|Shares Out. (in M):||191||P/E||0||0|
|Market Cap (in $M):||2,900||P/FCF||13.3||12.0|
|Net Debt (in $M):||111||EBIT||0||0|
Summary: We are long Blackstone Minerals (BSM) and believe it is a misunderstood, defensive investment with unusually asymmetric upside given the business quality (it is a royalty company, not an E&P). We view this as a low risk +50-140% over the next 18-24 months (30-80% IRR) and believe it represents one of the best risk/reward skews we have come across in the market (high quality business, unlevered, aligned management, unique structure that protects downside, inexplicably discounted valuation vs. peers who have lower quality assets, clear explanation for why the mispricing exists). BSM is largely unlevered and pays a 7.5% dividend yield that is 2x covered at current depressed/trough commodity prices. The common dividend is contracted to grow a minimum of 9% per year through Q1 2019 and is insulated by the company’s unique subordinated unit structure (which is underappreciated by the market and adds a significant layer of downside protection, see discussion below). A further recovery in commodity prices offers upside optionality (especially for you gas bulls – production is 2/3 gas) but is not necessary to achieve our targeted return (in fact, given the protection of the subordinated unit structure, the return profile outlined here works down to oil at $30/bbl and gas at $2.00/mcf – so any improvement in commodities represents incremental upside). BSM is run by an owner-operator management team (who has been there since the company was founded in the early 1980s). Management collectively owns more than 20% of the company and has a long history of value creation through the cycles (note the share buybacks they executed in Q1 2016 at the market bottom along with the various acquisitions they were able to execute over the last year as the energy cycle troughed). Lastly, we also believe the company’s outsized exposure to the Haynesville Shale could be an underappreciated source of upside due to the increasing competitiveness of the play (we think now one of the most economic gas play behind the Marcellus/Utica) and its proximity to the growing gas demand in the Gulf Coast region (i.e. no differentials which have plagued economics for Marcellus/Utica producers).
What this opportunity exists: BSM was structured as a Master Limited Partnership and IPO’d in mid-2015 into the MLP bloodbath last year (however, it should be noted there are no general partner promote/splits at BSM, unlike most other MLPs). Given the losses sustained by investors in MLPs over the last year and the heavy retail/high net worth concentration of the MLP investor base, there has been apathy/disinterest around anything MLP-oriented and this dynamic has contributed to the mispricing of BSM. BSM is the largest U.S. holder of mineral interests and represents a very unique and high quality asset base that is virtually impossible to replicate. Mineral royalties are arguably the highest quality natural resource assets you can buy given they represent perpetuity call options and bear no capex or opex (in sharp contrast to the E&Ps that drill on their lands who bear all these costs as well as geological risk – which over time has rendered them very mediocre businesses). Despite this differentiated asset base, the company is covered by E&P analysts (and even worse E&P MLP analysts who cover business models that should never have existed like Linn Energy) who comp BSM against their E&P coverage universe despite the radically different business models. Despite being the largest and most diversified royalty portfolio with the highest quality asset base and most established management track record, BSM trades at a 50% discount to the 4 public royalty comparables (see below) on both yield and EV/EBITDA. A multiple in line with the group would imply +140% to the stock price.
Company Background: Black Stone Minerals is the largest U.S. owner of oil and gas perpetuity mineral interests. The company’s royalty portfolio spans 17 million gross acres in 41 states covering every major U.S. resource basin. The Company owns the mineral rights that oil and gas E&Ps lease in order to drill and produce hydrocarbons. When mineral rights are leased (usually for a three-year term), BSM receives an upfront cash payment (known as a lease bonus) and retains a royalty interest in all future production from the well. The royalty interest is free and clear of any capex or opex and typically entitles BSM to 20-25% of well production. Upon termination of lease, all future development rights revert to BSM to explore or lease again.
In addition to its royalty interest production, BSM has the option under its lease agreements to participate directly in the wells its lessors drill on a well by well basis (and bears its proportionate share of both opex and capex). This working interest business represents ~1/3 of total production but produces minimal current free cash flow given the upfront capex spend. As we will discuss below, we think this portion of the business is a key piece of the misunderstanding.
The company went public in Q2 2015 into the worst energy and MLP market since 2009 and has sold off meaningfully below its $19.00 IPO price (now $15.25). BSM has a minimally levered balance sheet and aims to be consolidator of royalty interests in a period of forced selling among E&Ps and other royalty interest holders. The company currently has rights to 30boe/d (net to them) of production, 2/3 of which is gas.
Misunderstood Business Model: At a cursory level, BSM could resemble a more traditional E&P MLP and is often grouped with those companies and is covered by E&P analysts. However there are important differences that make BSM and royalty trusts more generally a vastly higher quality business model than a traditional E&P / E&P MLP. There is no opex or capex associated with royalty revenue. In contrast to E&Ps, BSM simply collects a fee from third-party production on its land and effectively outsources all of the geological risk, technical expenses, capital outlays, and operating costs to others. And while BSM does plan to expand via land acquisitions (several announced already this year), drilling and new discoveries on its existing minerals provide a cost-free growth mechanism, which is in stark contrast to both midstream and E&P MLPs which grow only at significant capital cost. Royalties are a very high quality business and are in effect a “perpetuity call option” on future growth in production and in commodity prices.
Despite these differences with traditional E&P companies, BSM has been lumped in with E&P MLPs which the market (correctly) views as impaired business models. Part of this may be due to the ~1/3 of BSM’s production is from working interest production (and not royalty interests), and which does require opex and capex. It should be emphasized that BSM has the option but not an obligation to participate alongside operators (meaning the working interest program is entirely discretionary). The working interest program allows BSM to “cherry pick” plays and participate in these wells on a “half-cycle economics” basis (i.e. the exploration and delineation risk is borne by the E&P company and BSM can choose to participate once the play has been de-risked). It is also worth noting that BSM’s working interest program represents <10% of its cash flow, implying that > 90% of the distributable cash underlying the dividend is from the pure royalty portfolio.
We believe that this option to invest in wells at BSM’s discretion is valuable for at least two reasons. First, it is simply an attractive use of capital given the information that BSM has when it makes drilling decisions (again they can simply cherry pick the best acreage in which to participate). Second, it lets the company control its own destiny to a degree, which is contrast to its royalty peers. It is difficult for royalty companies (much less analysts) to estimate their production growth because ultimately drilling budgets are out of their hands. BSM has said that over their history, production on their acreage has organically grown on average at a 5-6% annualized “same-store sales” level under their ownership, we acknowledge that there could be some lumpiness in their production results. This drilling program helps to smooth that lumpiness and provides a growth backstop. Evidence of this is their execution through this most recent downturn: BSM has managed to grow production despite the weak industry conditions (deepest and most elongated sector downturn in the last 50 years).
Significant discount to comps: While there are a few other royalty trust business models in the market both in the US and Canada, BSM differentiates itself in both size and scale. BSM is by far the biggest player and has far more geographic diversity. With the exception of Dorchester Minerals, the other royalty trusts are confined to a single region.
Despite offering geographic diversity, scale, hedge protection (BSM is the only one to use hedges), and a growing/protected dividend (more on that later) BSM trades at a significant discount (~50% below) vs. its peers. We think that this may be due to the capex associated with its working interest program, although bear in mind again that this is completely discretionary and this owner operator management team only engages when it sees attractive returns on that capital. In addition, Freehold Royalties has similar working interests as a mix of its production yet trades at a significantly higher multiple.
Dividend Structure Provides Growing Support: Like all MLPs, BSM pays out the nearly all of its cash flow in a given quarter as a distribution. BSM however has structured its dividend to protect the common units (50% of total units outstanding) over the subordinated units (also 50% of total units). The subordinated units, which are owned by the Company’s legacy shareholders and management, only get paid after all common units have received the Minimum Quarterly Distribution (MQD). There are no arrearages for Subordinated Units. For example, while BSMs cash flow covered 1.1x their Q1 2016 dividend paid to all units (common + subordinated), cash flow covered 1.9x the dividend paid to just common units. Said another way, in that period, cash flow would have had to decline 47% before the common dividend would be as risk. As noted above, this would require oil < $30/bbl and gas < $2.00/mcf.
The second nuance to the structure is dividend growth. BSM’s Minimum Quarterly Distribution (i.e. the amount that the common must get paid before the subordinated can get paid) is contracted to grow 9% per year through Q1 2019, after which the subordinated units will convert to common units at a ratio that guarantees the free cash flow of the company is adequate to maintain the Q1 2019 dividend run-rate. This structure is unprecedented in the world of MLPs and underappreciated by investors and sell-side analysts.
Haynesville Concentration is Positive for Gas Bulls: In 2015, ~25% of total production was from the Haynesville shale in North Louisiana and East Texas, and nearly all of the 2016 drilling capital budget will be spent in the Haynesville/Bossier. The Haynesville was an early beneficiary of the shale revolution, but has been little more than an after-thought over the past cycle due the rise of the Marcellus/Utica. However given the decline in liquids pricing (making dry gas more economic in comparison) and the onerous basis differentials seen in the northeast (in Dom South hub producers right now are getting ~$1.40/mcf less than they would in the Haynesville), interest in the area has picked up and the drilling and completion techniques that were perfected in the Marcellus/Utica are starting to be applied in the Haynesville.
If you are a gas bull, the exposure to the Haynesville is pretty attractive. As a refresher for those who haven’t been following, U.S. gas supply and demand are heading in different directions. Supply has been declining outside of the northeast for several years, and due to the poor realized economics in the northeast new drilling has slowed dramatically and production there has been started to roll over as well. The backlog of pipelines projects that will eventually alleviate the basis differentials in the northeast appear to be slowly moving to the right. Meanwhile, demand has been strong with record demand from power burn and looming LNG and Petchem projects in the Gulf Coast. This dynamic is potentially setting up the gas market to be undersupplied in the 2017-2018 timeframe, requiring a price signal to incentivize drilling. Given its geographic proximity to gas demand growth (i.e. no basis differentials in contrast to the Northeast) and encouraging well results (reflecting significant cost reductions and well productivity advancements over the last 1-2 years), we think the Haynesville should be a beneficiary of the gas bull thesis – along with the Marcellus/Utica, it will be next in line to dispatch on the cost curve. BSM’s largest partner in the Haynesville is XTO (ExxonMobil subsidiary), and our research indicates they have been seeing impressive well results there and are increasing rig counts. A bit of history on the Haynesville: it’s a pure dry gas shale play that was discovered in 2008 and was a focus for the industry from 2008-2011. However, the Haynesville was thereafter de-emphasized when drilling capex shifted to oil shale wells (which bring associated gas as a by-product) given the more attractive economics those plays were yielding at $110/bbl oil. The fall in oil combined with the application of recent technology advances from the oil shale plays to the basin has rekindled interest as the basin has rapidly moved back down the cost curve.
Guidance Revision: Q1 results were strong, and the company indicated that they may be revising guidance with its Q2 results.
Owner Operator Management Team: Board of Directors, affiliates, and management own >20% of company. CEO Tommy Carter owns ~10% of units (split 50/50 between common and subordinated) creating a strong incentive to preserve and grow the distribution and allocate capital prudently. Importantly, because of his split ownership of both share classes, he has no incentive to game the subordinated share conversion mechanism.
Valuation: Valuing a perpetuity call-option that a royalty interest represents is a difficult exercise. The reality is that these royalty trusts (and MLPs more generally) typically trade on a yield basis. Using that short hand, we see substantial upside if this were to even approach the yields that its comps trade at (average of 3.5% yield), using the guaranteed $1.35/unit dividend in 2018.
Q2 earnings (raise production guidance)
Investor re-engagement on yield-oriented investments that is occuring across the market as yields have fallen
|Subject||Re: PDP decline rate|
|Entry||07/25/2016 04:05 PM|
Thistle - I'd push back hard on your conclusions about underlying decline rates. The company has very broad/diversified exposure (17mm gross acres across >60 plays, and only ~15-20% of their acreage is currently leased). The region they label "Louisiana-Mississippi Salt Basin" in their 10-K has 5-6mm of their 17mm gross acres (~30%) but only contributes ~20% of production. Furthermore, this region also includes the Haynesville and Bosier shale where they have significant acreage - and the Haynesville/Bosier is the primary contributor to their production from that region. The old conventional salt dome drilling you describe has long been in decline for the industry and was surpassed years ago by the shale plays. Separately, the Haynesville shale itself in particular went through a period of rapid growth (2008-2012) and then rapid decline and has stabilized around 5-6 bcf/d now that the play is through the high decline rate phase (the first few years of well production). All this equates to a lower PDP decline rate out of these mature assets (the "long tail" in a royalty stream).
However, the best proof that they have manageable decline rates is in their current production rate: they grew production +4% in Q1 despite the largest drilling downturn in the industry since the mid 1980s (the current 460 active rig count in the U.S. is the lower than where the rig count bottomed in the 1999 downturn). If the declines rates were anywhere near what you described you would have seen lower production give the massive (-75%) decline in drilling activity over the last 18 months. Also if we are right on the Haynesville (see Tudor Pickering report on this week that reaches the same conclusion we laid out in our note), this could be a source of production upside for BSM.
If you look at page 75 of their S-1, they show their royalty production since 1980 on a same-store sales basis - you'll see that over that period of time the assets have shown consistent growth.
Also keep in mind the common/subordinated equity structure - this is unique to BSM and creates a huge margin of safety relative to other royalty companies.
|Subject||Haynesville shale renaissance|
|Entry||08/04/2016 08:37 AM|
Chesapeake reported today and offered a lot of new disclosure on the economics in the Haynesville given the improved well technology. When you combine these results with the superior economics (no basis differentials vs. the Marcellus/Utica) it underscores why the play is likely in my view to become the leading dry gas play ex-Marcellus/Utica (which are pipeline constrained and will grow with pipeline expansions). As noted BSM has huge optionality here.
|Subject||Q2 beat and raise|
|Entry||08/08/2016 05:22 PM|
BSM reported $74mm in EBITDA vs. consensus of $51mm and raised production guidance for 2016 by +9% (from previous 29,000 boe/d to 31,500 boe/d). Importantly very little of the Q2 production growth came from the two acquisitions they closed at the end of the quarter ($122mm combined acquisitions from Freeport-McMoRan and other Wattenberg sellers). They also called out higher leasing activity in the Haynesville shale as one of the drivers for the strong leasing revenue ($15.1mm in Q2 2016 vs. $8.2mm in Q2 2015). I'm sure they will elaborate more on the call tomorrow about what they are seeing in the Haynesville broadly.
Dividend was raised +10%.
|Entry||02/13/2017 02:13 PM|
Hey jso1123, updated thoughts on BSM?
|Subject||Re: Still following?|
|Entry||02/13/2017 03:27 PM|
Still really like it, actually bought some more today. I think they are going to get the working interest production off balance sheet that could go a long way to driving the multiple higher. I also think the risk is to the upside on production vs. consensus if you look at what is going on in their underlying plays.
|Subject||Re: Re: Still following?|
|Entry||02/13/2017 04:08 PM|
Thanks for update jso. What have they said on getting working interest off BS? How would they accomplish?
|Subject||Re: Re: Re: Still following?|
|Entry||02/13/2017 04:30 PM|
Not sure, only speculating based on their alluding to it last call. But if you look at Dorchester Minerals that's prob a good case study. My thought is you sell the working interest program to a private buyer who agrees to give you a net profits interest above a hurdle rate. That way BSM can exercise its call option on taking part in wells and sell down to one or a couple of private market buyers but retain a profits interest that is free of any capex. So FCF would be royalty EBITDA and a capex-free net profits interest. I think mgmt here is great and real owner-operators that understand capital allocation so I trust this works out the right way for shareholders. Note they bought back stock in Q1 2016 while everyone in the industry was hiding under their desks - pretty bold for an MLP (b/c of the commitment to maintain a dividend). Most MLPs were out doing what most management teams and boards do at cycle bottoms which is issue expensive equity and preferreds to delever so that they are positioned to over-lever themselves at the next cycle peak buying assets.
|Subject||Re: Re: Re: Re: Still following?|
|Entry||02/13/2017 05:48 PM|
Couldn't agree more :) Thanks for your thoughts.
|Subject||Re: Comparable, Big Picture Question|
|Entry||02/15/2017 11:23 AM|
No strong views on Viper. I see argument for it being cheap but I also think it has a healthy dose of MLP financial engineering (i.e. it is a very small asset base - ~100,0000 gross acres vs. BSM at >17 million gross acres) but the acreage is well located (all Permian) so it has a higher near-term organic growth rate.
Mineral rights are an absolutely amazing business model - it's a perpetuity call option with the ultimate "capital lite" business model. If you look at BSM's acreage, production has grown organically ~6-7% on a "same-store sales" basis on average since the partnership was founded ~35 years ago in the early 1980s and the royalty owner spends $0 capex and is indifferent to cost inflation (in fact you root for it as a mineral owner b/c it means higher commodity prices over time which you participate in as you skim off 15-20% of production free and clear of opex/capex). US energy production grows over time, at various points in time different basins emerge as low cost and will outperform for periods of time (Barnett, Haynesville, now Permian/Marcellus) so I like owning a broad basket with exposure to all basins as it's a better hedge to shifting economics. Think about it in our business - imagine if you owned a perpetuity call option on all 500 stocks in the S&P? Over time earnings grow, some businesses will flame out of course but most will grow earnings 5-6% per year and you get that upside in perpetuity. That's why its so hard to get these mineral rights and accumulate big portfolios - people who own them (often rich families) never sell them. BSM's portfolio can't be replicated. Most important question to ask is whether those acres are located in basins that will ultimately see growing production. Given the US is broadly one of the lowest cost producers of energy in the world, I'm confident that US production will grow for the intermediate to long-term and thus holding a broad basket of mineral rights across multiple basins in the lowest cost producer is a great and irreplicable position to have.
|Subject||Re: Comparable, Big Picture Question|
|Entry||02/15/2017 11:29 AM|
Also note VNOM has a $1.7b market cap and BSM has a $3.3b (assuming sub units convert fully to common) yet BSM has a much broader and asset base. And they have >1mm gross Permian acres vs. VNOM 100,000 gross acres. So I would argue NAV on BSM more attractive. But I get right now VNOM's 100,000 acres are in the "sweet spot" with 80% being drilled by Diamondback (their sponsor) and RSPP so it has a higher organic growth rate and those people view as a better growth profile over next few years.
|Entry||02/28/2017 09:44 AM|
Updated thoughts post earnings? My quick read of earnings was they missed but mostly due to a hedge mtm...?
|Subject||Q1 earnings update|
|Entry||05/11/2017 10:17 AM|
BSM posted a very positive quarter - production grew +17% q/q due to the aggressive drilling in the Haynesville that we referenced in our original write-up that is now showing up as higher volumes. In addition, they executed a major farm-out of their acreage to a large operator (we think BP) that will add +5,000-6,000 BOE/d to royalty production over the next 2 years (+25% increase in their base royalty volumes from this deal alone). EBITDA beat consensus by a healthy amount and they are 1.5x covered on total dividends and 2.5x on common dividends. Leasing bonuses surprised to the upside which is a healthy indicator of future drilling on their land. The dividend goes to $1.25 next quarter which implies an almost 8% dividend yield. The balance sheet is 1.3x levered with ~$200mm in revolver capacity so liquidity and leverage are in a good place.
This situation screens very cheap - an almost 8% dividend yield that is growing ~10% organically, 1x levered b/s, no general partner IDRs, and mgmt that owns a lot of stock (25% held by insiders) and are clearly good operators and know how to incentivize drilling/activity on their lands in tough times (they managed to grow royalty production by +10% in 2016 despite a 75% drop in the industry rig count in 2015/2016).
It's also worth noting that they are moving working interest production off balance sheet (note the deal they did with Canaan Resources last quarter) with the goal of moving royalty production from current 60-65% to 75%+ of total volumes. I anticipate they will do more of these deals in the years ahead.
|Subject||Spoke with IR yesterday|
|Entry||06/16/2017 03:15 PM|
I realized I knew the guy and called him up. Spoke for 90 minutes. I agree this is stupid cheap. Seems pretty clear (as you point out) that the reasons for the mispricing are the non-op working interests, Haynesville burned a lot of investors previously, subordination protections take a few minutes of reading to understand (and of course I missed it in my VNOM comp table too), and frankly you just can't model it - it's a "trust me" situation with respect to management guidance but the counter to that is the absolutely massive insider ownership. IR told me the stakes owned by Stuart Alexander, Tom Carter, Bill Mathis, John Longmaid and Jerry Kyle are their personal money, not legacy institutional investors in the pre-IPO Black Stone. That's $225mm right there.
The other thing that seems to have spooked some people is BSM has apparently been talking about their interest in doing a secondary at the right price to pay down the revolver. I guess investors want to see a specific acquisition for the use of proceeds, but the issue with BSM is they have done a bunch of modest deals on the "credit card" so there isn't one flagship deal to point to. It's just optics.
As far as the working interest stuff I think that is the main hangup. It's not necessarily bad stuff because you don't have all the land/seismic/science costs that are such a black hole for capital at many E&P companies, but I think the valuation would be helped significantly if they got rid of it. If they're going to make capital investments I would just as soon see them redirect that money towards share repurchases anyway.
Crazy that Prairie Sky trades at such a premium to this given both have significant gas exposure. Maybe just maybe they have some better rock up there but the differentials are overwhelmingly in favor of BSM. IR at BSM and basically everyone else I talk to agree that PSK gets the premium because of liquidity and there is more of a captive investor base up there. The CEO talks a good time too. He says all the right things. Seems outstanding. The working interest is an issue but is it really worth 13 turns of EBITDA and giving up >500 bps of yield to avoid it and take on punitive gas differentials? Not even close.
With respect to the Permian, slide 18 of BSM's Jun-01-2017 has that map of their Permian holdings. I was wrong that the 488,053 gross/41,092 net royalty acres is scattered all over the basins. That represents just the stuff inside the Midland/Delaware, not the Central Basin Platform or the arch. There are a few very nice pockets. Even if that's just 5,000 net mineral acres, at $100k/acre that's $500mm.
I like Viper better, but I like this too. Nice catch.