by Travis Johnson, Stock Gumshoe | February 5, 2014 12:40 am
It’s fair to say that we get more than our share of teasers for commodity and natural resources stocks here at Stock Gumshoe — those kinds of stocks take up a big chunk of the newsletter world, with only tech stocks and biotech maybe keeping up. They’re areas where it’s easy to have (or pretend to have) real insider knowledge that sounds impressive to regular folk like you and I, and sectors where the shockingly big winners we all lust after are sometimes found.
That’s for the growth jockeys, the mining enthusiasts, the folks who watch the corn and oil futures markets or pore through assay results to sniff out their opportunity at the next commodity supercycle or the next mega gold mine — but there’s also the pocket of the natural resources world where you find appealing income investments, companies who spit cash out to shareholders and make retirees smile. In that world we find the pipeline and producting MLPs, timber REITs, the almost-gone-but-not-forgotten Canadian royalty trusts, and, beneficiaries of a resurgence of investor interest in recent years, the US oil trusts. It’s one of the latter that’s being teased today by Stephen Leeb for his Leeb Income Millionaire newsletter.
And we’ll get to the specific one in a moment (yes, the mighty Thinkolator has solved the puzzle yet again!), but first a quick word on what oil trusts are:
Publicly traded oil trusts in the United States are owners of land or royalty/mineral rights that cover a specific area or oil field. They are not operating companies, they have no employees and make no business judgements about what to produce or where to drill, they are passive participants in the process and they simply collect their share of whatever the operating company (often the company that created the trust in the first place) produces from or earns from that oil or gas well or field. In most cases, the Trust is managed by a bank officer and its only real expense is a few board members or auditors who oversee the Trust and the administrative costs of collecting the money and spitting it out to shareholders/unitholders like you or I.
Trusts are sometimes perpetual, and sometimes have a specific dissolution point that’s driven either by a cumulative production level being reached, or production declining to a certain point, or by other specific factors — but in truth none of them are really perpetual because they are passive owners of a finite resource, so they are expected to gradually see production decline as the oil or gas is produced from their fields… they can certainly have reserves that last far longer than expected, because their rights may end up covering more oil than was thought to be there when the trust was created, or the producer might do more infill drilling or well stimulation and produce more than expected, but they can’t go out and acquire new assets or expand themselves. Trusts do not pay taxes, they simply pass along their income and any tax liability to shareholders — and often that tax liability is quite low, just like with MLPs, because of the non-cash impact of depletion or depreciation (the trust is in part paying out a share of its assets, not actual income).
But really, what you look for when you’re looking at a royalty trust like these is: for how long will its wells produce oil or gas, and at what rate of decline? Beyond that, it’s really just a question of what you think the oil and gas prices will be in the years that the trust is active — if oil and gas prices rise it will obviously produce more cash flow from the expected oil pumped out of the ground, but higher prices can also push the producer to do more to enhance oil recovery or drill more wells, which can help depending on how the trust is set up (some cover physical regions or fields, some cover a specific number of planned wells). In general, production is fairly steady and predictable because these trusts are set up as a way for oil and gas producers to offload their slow-decline, long-lived producing assets to the income-focused folks who will value them more highly, which lets them pay off debt or reinvest in making new discoveries.
So after that long spiel … which trust is being pitched by Stephen Leeb’s letter? Here’s how he gets us excited:
“The ‘Super-Giant’ Of Income Investments from the Seventh Oil Wonder of the World …
“A little-known Texas oil and gas trust sports a whopping 11.12% yield. But, that’s not the only reason the billionaires who back this outfit call it the ‘boring’ way to get insanely rich. There were once six super-behemoth oilfields in history. Now, there is a lucky seventh…”
That seventh “super-behemoth” field that they’re pitching is the Permian Basin, the fields roughly centered around Midland in West Texas that produced oil and minted new millionaires for decades in the first Texas oil rush but were thought largely “done” twenty or thirty years ago … and have been given a new lease on life by horizontal drilling and hydraulic fracturing which have enabled the vast shales of “trapped” oil, like the Cline and the Wolfcamp, to be produced. That’s not news to most folks who follow the oil industry at all, of course, the shales of the Permian Basin are the hot ticket, foremost in investor minds after they spent a couple years focused on the Eagleford in South Texas, and a few years before that on the Bakken in North Dakota.
And then Leeb gives his pitch about what the most profitable investments in the Permian are:
“Texas Oil & Gas Royalty Trusts Are An Income Investor’s Dream And The Best Kept Secret On Wall Street
“T. Boone Pickens created the first Texas Oil & Gas Royalty Trust in 1979 involving Mesa Petroleum. Investors received monthly distribution checks and scored huge nest eggs as the stock quadrupled.
“Texas Oil & Gas Royalty Trusts are powerful income investment vehicles for people who wish to invest directly in extraction of petroleum or mining of other materials, but who do not have the resources or risk tolerance to buy their own well or mine.
“These Trusts often own hundreds of individual wells, oil fields, or mines, and they represent a convenient way for the individual investors to diversify investments across a number of properties.
“And Texas Oil & Gas Royalty Trusts have a government mandate to pay out every penny of their profits in the form of monthly distribution checks to shareholders!
“Best of all, as an investor in Texas Oil & Gas Royalty Trusts, you may pay absolutely zero taxes on investment gains and distribution checks in your mailbox.
“It’s no wonder Texas Oil & Gas Royalty Trusts have become the king of all income investments!”
Which is more or less what I said above, minus the exclamation points … but then he gets into the specific trust he favors:
“My favorite pick: A Litle-Known 11.12% Yielder
“After analyzing balance sheets, leases, proven reserves and drill-test results of all 307 oil and gas companies, I’ve uncovered one Texas Oil & Gas Royalty Trust in the Permian Basin that’s going to be the big winner.
“This under-the-radar profit-gusher has seized control of over 32,000 oil-saturated acres with 13 years worth of proven oil and natural gas reserves within the Permian Basin. And they own nearly 350 net oil wells and over 100 net gas wells that are increasing production full bore.
“This profit-gusher also owns working partnerships in the most lucrative oil fields in Louisiana and New Mexico with major oil production companies Occidental Petroleum and ConocoPhillips.”
And apparently this trust is seeing growth, according to Leeb:
“… those big monthly distribution checks could well get a whole lot bigger.
“Because this Texas Oil & Gas Royalty Trust is rapidly growing its oil and natural gas production and earning more profits.”
And it has some well-known shareholders:
“The operations are backed by two of the country’s most successful private equity firms—Carlyle, with over $80 billion in assets and Riverstone Holdings, a specialist in energy investments that grew from about $200 million to over $16 billion in 15 years.
“And, the CEO at the helm is a tough, no-nonsense, low-profile Texas oil billionaire. Not every Texas oilman ‘goes East’ for a business degree, but this CEO is a Wharton alumnus….
“You see, this brilliant entrepreneur has founded six — that’s right, six! — oil and gas companies listed on the New York Stock Exchange. And without exception almost every single one of them turned main street investors into millionaires!”
So what’s the stock? The Mighty, Mighty Thinkolator tells us that Leeb is teasing: Enduro Royalty Trust (NDRO), one of the “new generation” of US trusts that came public in the last few years — NDRO was a venture capital-backed IPO back in 2011, and is still controlled by the Carlyle Group and Riverstone Partners. The CEO of Enduro Resource Partners, which is the parent of the trust, did indeed get a degree from Wharton and build a bunch of oil companies, that’s Jonny Brumley (Encore Acquisition, Cross Timbers Oil/XTO Energy, Mesa/Pioneer Natural Resources), and it was likely the idea of investing in him that got Carlyle and their partners to throw $200 million at the Enduro in the Spring of 2010, which was followed up the next year by an IPO of the new Enduro Royalty Trust.
This isn’t quite like most of the other trusts, in that they own not just a passive income stream but a net profits interest of 80% on the oil fields that were owned by Enduro prior to the trust’s creation (mostly in the Permian) — so they are responsible for their share of the capital investment program, which is a key part of how the trust plans to keep production either close to stable or even, possibly, growing over time as they work over Permian wells to boost oil production … but it also increases the risk if capital investments go awry, they’re not just a passive recipient of royalties. In that way they’re a little bit like Dorchester Minerals (DMLP), a MLP I’ve owned for a long time that relies in part on net profit interests, though I imagine that they don’t technically get to decide when to make investments (that may become a bigger issue in the future someday, if and when the parent and the trust have different ownership structures — particularly if the big backers like Carlyle continue to sell down their trust holdings and the motivation to invest for boosted production may change).
Beyond that, it will take an oil accountant to figure out exactly how you think the company should be valued by making some kind of guess as to the rate of production decline, the amount of capital expenses, and the lifetime of the wells in which they’re participating. The yield is currently in the 10% neighborhood — on a trailing twelve months basis it’s 9.7%, if you annualize it based on the last monthly payout it’s 10.4%, but the actual monthly payout depends on production patterns over the previous couple months and on oil and gas prices realized in those months, and is also impacted by their share of capital investment that hits as work is done, so it’s quite variable (the monthly payment has ranged from under 6 cents to over 16 cents over the last twelve months). Their latest news about 2014 capital expenditures, and about the current monthly dividend, was announced a few weeks ago here.
Most of the young oil trusts (CHKR, SDT, SDR, PER come to mind) have been in pretty steady decline over the last couple years and have done worse than the oil price, which has been relatively stable. NDRO has been one of the better ones of this recent crop, even with the huge hit the shares took back in September when there was a substantial secondary offering of shares below the market price, but that’s not saying much. I am not an expert on NDRO, I’m afraid, having never even glanced at them until today, and I know the Permian Basin is seeing lots of excellent production and production growth that could conceivably really help boost their payouts, particularly if gas prices stay elevated and oil climbs again … but I’d be a bit nervous about Carlyle continuing to sell off shares and about the trust’s lack of control over those capital investments that are required of it. That said, at first glance this one does look more appealing to me than the more clearly declining and limited Sandridge and Chesapeake Trusts (PER, SDT, SDR, CHKR) that pay 20% yields and look like they’re in a neck and neck race to see if the share price can be paid back to unitholders through those dividends before the trusts go kaput.
NDRO looks like it’s got more time than many other trusts, more potential upside if production by their partners is better than anticipated, and probably a slower and steadier production decline over the coming decade … and the more reasonable yield buttresses that quick opinion. They’re just entering what are supposed to be their best years of production increases before the anticipated decline, but production hasn’t really increased much yet and I haven’t seen enough that makes me want to rush out and buy it … or, frankly, given my overexposure to natural resources already, that makes me want to even research it that much more. If oil and gas stay relatively stable, my base assumption going in would be that the share price would decline a few percent every year but the dividend would still mean that investors make some return on their money — but that’s just the relatively pessimistic assumption I’d start out with without knowing the specifics of the company very well yet. I it could certainly do far, far better if their wells are gushers or we see much higher prices for oil and gas in the years to come (likely for pretty much all energy companies) … or, of course, far worse if oil falls to or below $70 for a while.
So it’s up to you, I guess — wanna piece of Leeb’s favorite Enduro Royalty Trust? Think it’s too pricey? Let us know with a comment below.
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