Executive Summary / Key Takeaways

• Acquisition-Driven Growth Masks Deteriorating Economics: TXO Partners has grown revenue 42% year-over-year through aggressive Williston Basin acquisitions, but operating income collapsed 72% and net income fell 50% as higher depreciation, production costs, and interest expenses overwhelm top-line gains.

• Distribution Yield Is a Mirage Funded by External Capital: The eye-catching 16.96% dividend yield is not supported by free cash flow, which turned negative at -$155.86 million over the trailing twelve months. With a payout ratio of 562.5%, distributions are being funded through debt drawdowns and equity issuance, not operational cash generation.

• Williston Acquisitions Increased Volume but Compressed Margins: The EMEP and WRE acquisitions added substantial production, but these assets carry higher depletion rates (DDA per Boe up 62%) and operating costs, eroding per-unit profitability and exposing the limits of growth-through-acquisition in a capital-intensive business.

• Commodity Volatility and Inflation Create a Vice: While natural gas price increases contributed $13.2 million to revenue, oil price declines shaved $19.8 million. Simultaneously, inflation in steel, chemicals, labor, and fuel has driven production costs up 22%, with management explicitly stating these pressures will not reverse in the near term.

• Expanding Credit Facility Signals Rising Financial Risk: The borrowing base increased to $410 million in July 2025, with $264 million currently drawn. The company is operating with negative working capital of $86.3 million and a net-debt-to-EBITDAX ratio approaching 1.5x, limiting flexibility if commodity prices weaken further.

Setting the Scene: A Classic Upstream MLP with an Acquisition Habit

TXO Partners, L.P. was established as a Delaware limited partnership in January 2012, with operations commencing immediately under the control of its general partner, TXO Partners GP, LLC. From inception, the company has operated as a conventional upstream oil and gas partnership, focusing on acquiring, developing, and optimizing mature assets rather than pursuing high-risk exploration. The general partner's board is appointed by MorningStar Oil Gas, LLC, a structure that has shaped the partnership's strategy toward financial engineering and distribution-focused capital allocation.

The company makes money through a single reportable segment: Exploration and Production. Its properties are concentrated in three basins: the Permian Basin of New Mexico and Texas, the San Juan Basin of New Mexico and Colorado, and the Williston Basin of Montana and North Dakota. This geographic focus on proven, conventional reserves has historically provided stable, low-decline production profiles compared to the shale-focused strategies of many peers.

TXO's business model centers on acquiring underexploited assets and applying operational improvements to extend their economic life. The partnership agreement mandates distributing all available cash to unitholders, creating a variable distribution policy that management adjusts based on market conditions. This structure positions TXO as a yield vehicle in the energy sector, but one that must constantly balance acquisition opportunities against unitholder distributions.

A phase of aggressive expansion began in August 2024 with the $244.2 million EMEP Acquisition of Williston Basin properties, followed by the $17 million KFOC Acquisition. The strategy accelerated in July 2025 with the $338.6 million WRE Acquisition, which contributed $11.5 million in revenue for the partial quarter. These deals transformed TXO's production base but also fundamentally altered its cost structure and capital intensity.

Trading at $11.98 per share with a market capitalization of $652.48 million, TXO presents itself as a high-yield energy play. However, the underlying financial reality reveals a partnership consuming more capital than it generates.

Technology, Products, and Strategic Differentiation: Conventional Assets in an Unconventional World

TXO's core strategic differentiation lies in its focus on conventional, low-decline assets rather than the high-growth unconventional shale plays that dominate peer strategies. The company's properties feature production decline rates of 5-10% annually, materially lower than the 20-30% first-year declines typical of horizontal shale wells operated by competitors like Vital Energy or Riley Exploration Permian . This geological characteristic should provide predictable long-term cash flows, reducing the capital intensity required to maintain production.

The partnership employs a dynamic capital allocation framework, shifting funds between development projects, acquisitions, and distributions based on projected economic returns. Management explicitly states it may prioritize debt repayment from acquisition cash flows or modify capital budgets to preserve distributions. This flexibility is both a strength and a vulnerability—it allows rapid response to opportunities but also enables unsustainable distribution policies.

A comprehensive hedging program covers approximately 10,000 barrels per day of oil and 50,000 MMBtu per day of natural gas through 2025-2027. These derivatives generated $16.9 million in gains during the first nine months of 2025, comprising $10.6 million in unrealized mark-to-market gains. While this provides near-term cash flow stability, it also means the partnership is not fully participating in potential price rallies, capping upside in favorable commodity environments.

TXO's non-operated working interest model provides capital efficiency advantages. By partnering with larger operators, the company avoids the full cost burden of drilling and completion while still capturing production upside. This approach contrasts with operators like HighPeak Energy that bear complete operational responsibility and associated risks. However, the model also limits TXO's control over development timing and cost structures, making it dependent on partners' efficiency and capital discipline.

The company's optimization techniques—targeted workovers , infill drilling , and facility upgrades—are designed to extend reserve life and improve recovery factors. These methods are less technologically intensive than the advanced completion designs employed by shale-focused peers but also require less upfront capital. The trade-off appears in per-unit economics: TXO's production expenses per Boe have risen from $17.83 to $18.23, reflecting the higher maintenance requirements of mature conventional fields.

Financial Performance & Segment Dynamics: Revenue Growth That Destroys Value

The nine months ended September 30, 2025, reveal a stark divergence between revenue growth and profitability. Total revenues increased 42% to $275.1 million, driven by a 1,210 MBoe production increase that contributed $71.3 million. The Williston Basin acquisitions were the primary driver, offsetting natural declines in the San Juan and Permian Basins. Natural gas price improvements added another $13.2 million, and hedging gains contributed $16.9 million.

However, this top-line expansion came at a severe cost to profitability. Operating income collapsed from $12.4 million to $3.5 million, a 72% decline that signals fundamental problems with the acquisition strategy. Net income fell from $13.3 million to $6.6 million despite the revenue surge, as every major expense category outpaced sales growth.

Production expenses rose 22% to $133.5 million, with $23.5 million directly attributable to Williston acquisitions. On a per-unit basis, costs increased from $17.83 to $18.23 per Boe, reflecting both the higher cost structure of acquired properties and inflationary pressures in steel, chemicals, labor, and energy. Management explicitly states these cost increases are not expected to reverse in the short term, creating a permanent margin headwind.

Depreciation, depletion, and amortization (DDA) exploded 94% to $66.8 million, with $28.6 million coming from Williston production. The DDA rate per Boe jumped from $5.63 to $9.12, indicating the acquired assets have substantially higher depletion rates than legacy properties. This is a critical detail: TXO is buying production volume but at the cost of faster reserve exhaustion and higher non-cash charges that erode reported earnings.

General and administrative expenses surged 59% to $16.7 million, driven by $4.3 million in higher personnel costs from unit award amortization and increased public company expenses following the co-CEO appointments in April 2025. On a per-unit basis, G&A rose from $1.72 to $2.28 per Boe, demonstrating that scale benefits from acquisitions are not materializing in administrative efficiency.

Interest expense increased 175% to $10.7 million as borrowings rose to fund acquisitions. The partnership's debt strategy has transformed it from a low-leverage yield vehicle to a leveraged acquisition platform, with interest costs now consuming a meaningful portion of operating cash flow.

The hedging program's $16.9 million gain masks underlying operational weakness. Without these derivatives, the partnership's financial results would be substantially worse, yet the hedges also cap participation in price rallies. This creates an asymmetric risk profile: protected on the downside but limited on the upside, precisely when upside is needed to service growing debt and distribution obligations.

Outlook, Guidance, and Execution Risk: A Fragile Funding Strategy

Management's guidance reveals a precarious funding strategy. The company expects to finance distributions, debt obligations, and $65 million in 2025 capital development programs through a combination of cash flow from operations, public offerings, and Credit Facility borrowings. This three-legged stool assumes continuous access to equity markets and stable commodity prices—assumptions that appear optimistic given current conditions.

The guidance explicitly states that if cash flow from operations does not meet expectations, TXO may reduce capital expenditures and/or distributions to unitholders. This contingency plan acknowledges the unsustainable nature of current policies but provides no clarity on which lever would be pulled first. Given the partnership's distribution-focused identity, any cut would likely trigger significant unit price pressure.

Commodity price assumptions underpinning the outlook appear fragile. WTI crude oil declined from $86.91 per barrel in April 2024 to $57.52 by October 2025, while natural gas fell from $4.49 per MMBtu in March 2025 to $3.40. Management expects markets to remain volatile, yet the partnership's cost structure is increasingly fixed and elevated due to acquisition premiums and inflation.

The timing and amount of capital expenditures remain largely at management's discretion, allowing for deferral based on commodity prices, equipment availability, and capital constraints. However, deferring development could reduce proved reserve volumes, production, and cash flow, creating a negative feedback loop where cost-cutting exacerbates the underlying problem.

Inflationary pressures on steel, chemicals, transportation, and wages are expected to persist for the foreseeable future. If higher costs cannot be recovered through higher commodity prices, management warns this could significantly impact revenue streams, future reserve estimates, borrowing base calculations, impairment assessments, and property values. This is not a hypothetical risk—it is already manifesting in the 22% increase in production expenses.

Risks and Asymmetries: The Distribution Trap

The most material risk to the investment thesis is distribution sustainability. With a 562.5% payout ratio and negative free cash flow, the current $0.35 per unit quarterly distribution is mathematically impossible to maintain without external capital. The partnership is essentially borrowing money to pay unitholders, a strategy that works only until credit markets or equity investors lose confidence.

Debt burden represents a second critical vulnerability. Interest expense increased 175% year-over-year, and the net-debt-to-EBITDAX ratio now sits between 1.0x and 1.5x. While this remains within the 3.0x covenant limit, the trajectory is concerning. The WRE Acquisition was entirely funded by Credit Facility borrowings, and management has shown willingness to increase leverage for growth. In a commodity downturn, this leverage could quickly become unsustainable.

Commodity price exposure creates acute downside risk. A hypothetical 10% decline in oil and gas prices would reduce the derivative asset value by $37.2 million, directly impacting equity and potentially triggering borrowing base reductions. With oil prices already down 15% year-over-year and natural gas prices falling from their March 2025 peak, the partnership is experiencing this risk in real-time.

Integration challenges with Williston acquisitions present operational risks. The acquired assets carry higher DDA rates and production costs, yet are not generating sufficient cash to cover their cost of capital. The $71.3 million revenue contribution from increased production must be weighed against the $28.6 million in additional DDA, $23.5 million in higher production expenses, and increased interest costs from acquisition financing.

Working capital deficiency of $86.3 million indicates liquidity stress. While management believes the company has adequate liquidity for the next twelve months, this assessment depends on continued access to capital markets and stable commodity prices—both of which are outside the partnership's control.

Valuation Context: Pricing a Yield That Cannot Last

At $11.98 per share, TXO trades at 29.77 times trailing earnings, a multiple that appears reasonable until one examines earnings quality. Net income of $23.5 million over the trailing twelve months includes $16.9 million in hedging gains and is burdened by rapidly rising costs. The enterprise value of $918.27 million represents 9.05 times EBITDA, a moderate multiple for an upstream producer, but one that ignores the deteriorating cash flow profile.

The enterprise value-to-revenue ratio of 2.52x sits between peer averages, but revenue quality is declining. Unlike competitors such as Granite Ridge Resources (GRNT) with 8.83% profit margins or Riley Exploration Permian (REPX) with 21.73% margins, TXO's 4.62% margin reflects an inability to convert top-line growth into bottom-line profitability.

The 16.96% dividend yield is the market's primary valuation anchor, but it is a trap. With free cash flow of -$155.86 million, the partnership is paying distributions from capital, not earnings. This is evidenced by the May 2025 public offering that generated $189.5 million in net proceeds, which were used to repay Credit Facility borrowings and fund the WRE Acquisition deposit. The circular logic is clear: issue equity to pay debt, then borrow more to pay distributions.

Peer comparisons reveal TXO's competitive disadvantages. Vital Energy (VTLE) operates at 5-6x the production scale (140 MBOE/d vs. TXO's implied 25-30 MBOE/d), enabling materially lower per-unit costs. While VTLE shows GAAP losses due to impairments, its adjusted cash generation and scale advantages position it better for sustained distributions. HighPeak Energy (HPK) maintains higher oil weighting (70% vs. TXO's mixed commodity profile) and lower decline rates on its unconventional assets, while Granite Ridge Resources' non-operated model generates superior margins with less capital intensity.

TXO's return on equity of 2.48% and return on assets of 0.10% lag most peers, reflecting poor capital allocation efficiency. The debt-to-equity ratio of 0.37 appears conservative but is rising rapidly as acquisitions are debt-funded. In contrast, GRNT's similar leverage ratio of 0.47 supports a profitable, cash-generating business, while REPX's 0.65 ratio funds high-return growth projects.

The current ratio of 0.48 and quick ratio of 0.32 indicate liquidity pressure, particularly when compared to peers like HPK (current ratio 1.65) and GRNT (1.41). TXO's working capital deficit suggests that near-term obligations exceed liquid assets, increasing reliance on the Credit Facility for operational needs.

Conclusion: A Yield Built on Borrowed Time

TXO Partners has engineered impressive production growth through strategic acquisitions, but this expansion has come at the cost of profitability, cash generation, and financial flexibility. The partnership's 17% distribution yield is not a sign of strength but a warning flag: it is funded by debt and equity issuance rather than free cash flow, making it unsustainable in any scenario other than perfect execution and stable commodity prices.

The Williston Basin acquisitions have increased volume but compressed margins, as evidenced by DDA rates rising 62% per Boe and production costs increasing despite operational improvements. Management's explicit acknowledgment that inflationary pressures will not reverse, combined with commodity price volatility, creates a vice that will continue squeezing margins.

For investors, the critical variables are free cash flow generation and distribution sustainability. The current trajectory suggests that without continuous access to capital markets, TXO will be forced to choose between growth investments and distribution cuts—a choice that typically leads to significant unit price declines in the MLP sector.

The partnership's competitive position is weakening relative to peers who maintain better margins, stronger balance sheets, and more sustainable capital allocation policies. While TXO's conventional asset focus provides theoretical stability, the financial engineering required to maintain distributions undermines this advantage.

Ultimately, TXO Partners represents a classic yield trap: an attractive distribution rate built on financial leverage rather than operational excellence. Until the partnership demonstrates an ability to generate positive free cash flow that covers distributions, the investment case remains fragile and dependent on external capital markets that may not always be accommodating.