Dorchester Minerals: Royalty Firm Setting The Standards For Investor Returns And Operations

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About: Dorchester Minerals, L.P. (DMLP)
by: George Fisher
Summary

Dorchester Minerals has outperformed its peer group in total returns over the past 5 years by a whopping 36%.

Organic replacement of production over the previous 16 years is 105%, aided by only 3 land acquisitions, no debt, and a puny 14% stock dilution.

The largest contributors to revenue are from the Permian and Bakken fields.

I have been a Dorchester Minerals Limited Partnership (DMLP) unit-holder since noticing it in a one-sentence mention in the 2006 Barron’s Roundtable discussions. My portfolio is quite happy I waltzed into this investment and even happier with the income it produces. DMLP is a small oil and gas royalty firm disguised as an MLP. Within the world of energy royalty trusts, DMLP is my gold standard as it should be yours. As a relatively opaque company with no analyst following, the best information comes from the 2018 annual report 10-K and 2019 annual shareholder meeting presentation. These seem to come together by mid-May every year. Here are my current thoughts on DMLP.

Oil and gas royalty firms are often overlooked energy income investments

Dorchester Minerals is a small firm that owns the mineral rights on over 2.3 million acres (gross) in various oil and gas fields across the US. Its main revenue generators are in the Permian, Bakken, Houghton, and Fayetteville fields, and its assets are classified as net profit interest NPI and royalty interest. The main difference is with NPI assets the firm’s interest is paid after E&P expenses, while the royalty interest is based on revenue collected per well.

From their annual report:

The Partnership’s independent engineering consultants estimated its total proved oil and gas reserves to be 98.5 billion cubic feet of natural gas equivalents (bcfe) as of December 31, 2018. Approximately 33% of these reserves are attributable to the Partnership’s Net Profits Interests and 67% are attributable to its Royalty Properties. Natural gas accounted for 45% of proved reserves as of December 31, 2018, all of which were classified as proved developed producing.

Dorchester Minerals excels in the following attributes:

  • No debt
  • Diversified holdings
  • Great organic growth
  • No date or production expiration and no field limitations
  • Not a big issuer of new units
  • MLP structure with reasonable GP fees, no IDRs
  • No UBTI
  • Proven managers
  • Unhedged exposure to oil and gas pricing

In the firm’s charter are a few interesting directives. The partnership is not to incur any long-term debt and is not to invest nor structure assets in such a way as to potentially generate UBTI, unrelated business taxable income and an Achilles heel for many MLP unit-holders. These two attributes assist in offsetting some of the risks to unit-holders, especially in the oil and gas industry. In addition, DMLP offers an interesting twist in that many royalty interests are not payable until the E&P firm receives a minimum return on their investment, usually when revenue reaches ~150% of their cash investment. This creates assets which are categorized as producing but not yet in a payout mode.

Of major concern to all royalty investors, regardless of the firm chosen, should be the only thing they own – oil and gas reserves, and the firm's ability to expand those reserves over time. Unlike many within the royalty business, DMLP investors are not constricted by field location and production quotas, and there is no defined date for the firm to turn into pixie dust and blow away. There are two methods of expanding reserves – by finding it organically on current property owned or by purchasing assets from third parties. Since its formation in 2003 from the combination of two previous royalty firms, DMLP has purchased three third-party acreages, in 2004, 2009, and 2019, and the firm issued new units as payment each time. Over the previous 16 years, the growth in units outstanding was a mere 14%, rising from 29 million shares outstanding to a current 33 million. The balance of reserve replacement beyond these minor additions has been through organic growth. Since 2003, DMLP has replaced its total oil and gas production with upward revisions of its reserve assets, and currently has 5% higher reserves than in 2003. Below is an interesting chart of DMLP’s reserve history and more detailed reserve and production history of 2018, from their presentation:

In early 2019, management announced its third purchase of acreage in exchange for 2.4 million units, valued at $43.2 million. Below is an interesting map of both the recently acquired acreage locations and overall acreage. As shown, DMLP has an interesting geographic reach.

Over the years, DMLP has added substantial oil assets. In 2008, production was 82% natural gas and 18% oil; in 2018, production was closer to 50% - 50%.

As an unhedged royalty firm, revenue and distributions are quite variable. DMLP has paid 66 quarterly distributions, ranging from under $1.30 in trailing 4-quarter payouts in 2010, 2016, and 2017 while exceeding $2.00 in 2006, 2007, 2008, and 2009. The average annualized quarterly payout is $1.75 per unit, and currently, the trailing 4-quarter distribution is $1.94, for a TTM yield of 9.8%, and an annualized quarterly forward yield of 10.2%. Below is a chart from gurufocus.com of the historic distribution yield of DMLP, dating back to its formation in 2003. As shown, the current yield is close to previous yield peaks in 2007 and 2015/2016.

TD Ameritrade offers the following charts of 1) historic prices of DMLP units, 2) the most telling total return chart for DMLP, and 3) comparisons to its peers. Of interest to income investors should be the uneventful and very uninspiring 30.8% price return over the previous 16.5 years. But the total return including distributions is 12 times the price return at 362%. The average annual total return is therefore 22% - outstanding by any consideration – and it been mainly in cash that investors could take to the bank.

There are several peers in the oil and gas royalty industry. Ameritrade offers the following chart and table of their royalty peer group of Sabine Royalty Trust (SBR), Permian Royalty Trust (PBT), San Juan Basin Royalty Trust (SJT), and Cross Timbers Royalty (CRT). As shown, DMLP leads the pack in several of the categories.

As part of the annual 10-K, firms publish 5-yr total returns vs a peer grouping and an index. Management has chosen the above peer list plus Mesa Royalty Trust (MTR) and Houghton Royalty Trust (OTCQX:HGTXU). Below is the latest chart of DMLP's 5-yr performance vs its peer grouping.

Most interestingly, Dorchester Minerals has outperformed its peer group in total returns over the past 5 years by a whopping 36%. This time frame includes the energy meltdown of 2015/2016.

Overall, I have been extremely satisfied with DMLP as part of both my income portfolio and my energy sector allocation. As it is my 6th largest position, I don’t plan on adding more units anytime soon, but if I didn’t own it, today’s price seems fairly valued and the name should be ripe for new additions.

Investors looking for a small capitalization income play with an unhedged exposure to the oil and gas markets should review Dorchester Minerals. Investors looking to add a royalty firm or investigating the industry should compare their choice to DMLP.

The results should surprise you.

Disclosure: I am/we are long DMLP. 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.