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Why Texas Pacific Land Trust Has a Better Business Model Than Exxon and Chevron

By Luis Sanchez CFA - Feb 19, 2021 at 6:00AM

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Texas Pacific Land Trust has a unique way to profit from the fracking activity in the Permian Basin.

Unlike most oil and gas companies, Texas Pacific Land Trust (TPL)has a capital-light business model that allows it to benefit from the upside of oil and gas production without the downside of investing a lot of capital and taking on debt. This business model has many advantages over conventional oil and gas exploration businesses.

In this video from the Industry Focus podcast recorded on Dec. 10, Motley Fool contributor Luis Sanchez and Industry Focus host Nick Sciple compare the company's business to traditional oil and gas companies.

Nick Sciple: 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.

Luis 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 spend a bunch of money to build their rigs, and they have to spend money to produce the oil. Then when they have produced the oil, then they're subject to the price of oil at market.

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, 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.

Oil and gas investing through conventional exploration and production companies tend to be a bit risky. But Texas Pacific has a different tact. They're essentially like an asset-light way to supply oil and gas exploration in the Permian Basin. They have 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. 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 are seeing with a company like Exxon (XOM 1.19%) or Chevron (CVX 0.46%), 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.

I think the bottom line is really just looking at the way that Texas Pacific's stock price has performed. 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 stocks 3X from 2015 to 2020. It's going to be tough, especially a mid-cap or a larger cap company like Texas Pacific. That trend continues even this year. They are roughly flat on the year despite the terrible environment that we've seen for these commodity producers.

Sciple: Right. You see that over the past five years, find me any oil and gas stock that's performed well, and one of the things that we were talking about as we were prepping for the show is Texas Pacific is someone who gets a little bit of a cut of the oil that's produced on the land.

One of the things we talked 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 would want management to be rewarded based on earnings per share, or return invested capital, or something like that. Oftentimes, you will 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 a little bit of money. That's great if you're Texas Pacific Land Trust, because they get paid more and more of the more production takes place on their land. So if you're someone who thinks oilmen 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 are not going to go down in value. 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.

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Stocks Mentioned

Texas Pacific Land Corporation Stock Quote
Texas Pacific Land Corporation
Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
$97.78 (1.19%) $1.15
Chevron Corporation Stock Quote
Chevron Corporation
$177.41 (0.46%) $0.82

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