Owning the Land

In this edition of the Smart Investor newsletter, we examine a landowner of the Permian Basin’s shale oil potential. But first, let us delve into the latest Portfolio news and updates.


Portfolio Stock Updates

❖ Stellantis N.V. (STLA) has continued to act on its share buyback program, repurchasing common shares for over $197 million during the last week of May. The company now holds 4.5% of its stock and is set to proceed with the plan to buy $1.09 billion worth of shares by August 30, 2024, underscoring its commitment to enhancing shareholder value.

❖ Dell Technologies (DELL) fell last week following its Q1 report, as investors were disappointed by in-line EPS results and weaker-than-expected margins. However, analysts from leading Wall Street firms are sticking with their “Buy” rating on the stock, saying the selloff was sparked by outsized investor expectations that propelled DELL by over 50% in May before the report was released. Moreover, in the report, Dell raised its full-year outlook, as the company continues to capitalize on the surging demand for AI servers. Looking into the details, margins declined as the company continued to invest in the expansion of its AI-related offerings.

❖ Taiwan Semiconductor Manufacturing (TSM) ruled out moving its production units out of Taiwan, saying that the move is impossible since over 80% of its manufacturing capacity is located in the country. In other news, TSM’s newly elected chairman, who also serves as the company’s CEO, confirmed expectations for the AI-fueled chip industry rebound this year.

❖ Super Micro Computer (SMCI) has been included in the Fortune 500 list of the largest U.S. companies by revenue. In other news, the company unveiled a new portfolio of X14 servers, including enterprise, cloud service provider, mid-range, and entry models, and featuring the latest Intel Xeon 6 processors. The flagship of the new server family is SuperBlade, a high-performance, energy-efficient platform optimized for AI, as well as cloud and other workloads.

❖ Arista Networks (ANET) has announced a collaboration with NVIDIA (NVDA), which will deliver holistic AI solutions through aligning compute and network domains as a single managed AI entity. In simple terms, the two industry leaders are working together to create unified AI management systems. This announcement is expected to alleviate investor fears over NVIDIA’s competitive threat to ANET in the networking space.

❖ Vertex Pharmaceuticals (VRTX) saw its stock surge to an all-time high after several Wall Street analysts lifted price targets based on optimistic prospects for some of the new drugs under development at the biopharmaceutical company, including a non-opioid acute pain treatment.


Portfolio Earnings and Dividend Calendar

❖ The Q1 2024 earnings season is over, but Portfolio companies with fiscal years that differ from the calendar year are still scheduled to report. Thus, Broadcom (AVGO) will publish its fiscal Q2 2024 results on June 12th.

❖ There are no ex-dividend dates for Portfolio companies in the next several days.



New Buy: Texas Pacific Land (TPL)

Texas Pacific Land Corporation is a real estate operating company, headquartered in Dallas, Texas. With almost 870,000 acres in the Permian Basin, TPL is one of the largest landowners in Texas. TPL has royalty, as well as water and surface rights, i.e., it earns its revenues from any activities occurring below or on the surface of the land it owns, such as oil and gas drilling and production, pipeline construction and usage, water supply, waste disposal, alternative energy facilities, etc.


Multiple High-Margin Revenue Streams

TPL was originally organized in 1888 as a business trust to manage the property of the Texas and Pacific Railway Company; for nearly 130 years, this management was mostly passive. As the shale oil revolution in the 2010s led to a surge in production in the Permian Basin, the company embarked on a new strategy to maximize the value of its footprint through active management of surface and royalty interests, finalizing its reorganization into its current corporate structure by 2021.

Today, Texas Pacific Land Corporation operates through two business segments: Land and Resource Management and Water Services and Operations. The Water Services and Operations segment, acting through TPL’s wholly-owned subsidiary Texas Pacific Water Resources (TPW), supplies water for oil and gas activities such as those used in fracking shale and facilitates produced water disposal solutions. The segment, which is responsible for 31% of TPL’s revenues, also receives revenue from the construction and management of water infrastructure, as well as from tracking, analytics, and well-testing services. TPW is the company’s primary driver of revenue growth.

The Land and Resource Management segment is responsible for 69% of the total revenues, which are acquired through two main subsegments. The first is Oil and Gas Royalties, a high-margin royalty revenue derived from oil and gas production with no capital and minimal operating expenses. The second is Surface Leases, Easements, and Material (SLEM), which monetizes third-party development activities occurring on surface and royalty acreage. These include sales of materials such as caliche; revenue derived from easement contracts covering activities such as oil and gas pipelines, electrical lines, and subsurface wellbore easements; land sales; and leasing arrangements across a wide array of industries including agricultural, oil and gas, construction, wind power, and others.


The Landlord of the Permian Basin

The Permian Basin dominates U.S. shale activity due to attractive drilling economics combined with a massively undeveloped inventory of wells. Although its potential is far from being realized, Permian is already a major contributor to global oil, natural gas, and NGL markets, ranking as one of the largest oil and NGL producing regions globally. It is a top-tier focus area for many energy super-major and large-caps with multi-basin portfolios.

These oil and gas majors include TPL’s four largest customers, who together provide about half of its revenues: Occidental Petroleum, Chevron, ConocoPhillips, and EOG Resources. While customer concentration is high, these four fossil fuel producers constitute an advantage rather than a risk due to their leading market position.

With a market capitalization of $13.7 billion and annual revenues of $632 million, TPL has largely flown under investor radar. This is despite its very efficient and high-margin business profile, allowing it to generate revenue throughout the oil and gas development value chain – from infrastructure construction to production – with no costs associated with the development of these resources.


Impeccable Finances, Strong Earnings Growth

TPL boasts enviable financial health with zero debt and a $837 million cash position (as of March 31st, 2024). Its profitability metrics, such as ROE, ROIC, and ROA, strongly surpass its peer averages, falling within the top 5% of its industry. In addition, the company has an unbeatable margin profile with a gross profit margin of 94%, an EBITDA margin of over 80%, an operating margin of 78%, and a net profit margin of 64%. These metrics underscore TPL’s competitive advantage and wide moat in the energy industry.

Despite the cyclical nature of the oil and gas industry, Texas Pacific Land has been able to sustain consistent growth in revenues and earnings within the last decade. Over this period, its revenue increased at a CAGR of 30%, while the adjusted EPS rose at a CAGR of 32%.

While fossil fuel production seems to be in high demand for the foreseeable future, providing TPL with rising revenue streams, the company is not resting on its laurels. Texas Pacific Land invests in the development of innovative projects such as produced water desalination technologies that are expected to significantly add to its revenue potential as they are critical for those operating in the Permian to maintain production growth. In addition, TPL is developing several environmental projects, including greenhouse irrigation, Pecos River desalinated water discharge, and more. These projects are likely to increase the value of the TPL-owned land over time, creating various agricultural opportunities.

In the latest reported quarter, Q1 2024, TPL reported a 19% year-over-year increase in revenues and a 33% surge in adjusted EPS, while its free cash flow grew by 30%. These results showcased the company’s strong and diverse revenue model, as surging water sale volumes, which rose over 51% year-on-year, compensated for slower growth in oil and gas royalties (directly impacted by prices). Notably, all of TPL’s revenue streams increased year-over-year.


Extremely Shareholder-Focused

Texas Pacific Land Corporation’s policies are extremely shareholder-friendly. Before elaborating on dividends and buybacks, it is important to note that the company has formalized a strategic acquisition committee, with TPL’s largest shareholder included in its board of directors. This move sends a strong message that TPL’s shareholders can weigh in on decisions concerning the use of the company’s free cash flows.

Texas Pacific Land’s capital allocation framework is focused on maximizing shareholder value through investing in high-return opportunities, maintaining an impeccable balance sheet to preserve financial flexibility, and returning substantial amounts of capital to shareholders through dividends and share repurchases.

Though TPL’s current dividend yield is a modest 0.8%, its low payout ratio, coupled with strong finances, allows for the outlook of continuous dividend increases for years to come. As for buybacks, the company has authorized a $250 million buyback plan in 2023 and performed share repurchases for about $43 million, adding $10.3 million in Q1. While these amounts aren’t large, up until March this year, the number of TPL’s shares that were outstanding was on the smaller side. This March, however, the company announced a three-for-one stock split, tripling the number of shares on the market. The stock price discussed further is split-adjusted.

Texas Pacific Land’s stock has risen by ~30% in the past 12 months, outperforming the S&P 500, though it has slightly lagged behind the index year-to-date. As for its valuation, comparison to the Energy sector or the Oil & Gas industry where it technically belongs is meaningless, as TPL has a completely different business model compared to traditional fossil fuel producers. Currently, the company trades at a P/E similar to its long-term average and is about 30% undervalued based on the projected FCF-to-equity ratios for the next three years.


Investing Takeaway

Texas Pacific Land is a very efficient, high-margin business with a diversified, capital-light business model, multiple lucrative revenue streams, and several potentially highly profitable initiatives. TPL is well-positioned to capitalize on the development of the Permian Basin without the capital intensity and risks associated with oil and gas production. Its outstanding balance sheet and consistently high earnings growth provide it with a great amount of financial flexibility in terms of further growth as well as investor compensation. Considering these factors, we believe that TPL can be a valuable addition to the Smart Investor portfolio.



New Sell: Flex (FLEX)

Flex Ltd. is a multinational diversified manufacturing company, providing contract manufacturing services to global companies in automotive, cloud, communications, healthcare, and other industries. It is the third-largest global electronics manufacturing services (EMS) and original design manufacturer (ODM) company by revenue.

Flex Ltd. boasts robust financial health and above-average capital efficiency metrics, while its profitability metrics, including margins, are average for its industry. Over the past three years, the company’s revenues have increased at a CAGR of 8%, while its earnings-per-share surged at a CAGR of 26%.

Flex’s latest reported results (for fiscal Q4, 2024, and the full fiscal year), released on May 1st, were robust, with revenue and EPS surpassing analysts’ estimates for the quarter. However, the full-year results were disappointing, portraying a larger-than-expected decline in revenue. The company also announced a restructuring plan aimed at reducing its workforce and enhancing operational efficiency.

A slight miss on revenue would not be alarming, in general. However, the strong rise in the stock in the past year, amounting to ~70%, left the company with little margin of safety. Against this backdrop, heavy selling of Flex’s shares by the company executives in the past month was interpreted by investors as a signal that its stock may have outrun its fundamentals.

Flex Ltd. remains a robust and profitable company with strong earnings growth potential. We believe that it will be worth revisiting in the future when the market conditions stabilize. However, for now, we are concerned that our gain on the stock could decline substantially. Therefore, we believe that it is appropriate to sell the stock now and lock in gains.



Portfolio Stocks Under Review

❖ R. Berkley Corporation (WRB) remains under review as several Wall Street firms, such as BMO Capital and Bank of America, have reduced their price targets on the stock over the past weeks.



Smart Investor’s Winners Club

*The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.

The markets were volatile in the past week, with punishing developments for many technology and industrial stocks. As a result, our exclusive club’s ranks have shrunk, as Parker Hannifin (PH), Dell (DELL), and ITT Corp. (ITT) fell below the threshold, while Vertex Pharmaceuticals (VRTX) ascended into the Winners Club.

The Winners Club now counts 11 stocks: SMCI, GE, AVGO, ANET, EME, TSM, AMAT, ORCL, APH, GD, and VRTX.

The “fallen angels” PH and ITT are now the contenders for re-entry, with 28.8% and 28.4% gains, respectively, since their purchase dates. Will they close these minute gaps, or will someone else outrun them to the finish line?



Smart Investor Portfolio

 Portfolio Return YTD
Portfolio Volatility (Beta) Portfolio Dividend Yield
15.26% 1.08 0.86%



New Portfolio Additions

Ticker Date Added Current Price
TPL Jun 5, 24 $584.48

New Portfolio Deletions

Ticker Date Added Current Price % Change
FLEX Feb 21, 24 $32.33 +16.59%

Current Portfolio Holdings

Ticker Date Added Current Price % Change
SMCI Nov 8, 23 $771.61 +202.12%
GE Jul 27, 22 $161.38 +188.80%
AVGO Mar 22, 23 $1330.82 +110.93%
ANET Jun 21, 23 $293.18 +93.51%
EME Nov 1, 23 $368.89 +78.75%
TSM Aug 23, 23 $152.47 +62.57%
AMAT May 31, 23 $212.22 +59.20%
ORCL Dec 21, 22 $120.07 +47.33%
APH Aug 9, 23 $130.05 +47.05%
GD Dec 22, 21 $297.32 +45.92%
VRTX Aug 2, 23 $474.95 +36.58%
ITT Oct 18, 23 $127.50 +33.49%
PH Oct 11, 23 $512.45 +28.82%
CI Jul 12, 23 $337.06 +25.45%
HWM Apr 10, 24 $82.29 +24.97%
MCK Dec 13, 23 $573.73 +24.15%
STLA Sep 6, 23 $21.71 +19.55%
CHKP Jul 19, 23 $151.03 +18.62%
DELL Mar 27, 24 $135.76 +18.41%
CXT Oct 25, 23 $60.58 +17.04%
TXT Nov 29, 23 $87.01 +13.13%
AIT Dec 6, 23 $186.33 +13.11%
SNX Apr 3, 24 $127.87 +9.83%
REGN Feb 7, 24 $993.29 +5.92%
AIG May 1, 24 $76.65 +1.78%
PYPL Apr 17, 24 $63.33 -0.16%
DOV May 8, 24 $179.44 -1.31%
WRB Jan 31, 24 $80.34 -1.58%
CBOE Apr 24, 24 $175.72 -1.73%
V May 15, 24 $272.42 -1.92%
EMR May 22, 24 $106.87 -6.01%
ADBE May 29, 24 $448.37 -6.28%


What’s Next?

Our next commentary will come out on Wednesday, June 12thUntil then – we wish you a world of investment success!

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