in demand this year. I'll tell you, as someone, again, who has vacationed in this area for a long time, I think there's certainly going to be growth over time, but there is a question of how quick this growth might take place? They have lots and lots of land, and you know, it's going to take a long time to sell that off, and you may be waiting for a long time, but you know, we'll see.
Any last thoughts on Joe before we wrap things up?
Sanchez: Yeah, just kind of like a funny idea that I've been toying with is, you hear people talk about these, like, flywheel businesses with network effects, and they're usually referring to social networks or other kinds of tech companies. But in a sense, Joe is a flywheel business that benefits from network effects. Because the more people that move to the Panhandle, the more valuable their land becomes and the more revenue they can generate from their hospitality and commercial leasing. And as their network gets stronger, it strengthens their flywheel. And I just think it's a funny idea, because people, when they're talking about these network effects and flywheel businesses, they're usually not referring to a land development company.
Sciple: Yeah, I think there is a little bit of that, because everybody -- you know, I have done this, somebody comes back from a vacation tells me how great a time they had, and I'd be like, well, I'm going to go there. And then all of the sudden, it becomes the place where everybody goes.
Last question for you, Luis, before we move on. It's the Highlander question I like to ask folks, if you can only pick one, which would you choose here between St. Joe and Texas Pacific Land Trust, and why?
Sanchez: Yeah. So, what I liked about both of them is that they, kind of, have this conservative bent to them. They own land, they don't have debt. And it feels like the downside is pretty limited, it's just more about what's the upside of the land value? [laughs] And then if you take it to the next, well, what's driving the upside, I feel a bit more comfortable with Joe, just because I think people moving to the Southeast is more inevitable. And while I do believe that there is still going to be a lot of oil production in The Permian Basin, [laughs] I would rather bet on people moving to warm weather and moving to the beach than us continuing to produce a lot of oil and gas.
Sciple: Yeah, I think if you're looking at the terminal value on these businesses, [laughs] I don't think land at the beach is going to go down in value anytime soon; just the connection the people have to that place. And I would say, in particular, I think that the Emerald Coast area is -- I have not found a place nicer than that.
I will say though, with Texas Pacific, you might get paid a little bit quicker, as oil production pops back in The Permian, but I think, yeah, if you're going to buy and hold for, you know, a long, long time, I think you can probably sleep a little bit better at night owning Joe.
Luis, thanks for joining me on the podcast, as always.
Sanchez: Thanks for having me, Nick.
Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.
Thanks to Tim Sparks for mixing the show. For Luis Sanchez, I'm Nick Sciple, thanks for listening and Fool on!