September 30, 2023

Tricia Oak

Business & Finance Excellency

2 Extraordinary Growth Stocks to Buy at a Discount

A company that owns land in the Permian Basin and another company famous for portable generators may not scream “extraordinary growth stocks!”, but Texas Pacific Land (TPL -0.23%) and Generac (GNRC -3.82%) have the historical results to back this description.

Since Generac’s 2010 initial public offering (IPO), its revenue has increased nearly sevenfold. Meanwhile, Texas Pacific has grown its sales by over 11,000% since the turn of the century. 

How exactly have these two growth stocks done it? And, more importantly, will it continue?

1. Generac: Ensuring “power at all times”

Mostly known for its portable and home standby (HSB) generators, Generac’s acquisitive nature provides a wide range of solutions that it hopes will power a smarter world. Operating through three segments — residential, commercial, and industrial (C&I) — as well as other (warranty, services, aftermarket, etc.), Generac provides backup and power generation systems, solar and battery solutions, power grid software, and more.

In the first quarter of 2023, the company saw revenue decline by a staggering 22% compared to last year as it continued to sell through excess inventory in its residential segment. Accounting for 59% of the previous 12 months’ sales, the residential unit saw revenue drop 46% in the quarter, highlighting the cyclical nature of Generac’s operations. 

Generac posted its fifth consecutive quarter of decelerating — and now negative — sales growth as the market continued to pressure the company’s share price.

However, there are still multiple reasons to be interested in Generac following this 62% price drop from all-time highs.

First, the company maintains a 75% market share in the HSB market. Yes, the cyclical industry is in the bust portion of its boom-or-bust cycle — but many robust megatrends could propel sales higher in the decades ahead.

From the combination of the work-from-home and age-in-place trends to the shift toward electric vehicle charging at home and the broader electrification of everything, having an energy backup at home is quickly becoming non-negotiable. And just 6% of U.S. houses have an HSB, so the long-term growth potential of this market is undeniable — particularly as power outages increase over time.

Furthermore, in-home consultations for HSBs — which generally convert to sales within 90 to 180 days — posted its second-highest-ever quarter in Q1 2023, only trailing Q1 2021 when Texas faced a prolonged freeze. This indicator points to the likelihood of a rebound in the second half of the year when management expects its residential unit to resume sales growth.

And all of this goes without mentioning a commercial and industrial segment that continues to fire on all cylinders, growing sales by 30% in Q1. Maintaining relationships with most of the world’s telecom carriers and towers, the company provides power solutions to an impressive 60% share of the critical industry, among many other verticals. 

Best yet, Generac barely trades above its lowest price-to-sales (P/S) ratio of the last decade.

GNRC PS Ratio data by YCharts

Should the company return to its historical norm of a 10% net profit margin, it would be trading around 16 times earnings. Considering its rebound potential in the residential segment and its strong track record of 18% sales growth since its IPO, Generac looks like an extraordinary growth stock trading at a fair price.

2. Texas Pacific: Decades of top-tier profitability

Owning 874,000 acres of land, Texas Pacific Land resulted from Texas and Pacific Railroad’s bankruptcy in the 19th century. Primarily situated in the Permian Basin, the company earns royalties and fees associated with oil and gas production on its land.

However, while the company’s oil and gas royalties account for the bulk of Texas Pacific’s sales, it has steadily diversified its sources of revenue over time, making it less dependent on commodity prices.

To see the value of this built-in hedge, as management calls it, look no further than the company’s first-quarter results compared to last year.

Revenue Source Q1 2022 Q1 2023
Oil and gas royalties $104.2 million $89.1 million
Water sales $18.8 million $21.7 million
Produced water royalties $14.9 million $20.1 million
Easements and other surface-related income $9.2 million $15 million
Land sales and other revenue $281,000 $400,000
Total revenue $147.3 million $146.4 million

Data source: Q1 2023 Texas Pacific Earnings Press Release 

Despite crude oil and natural gas prices dropping 19% and 43% year over year in Q1 2023, Texas Pacific saw revenue only dip 4% as non-oil and gas royalties grew to nearly 40% of sales. 

Even in 2020, when oil futures traded at negative prices for a short time, the company delivered a net profit margin of 60% during the year, despite revenue dropping around 40%. In fact, since the 1980s, Texas Pacific’s lowest net profit margins were a couple of years in the 1990s, at around 31%. 

With $590 million in cash, no debt, and having generated a new all-time high of $437 million in free cash flow over its last 12 months, Texas Pacific’s $10 billion enterprise value may not be doing the company justice. This is especially true considering management traditionally returns almost all of its free cash flow to shareholders through dividends and share repurchases.

Now trading below its historical price-to-free cash flow average, the company deserves consideration from long-term investors after dropping 49% from its 52-week highs.

TPL Price to Free Cash Flow Chart

TPL Price to Free Cash Flow data by YCharts

With management estimating that it still has over 14 years’ worth of oil on its property with a breakeven price below $40 per barrel, look for Texas Pacific to build upon its track record of being a surprising growth stock investment.