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San Juan Basin Royalty Trust (NYSE:SJT) just announced yesterday the reduction of monthly dividends to 1/10th of a penny per share. Yes, you read that correctly, the monthly dividend is 0.1 cents per share. This equates to 1.2 cents per year on an annual basis or 0.1% of the $13/share stock price.

The current announcement cites corrections to past operating expenses and production volumes that results in essentially no dividend. The Trustee comments that production volumes were not correctly reported in the prior two distributions. The July production associated with the dividend 2 months ago was overstated, while the production from last month dividend was understated.

Upon calling the trustee (Kaye Wilke, Investor Relations), they could not provide actual volumes for these months. The accounting errors associated with lease operating expenses were made in the July 2012 distribution and as a result $3.4 million is being collected from unit holders for overpayment of dividends in July. The trustee states that those overpaid distributions in July were a result of paying 100% of net revenues to unit holders versus the 75% they were supposed to receive. The San Juan Basin Royalty Trust was founded in 1980 - you would think they would remember to multiply by the 75% sharing ratio.

So what is going on with the SJT dividends? Natural Gas prices have rebounded, but the dividend goes practically to zero. Our model shows that the operator is spending higher amounts than usual in operating expenses and capital costs. Also, the production is going down. Many unit holders believe the production goes up but the reality is the production has a natural decline and the operator spends capital to drill new wells that partially offsets this decline but does not completely arrest it or reverse it.

Production in October thru December of 2011 averaged 2,900 mmcf per month. Current production is down as it is more than 5% less at 2,700 mmcf per month. Operating expenses and capital costs were unusually high for the month at $6.3 million compared to $4.0 million for the average year to date. Is this another accounting error?

So, what can we expect from here? We expect more accounting changes for next month. We expect higher operating and capital costs based upon higher costs associated with operating these properties in the winter months. As natural gas prices go up, the distribution will rise, but not to level that would justify any appreciable rise in the stock price. In fact, our models forecast 2013 dividends to total 50 cents for the year if gas prices rise to $4/mmBtu. At a 10% dividend rate, that would amount to a SJT share price of $5.00 per share.

We believe a royalty trust should pay a dividend close to 10% as the asset is a declining. (Eg the BP Prudhoe Bay Royalty Trust (NYSE:BPT) currently has a dividend rate of 9.8%). However, SJT is owned and the stock price is driven by retail buyers who are willing to accept a much lower dividend. If these owners are willing to accept a 5% dividend, then the appropriate stock price would be $10/share. As our model shows the dividend to remain depressed, we would recommend avoiding this stock until a large price correction has been made.

Source: San Juan Basin Royalty Trust Cuts Dividend To Virtually Zero; Accounting Errors Partly To Blame