Formed in 2003 by the merger of three oil/natural gas royalty trusts, Dorchester Minerals LP (DMLP - $21) offers investors both tax-advantaged current income and conservative exposure to long-term natural gas assets. DMLP is a master limited partnership (MLP) that owns mineral, royalty, net profits, and leasehold interests, consisting mainly of natural gas properties. DMLP controls about 3.1 mil gross acres (348,000 net acres) in 574 counties in 25 states, with some located in attractive natural gas plays. It is estimated that only 30% of the acreage is developed.
Dorchester Minerals collects an override payment on the production of wells on the land it controls. These are generated as a Royalty Interest (non-working interest) or a Net Profit Interest, NPI (working interest). A large percentage of revenues are based on selling price and production volume, making DMLP leveraged to the price of natural gas. Proven developed reserves, as of 12/08 third party estimates, were 61 bil cubic ft of natural gas (about 70%) and 3.5 mil barrels of oil (about 30%), not including the acquisition in June 2009 of additional Royalty Interests in the Bartlett Shale.
Dorchester Minerals controls diverse acreage in the Fayetteville Shale, Barnett Shale, Bakken/Williston Basin and in the Appalachians. As an example of one of their positions, DMLP controls 31,000 gross/22,000 net acres in and around the Marcellus Shale in the Northeast. DMLP continues to grow its portfolio of overriding interests and reserves. In June 09, management purchased assets in the Bartlett in exchange for 1.3 mil shares.
Revenues through 9/30/09 were $29 mil, with net income of $13 mil, down substantially from $75 mil in revenue and $57 mil in net income during the first nine months of 2008. As a direct participant in the feast-or-famine natural gas sector, these y-o-y results are pretty typical. Due to customary energy depletion tax allowances and their MLP structure, distributions historically will meet or exceed reported net income. Distributions in 2009 were $1.50, down from $2.80 in 2008. 2010 is starting out with a $0.32 first quarter distribution (representing 4th qtr revenues of approx $9 to 10 mil), annualized at $1.28.
The investment opportunity focuses on Dorchester Mineral’s distribution that is tied to the price of natural gas and the continuing development of its non-producing acreage. I believe longer-term industrial natural gas demand will return to “normal” and added usage will be encouraged for electric generation, home heating, and transportation.
Offsetting this will be increased productivity from unconventional plays, like shale. While a return to natural gas pricing of $13 is a ways off, so is a return to the recently experienced low of sub-$3, with current natural gas pricing of $5.30ish. I subscribe to the $6 to $7 for range medium-term price projections.
Below is a table of DMLP annual distributions since 2005. What becomes apparent is the volatility of DMLP distributions:
2005 2006 2007 2008 2009
$1.50 $2.83 $1.98 $2.80 $1.50
Dorchester Minerals is a bit different from other natural gas royalty MLPs. When DMLP enters into a working interest relationship (NPI), it tried to fund capital expenditures from the royalty payments due upon completion. In exchange for assuming greater exploration risk, the operating partner pays a lower royalty and retains royalty payments until all cap ex is repaid. For example, according to SEC filings, during the three months from Sept to Nov 09, DMLP “re-invested” $800,000 of NPI revenue in capital expenditures. This is the conservative nature of DMLP – lower exploration risk exposure.
Added to this approach is the fact Dorchester Minerals is forbidden by its charter from issuing long-term debt, and current long-term debt is $0. DMLP seems to offer fewer operating and investment risks.
Because it is structured as a Limited Partnership, there are additional tax considerations when investing in Dorchester Minerals. One reason DMLP has a high payout ratio is that MLPs are structured to pay no corporate income taxes. To avoid the typical double-taxation of dividends (corporate tax on income, personal tax on dividends), MLPs have larger distributions, and the investor is responsible for income taxes.
Ownership in an MLP is documented by the issuing of an annual tax form known as a K-1 which is filed with the tax return. If you use a tax accountant, it’s one more form for him; if you prepare your own taxes using a computer program, it’s a few more lines of data entry. If you do your taxes by hand, well…… the obvious answer could be to hold MLPs in a tax-advantaged account, like an IRA.
However, Uncle Sam doesn’t like you to accumulate tax-advantaged income in a tax-advantaged account, so they limit the amount of MLP distribution income to around $1,000 a year. If you do not currently own MLPs, or are thinking about adding one to an IRA, I strongly recommend researching the tax implications, or discussing with your tax advisor, prior to purchasing.
Over the long-term, higher natural gas prices will lead to higher Dorchester Minerals distributions, which should lead to higher share prices. DMLP currently pays an annualized distribution of $1.28, based on 4th qtr 2009 fundamentals. With share prices trading at $21, this represents a current yield of 6.1%. A $1.80 to $2.00 annual distribution seems a reasonable prediction based on the table above, and a return to “normalcy” similar to late 2006 to early 2008. This level of distribution would generate a yield on capital of 8.5% to 9.5%. The same current yield as today would equate to a share price of around $30.
With a market capitalization of about $640 mil, 30 million shares outstanding, and a low beta (0.33), Dorchester Minerals is one of the smaller energy MLPs, and is not followed by Wall Street. It is included in few general discussions and articles focusing on energy MLPs. Dorchester Minerals flies under just about everyone’s radar, and, by the looks of their website, they like it that way.
My personal price target over the next 12 to 24 months is $28, with the medium-term potential of collecting an annual 9%+ return on invested capital in cash.
For investors looking for income that is tied to the fortunes of natural gas along with the potential of acceptable long-term capital appreciation, DMLP is worthy of your due diligence, including research on personal tax issues.
Disclosure: Author is long DMLP and has been a shareholder since 2008