I don't know about you, but I have only come across one moderately positive article about U.S. finite life royalty trusts in quite some time.
As two of these trusts are a part of the Protected Principal Retirement Strategy portfolio (neither of which have performed well at all) I decided to spend some time over the weekend reviewing the original S-1's and recent 10-K's submitted by each in order to decide if I should add to, or grudgingly hold one or both.
Chesapeake Granite Wash Trust (NYSE:CHKR)
CHKR is a finite life trust that owns royalty (beginning to despise that word) interests in natural gas (20 percent), natural gas liquids (30 percent), and oil (50 percent). Percentage breakdown is approximate. Its royalty generating properties are located in the Colony Granite Wash play in Western Oklahoma [the Anadarko (NYSE:APC) Basin].
Insofar as specific data relative to wells, production, PV-10 etc., I will defer to the myriad of articles and press releases on CHKR. My intent is to provide a summary of what it all means to owners of the units, and my personal outlook on the trust.
CHKR began trading publicly in 2011 and has to date paid six quarterly distributions. The total amount paid to date has been $3.877. In its S-1 (page 52 if I remember correctly) there is a table that sets forth target distributions, incentive and subordination thresholds for the period beginning with the third quarter 2011 and ending with the second quarter 2017.
Originally, CHKR estimated that drilling obligations would be completed around 2016 and that four quarters later the subordinated thresholds would be suspended. After that, the distributions would fluctuate with the pricing of the underlying commodities. To date, CHKR is ahead of its original drilling schedule.
In reviewing its recent income statement I noted that gross profit for the quarter ending December 2012 declined from $30.1 million in September 2012 to $25.8 million. Operating income and net income also declined during this period.
In the 10-K, CHKR mentioned that due to lower commodity pricing, drilling activities increased.
Although distributable income available to unitholders increased (primarily due to a longer reporting period), CHKR specifically stated that lower commodity prices could lead to payments below subordination thresholds (red flag here).
As the best possible scenario we would assume that drilling continues per the S-1 (perhaps doubtful) and that future quarterly distributions meet the subordination thresholds through mid-2017. Unitholders would receive a total of $10.76 beginning with the first quarter of 2013 and ending with the second quarter of 2017. According to the distribution table in the S-1, the subordination threshold quarterly distribution would peak at $.72 in the third quarter of 2013 and then begin to decline.
Sandridge Permian Trust (NYSE:PER)
PER holds royalty interests in both oil and natural gas properties located in the central portion of the Permian Basin in Texas. The approximate royalty breakdown is 98 percent oil and two percent natural gas.
PER began public trading in 2011, and has paid six quarterly distributions since. The total amount paid to date has been $3.652. In contrast to CHKR, PER's quarterly distributions have all easily exceeded subordination thresholds, and all except for the last quarter have also exceeded target distribution levels.
In reviewing its income statement for the fourth quarter 2012, I noted that gross profits declined from $33.2 million in September 2012 to $31.7 million. Operating income for this same period showed a slight decline while net income increased slightly.
As of December 2012, PER had drilled a total of 865 wells, an increase of 165 since December 2011. It also mentions that commodity prices have declined slightly over the most recent reporting period.
If we flash forward (again assuming that drilling obligations remain on schedule), and that subordination thresholds are not removed until early 2017, PER would pay out (using subordination thresholds as a floor) an additional $9.63 by the first quarter of 2017.
The subordination threshold payments peak in the fourth quarter 2014 before declining.
It is my personal non-professional opinion that of these two trusts, PER has the greatest likelihood of meeting unitholder expectations. I prefer PER primarily since it is almost 100 percent oil, and also because all (except for one) quarterly distributions have exceeded target distribution estimates.
From the standpoint of CHKR, I believe that natural gas prices should continue to increase as it receives wider use as an energy source, and that natural gas liquids prices will also show improvement over time. This could sustain quarterly distributions should drilling obligations have an early completion.
Based upon my analysis, I have decided that I will not add to the portfolio's position in CHKR, but will continue to hold for now (and hopefully until at least the third quarter of this year).
As for PER, my optimism has been translated to the purchase of a few hundred additional shares for the Protected Principal Retirement Strategy portfolio.
Disclosure: I am long CHKR, PER. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information in this article does not constitute either a buy or sell recommendation for any of the stocks mentioned.