Back of the envelope investment summary :
Black Stone minerals is a large mineral royalty company with minimal CAPEX requirements and low debt, and it produced 16 to 18 percent distributable cash flow( DCF) even during covid panic year 2020. 75 % of its revenue is from natural gas which has longer leeway than Oil. They collect 20 to 25 % royalty on revenue of oil or gas produced from the land they own or lease. Management is shareholder-friendly, conservative and does not seem to be interested in taking risks
“ The best business is a royalty on the growth of others, requiring little capital itself. “ – Warren Buffett
Company :
A large pure-play mineral and royalty company, Blackstone (BSM) owns or leases 20 million acres of land available for exploration. They have assets in 40 states, diversifying their revenue sources and limiting their exposure to changes in state laws. BSM earns royalties on oil and gas extracted from their land. This is almost like owning a house and collecting rent, except you don’t need to take care of the land. In terms of revenue split, natural gas accounts for approximately 75 percent of revenue, while oil accounts for 25 percent. They provided capital for drilling (CAPEX) a few years ago, but now they have stopped doing so. Their focus is only on collecting royalties from oil or gas extracted from their leased lands without incurring CAPEX costs.
Management :
The CEO of Blackstone Minerals is Thomas Carter, who is a member of the founding family. W.T. Carter founded BSM in 1876 as a lumber company. With a few pivots, it has become a pure-play mineral royalty company. Approximately 25% percent of outstanding shares are owned by insiders. If COVID had ravaged for two years instead of one year, BSM might have faced bankruptcy. When Covid started they had significant debt on their balance sheet. They sold some prime assets at a discount in order to reduce risk and deleverage rapidly. BSM Manager got some (or a lot) of criticism for selling at the wrong time. However, to the credit of the management, they took a conservative stance by selling some assets and rapidly deleveraging. Imagine if Covid had ravaged the world for 3 years instead of 1 year, BSM might have stared at bankruptcy. The management is likable because they were willing to lose short-term in order to increase the long-term odds for BSM. Instead of trying to acquire more land, management is trying to utilize their existing assets for drilling oil/gas. From the earnings call, it sounds like they will buy land only at a reasonable price and won’t buy if the price is too high. Management has been involved in the oil/gas business in one way or another since the 1980s. They have the necessary depth of experience and relationships with drillers and government agencies.
Valuation :
When the first investment was made in Jan 2021, the stock traded around $7.50. In terms of distributable cash, BSM made around 1.20 to 1.40, yielding 16 % to 18 %. Dividends were paid out in the amount of 70 cents. Given the low level of debt (approximately 124 million) and minimum CAPEX, there is a good chance that once the Covid issue is fully resolved, they will increase dividends. The dividend yield would be around 14% if the dividend was increased to say $1.00. Furthermore, DCF number is from the end of 2020, a horrible year for oil and gas due to Covid shutdowns. When the world opens up fully after Covid, DCF is likely to increase further, increasing the likelihood of dividend increase.
RISKS :
Due to the fact that 75 % of BSM’s revenue comes from natural gas, the risk focuses primarily on natural gas.
Natural gas usage declines around the world :
Global warming and the migration to renewables will reduce the demand for natural gas over time. However, it’s not a big threat for the next 10 to 15 years. The most common uses of natural gas are electricity generation (38%), industrial (33%), residential (15%), commercial (10%), and transportation (3%). Natural gas accounts for at least 40 percent of the electricity generated in the US. Surprisingly, 19% of US electricity is generated by coal, and there is a good chance that coal will be partially replaced by natural gas in the future. Natural gas is also widely used in the industrial sector. Natural gas is used to make chemicals, fertilizers, hydrogen, as well as a heating fuel. Additionally, natural gas is widely used in home heating and cooking, providing a stable base of usage for the next 10 years. Although some counties in California have banned natural gas usage in new homes, there are still many new homes built with natural gas as the primary fuel source. It seems unlikely that the world will substantially reduce Natural gas consumption, though a significant climate change impact might require drastic action. Below you can see that natural gas consumption has been increasing steadily except for few years of lower consumption.
(From EIA.GOV)
Supply/Demand risk :
Natural gas is a commodity, is there a possibility for oversupply to lead to price declines? Natural gas prices have been all over the place due to supply and demand imbalances. In spite of the ups and downs of the natural gas price, BSM has been able to generate positive operating cash flow due to its low Capex and operating expenses. As their operating expenses are low, they can still maintain positive cash flow during the down cycle, even if the percentage of royalties earned is lower. Due to this, bankruptcy chances are significantly reduced for BSM, in contrast with companies that need to spend a lot of money on exploration.
Competitive landscape :
The oil and natural gas industry is highly competitive. Mineral royalty markets appear to have less intense competition. BSM’s competitors include publicly traded companies like Dorchester Minerals LP (DMLP) , Texas Pacific Land Corporation (TPL) , Viper energy (VNOM) etc and many smaller private firms. Among them, there doesn’t seem to be any significant price competition. The contract between oil and gas exploration companies and royalty mineral companies is long-term, reducing the chance for significant price wars.
Will BSM run out of land to drill? :
The company already has around 20 million acres of land and is also acquiring new mineral rights whenever the price is right. Good chance that the world will stop using natural gas before BSM runs out of land to drill. Drilling is also possible at already explored sites thanks to new technologies. For example : It was announced recently by BSM that advances in fracturing and other completion techniques can dramatically improve well performance in existing Texas Austin Chalk fields.
Investment Summary :
BSM produces 16 to 18 percent DCF with a dividend payout of 10 percent. This is during the covid shutdown period. As long as BSM keeps making the same or higher DCF, a significant amount of investment would be repaid as dividends. An additional bonus would be dividends/capital appreciation. The probability of increasing dividends/capital appreciation is quite high as oil and gas demand recovers after the covid induced shutdowns. If the initial investment is repaid as a dividend over time, say in 7 years, the money earned afterwards is pure profit. The investment is low risk with a good return potential!
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