Dorchester Minerals (Nasdaq: DMLP) is a small cap oil and gas play that often flies under the radar, yet it’s been quietly minting money for its unitholders for decades.

The company owns a diverse portfolio of mineral and royalty interests across multiple basins in the United States, including the prolific Permian and Bakken. Dorchester maintains a lean operational structure by not directly engaging in drilling or operating wells, which helps keep costs low and margins high.

Much of the company’s success stems from the expertise and capital expenditures of its operating partners, as well its active pursuit of accretive acquisitions. For example, in the past year alone, Dorchester closed four mineral and royalty acquisitions, adding approximately 3,700 net royalty acres across 14 counties in four states.

Over the past few years, the stock price has been on a powerful tear. It’s up more than 400% from its 2020 low.

But might this microcap be overheated? Let’s run it through our Value Meter to find out.

First, let’s examine Dorchester’s enterprise value-to-net asset value (EV/NAV) ratio. This metric sits at 6.53, just a hair below the industry average of 6.56 for companies with positive net assets. On the surface, this might suggest Dorchester is fairly valued.

However, there’s more to the story when we look at its cash generation…

Over the past four quarters, the company’s free cash flow averaged an impressive 18.85% of its net assets – more than double the peer average of 8.04%. Even more noteworthy, Dorchester generated positive free cash flow in each of those quarters.

It’s not all roses, though. Like all oil and gas companies, Dorchester is exposed to commodity price fluctuations. The recent decline in natural gas prices, for example, has put some pressure on results. Dorchester’s reported Q1 2024 net income of $18.2 million, down from $28.1 million in Q1 2023, largely due to lower natural gas prices and reduced net profits interest revenues.

However, the company’s diverse asset base and royalty-focused model help cushion these blows. In fact, its royalty revenues last quarter proved to be a bastion of stability, up nearly 1% year-over-year to $24.9 million.

What stands out is Dorchester’s distribution policy. For Q1 2024, the company declared a cash distribution of $0.782 per common unit, translating to an annual yield of around 10% based on recent prices. While not a consistent dividend grower, that yield is substantial. Since its inception, the company has distributed a cumulative $1.3 billion to limited partners – impressive for a small company.

It’s worth noting that Dorchester’s structure as a limited partnership means investors receive a K-1 tax form, which can be more complex than a standard 1099. However, for many investors, the tax advantages and high yield outweigh this minor inconvenience.

In conclusion, Dorchester offers a compelling package: exceptional cash flow generation, a high distribution, and exposure to some of the best oil and gas resources in the U.S. For investors seeking income and potential capital appreciation in the energy sector, Dorchester deserves serious consideration.

The Value Meter’s “Slightly Undervalued” rating seems right on the money.

— Anthony Summers

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