The end of the month is hectic for me as I focus on publishing Guiding Mast Investments. I have been rolling around in my head ideas for an updated Dorchester Minerals (DMLP) commentary, and lo and behold, up comes a review by Hidden Opportunities. It covers many of the investment highlights of DMLP, and this commentary will touch on a few of those, and will add to the information offered by Mr. Opportunities. If you like the oil and gas E&P business, Dorchester Minerals should be one of the core holdings of your energy portfolio.
I initially ran across Dorchester Minerals over 14 years ago and have been a shareholder since Feb 2006. DMLP was mentioned as a one sentence reference by, I believe, Mario Gabelli during Barron’s annual roundtable conversation with well-healed money managers, and this article marks my 12th commentary on SA since early 2010.
Dorchester Minerals is an oil and gas “royalty” firm, which means they own land and mineral rights in oil and gas fields and encourages energy companies to drill on their land in exchange for a percentage cut of the revenues, called a royalty. Royalty income is collected regardless of who owns the well and the payment to DMLP continues until the specific well’s production stops.
I will say Mr. Opportunities’ article outlines several of the important features of DMLP. These include:
No Debt: The Achilles heel of most oil and gas E&P firms is debt, pure and simple. According to Haynes and Boone E&P bankruptcy specialists, since 2015 and through July 2020, there have been almost 250 firms filing for bankruptcy, representing $170 billion in secured and unsecured debt. The chart below outlines quarterly bankruptcy filings from 2015 to 2020.
$170 billion would buy every man, woman and child living in Los Angles and Phoenix a Mini Cooper convertible, or every resident of Albuquerque a stripped-down Bentley, Rolls, or Ferrari – take your pick. Needless to say, that is a lot of money “lost” to bankruptcy. Dorchester Minerals has no debt on its balance sheet and is forbidden by its charter from issuing debt, except possibly for inconsequential trade receivables. For this reason alone, DMLP offers a lower risk profile than other oil and gas firms, including other royalty peers.
Distributions, K-1: As a master limited partnership, Dorchester Minerals offers a high distribution payout, which is logged as a “return of capital” for income tax reporting. This reduces an investor’s position cost basis and the lack of current income tax liability is somewhat offset by higher capital gains tax when the position is sold. In my way of thinking, capital gains taxes are lower than earned income taxes, and the delaying of any taxes due is better than paying up the following April. Once the adjusted cost per share basis reaches $0 through annual reductions of the cost basis, DMLP’s distribution is classified as taxable capital gains, again at usually lower rates than earned income. According to the IRS, investing additional capital adds to the position’s cost basis, delaying the date when the basis reaches zero and taxes are due. Much like the old fashion dividend re-investment plan, adding to the holdings of DMLP at least once a year by a minimum of the distribution maintains the majority of tax-advantages of the income. It is pretty easy to review the status of the adjusted cost basis as it is reported annually in the K-1 under the line titled “Ending Capital Account”. Adding to a DMLP position when unit prices are depressed is a great tactic to increase the position’s income and to delay the date the tax man comes for his share.
Quarterly distributions are variable. Royalty income varies with the realized price and production volume of the producing wells on its land. As oil and gas prices increase so will the distribution and as commodity prices decline, so does the distribution. If an investor is uneasy with a variable distribution, I recommend moving on. There are far too many cursory dividend articles lumping DMLP’s distribution into groups of stocks with “dividend cuts”. Yes, the distribution will go down some quarters, but it is the nature of the investment structure and not the usual slam on poor management.
Distributions as a percent of revenue. One fundamental tool I use to compare royalty firms is the percent of distributions to total revenues. This simple ratio of dividing total distribution to investors by total revenues allows investors to see where revenues coming in the door are going, such as operations like overhead and debt service vs. distributions to share/unitholders. The higher distribution payout to total revenues is better for investors as it shows management’s ability to distribute more of its revenues – adding another layer of analysis of royalty investor returns. As an example, I have compared Dorchester Minerals to a few of its peers. As shown, DMLP is high on the list. I encourage investors conducting their due diligence on DMLP and its peers to use this ratio in their decision making process.
Note: With many royalty firms cutting distributions in 2020, these numbers were derived from the 2019 10-K reports as filed with the SEC.
Oil and gas reserves: It is critical to appreciate that all E&P firms are on a treadmill of production declines countered by new producing wells, and the major asset investors are buying is the reserve profile combined with the ability of management to replace their depleting assets. Many E&P royalty firms are structured around a specific field, a certain time frame, or a specific amount of productions. As explained by SA author Laurentian Research in a late 2018 article, royalty firms can be divided into two basic groups: 1) royalty firms with gradually depleting properties plus those with time constraints and 2) royalty firms that can acquire additional properties to offset the expected production declines. Laurentian Research identified 19 stocks falling to the first category and only six in the second category.
Dorchester Minerals is in the second and more preferred grouping. DMLP has bought additional acreage only 4 times since its formation in 2003. The vast majority of its reserve replacement has been “revisions” to its existing land holdings. As Jed Clampett showed us on his Ozark mountain farm, there is no cheaper way to find oil than on land you already own. In review, since 2003, DMLP has paid a total of $30.61 in total distributions per share, has issued a total of 5 million shares for reserve acquisitions with a current diluted impact of $2.44 per share ($83 million in new shares / 34.7 million shares out) and presently has more Bcfe reserves than when it was formed 17 years ago.
The slide below from its 2019 investor presentation outlines reserve replacement since 2003. As shown, the partnership began with 94.0 Bcfe, produced 207.2 Bcfe, and exited 2019 with reserves of 103.7 Bcfe. In my opinion, this is the most important chart for investors to understand, combined with the knowledge that reserve additions have cost unitholders a fraction of the total distribution.
Source: 2019 Investor Presentation
Unitholders should realize that with no debt and no ability to borrow to build reserves due to charter restrictions, share issuance has been and will be the currency used to acquire additional reserves.
Paying vs. non-paying assets: One interesting aspect of Dorchester Minerals is time lag between the first production eligible for royalty income and realization of the income for unitholders. DMLP’s contracts usually allow the driller to initially generate 100% to 150% of the cash well production costs prior to paying royalty. While this encourages use of their land, it creates a situation of non-paying but producing wells. According to their presentation, in 2019, 50% of their wells were non-paying, 40% were producing and not yet reached the payout threshold combined with 10% classified as “non-producing”, or most likely considered “shut-in”. Non-paying production has not been a problem over the years, but investors should be aware of this time lag for revenue realization.
Dakota Access Pipeline: It has been asked what exposure Dorchester Minerals has to the controversy over the Dakota Access Pipeline [DAPL]. While not broken out specifically, according to the investor presentation, at the end of 2019, Bakken production represented ~$5.0 million in royalty income and ~$5.5 million in net profit interest income. Out of a total revenue in 2019 of $78.8 million, all Bakken production accounted for 13.3%. I cannot say how much of this production travels through the controversial DAPL, but overall, it seems manageable.
DMLP vs. oil prices: Readers have asked what impact changes in oil prices have on Dorchester Minerals. The answer is a great deal. Below is a chart offered by investing.com graphing the price-only performance of DMLP to WTI futures. While it is a very interesting comparison chart, it fails to tell the whole story. As a price-only chart, the +29% gain in WTI since Dec 2003 vs. the 36% loss in DMLP does not include the 176% cash distribution paid since 2003. Combining the 36% loss on share prices and the 176% cash distribution means a total return for DMLP of 140% vs. 29% for WTI.
Shown another way, dividendchannel.com offers a total return comparison for Dorchester Minerals with S&P Oil and Gas E&P ETF (XOP). Using a start date of 6/22/2006, which coincides with the IPO of XOP, the chart below is very telling. I encourage all readers considering a position in DMLP to check out the interactive chart offered by dividendchannel.com and plug in your own start date. Remember, with an income investment where the distribution is a large part of an investor’s return, it is critical to compare total investment returns and not just price-only charts.
With several royalty firms to choose from, Laurentian Research offered this original graphic which compares important attributes of high operating margins, asset durability, and growth. I think it does an excellent job of visualizing various characteristics of DMLP and its peers.
Dorchester Minerals is a very under-followed and under-rated stock for income investors. As my friend and DMLP follower “usiah” has stated in the past:
“An open-end royalty trust organized as an MLP, DMLP ought to be considered for investment by the income-oriented investor seeking position in the hydrocarbon E&P space. DMLP produces a reliable, relatively high though variable (depending on production and price), distribution.”
While my target price to add to my already substantial holdings of Dorchester Minerals is below $9.00 (because I can afford to wait and if it never gets there, oh well) if I was not a unitholder, I would be a buyer at the current price and aggressively add if the price falls.
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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.