Dorchester Minerals: Is The 'Master Limited Royalty Trust' Overpriced?

| About: Dorchester Minerals, (DMLP)

Summary

Is this the Royalty Trust MLP or a meta-E&P company?

Either way, it is a distribution play, and the current run up has lowered the yield.

At its current price, DMLP is extremely optimistic about high oil prices.

Dorchester Minerals Limited Partnership (NASDAQ:DMLP) is a unique animal in the oil and gas space. DMLP is a partnership that owns oil and gas property rights but does no real extraction or handling of the oil itself. It gets casually referred to as the "Royalty Trust MLP" but this is a bit misleading.

A typical royalty trust owns a specific set of mineral royalty rights or Net Profit Interests (NPI). Because it is a trust, it exists as a pass through vehicle. If the underlying royalty or NPI pays out, that is passed on to the trust owners, if not, there is no payment. Royalty owners have a real property ownership (typically recorded on the property deed with the county) of underlying oil and gas. Net Profit interests may or may not be real property and are essentially a share of the business at the well/property level. NPI's only pay out if there is a net profit from the property.

Royalty interests or NPIs do not need to be passive. While the operator/owner of the operating Net Profit Interest has the ultimate control over how the field is run, a royalty or NPI owner have exert more or less influence. DMLP attempts to exert more influence.

DMLP has a professional management team that manages the partnerships assets. They can sell interests, buy more, or, if its potentially beneficial to their ownership agrees to development costs to enhance future production. however , DMLP has no physical operating assets.

DMLP has no debt. Since current revenue cover partnership level expenses at about 6 times, oil and gas could take a massive plunge and the bankruptcy risk of DMLP is extremely small.

Nuances to No Debt: However, if a property is not making enough money to cover costs, cash flow can go to zero. Also, that property accumulates the unpaid expenses which must be paid off before future profits can results in a payment. NPIs can become bogged down with old costs that need to be paid off when higher oil prices return. Currently this is not a problem for DMLP, however if there were another major downturn in oil prices, an accumulation of costs at the NPI level is a real risk investors should be aware of.

Production Growth:

DMLP has several small but steady horizontal well programs on their various interests. This has resulted in steady growth of oil production this year and likely this trend will continue next year as the remaining wells are drilled and completed.

They do not appear to have an active drilling program on their gas properties. DMLP's gas production has decreased and will likely continue to decrease. Nationally rig counts are increasing but this trend may not play out with DMLP in the near term. In table 1 below, we look at their production from the last several years, and use those trends to estimate the balance of 2016 and 2017.

Table 1: DMLP Production Forecast and History Historical Performance:
2017 Forecast 2016 Estimate 201 5 201 4 2013
Royalty properties gas sales (mmcf) 3135 3300 3,704 3,574 5,049
Royalty properties oil sales (mbbls) 636 605 524 502 379
NPI gas sales (mmcf) 2532 2665 3,248 3,383 4,111
NPI oil sales (mbbls) 436 415 399 219 140
Royalty properties gas sales ($/mcf) $2.85 $2.61 $2.30 $4.21 $3.44
Royalty properties oil sales ($/bbl) $48.54 $43.42 $42.23 $78.64 $94.15
NPI gas sales ($/mcf) $2.96 $2.72 $2.49 $5.02 $4.15
NPI oil sales ($/bbl) $46.76 $41.64 $49.46 $80.83 $91.85
Sources: Historical Date from Company SEC filings, Future prices from CME website on Jan 31st and Production estimates by Authors analysis

in the production numbers. (This is DMLP's advantage over many royalty trusts; management has done a good job with the drilling program.) Gas production has been declining. Both oil and gas sell at a discount to the WTI oil price and Henry Hub gas price. The relative discounts are not expected to change. The futures curve prices were adjusted by this historical discount to get the estimated 2017 oil and gas prices. If oil volumes can continue to grow, this will more than offset the declines in gas volumes and increase the partnerships revenue.

Table 2: Estimated Revenue and Distribution
2017 2016
Estimate Revenue: $8,400 $5,950
Est. Minerals NPI costs $7,728 $5,474
Partnership costs 7000 7000
Net: $728.07 -$1,525.95
Est. Annual Distribution: 1.2 0.85
Est. Yield 7.1% 5.0%
Estimates from Authors Analysis

Next, from the production estimates, revenue and costs were estimated. The partnership has historically reported costs from the payments to the general partner and costs of operating the partnership. The various working interests are burdened with sharing revenue with the underlying Mineral owner. This is not well explained in the investor presentation, but appears to average about 8% of the revenue the partnership receives. The Partnership operating costs are expected to be $ 7 million, and this is steady year to year. The trailing yield is 5% at the current unit price.

The forecast yield for 2017 is just over 7%. What then is driving the rise in DMLP's price per unit?

Table 3: Sensitivity to Oil Prices
Current Futures Curve, in 000s plus 10%, in 000s minus 10%, in 000s Plus 25 %, in 000s
Estimate Revenue: $60,197 $65,322 $55,071 $73,011
Est. Minerals NPI costs $55,381 $60,097 $50,665 $67,170
Partnership costs $7,000 $7,000 $7,000 $7,000
Net: $48,381 $53,097 $43,665 $60,170
Est. Annual Distribution: $1.20 $1.45 $1.00 $1.64
Est. Yield 7.1% 8.6% 5.9% 9.7%
Estimates from Authors Analysis

DMLP's unit price has been run up by investors presumable bullish on oil's future. In Table 3, the average price of oil was varied by 10% and the distribution estimated. The price of natural gas was not varied. A 10% increase in oil price will increase the distribution by about 20%. A 25% increase in oil prices is needed to for DMLP to yield 10%. It seems investor have realized the run up past $18 per unit was excessive, however the units still appear overpriced.

Conclusion

DMLP is an interesting investment to study. The mineral rights are a long-term assets that may increase with future technology developments in drilling. The lack of debt offers a protection against bankruptcy in a prolonged oil bear market. However, the partnership owns depleting assets and the current yields are unimpressive. At current prices DMLP is a bet on much higher oil prices. Investors are better served waiting for DMLP to return to prices around $14 or real signs of oil moving above $65 per barrel. Until then, I will be sitting on the sidelines.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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