Trusts: Profitable Or Principal Traps? Learn To Understand

Includes: CHKR, WHX, WHZT
by: Tom Dorsey

Investing in a trust fund is similar to stocks, except trusts are different animals. A trust is not to be feared, but understanding the boundaries allows you as an investor to make better decisions on how, when and where to invest your money.

I have found several trusts that, once we peel back the facts, allow you to make good investment decisions with your money. But first, I want to describe what to look for in a trust and how to invest wisely.

A trust is an investment you can buy into that will pay a return on your investment. Most companies that create trusts do so for the purpose of recovering their investment and a profit quicker than had they held the investment for their own. An example: An oil company has drilled 25 wells and they are producing "X" amount of oil per day with an "Y" amount of expected reserves. If the company holds these wells and they produce as expected over several years they would make an estimated income from sales and a profit over the years. The company however, wishes to sell this early and reinvest their profits into new opportunities. They create and sell a trust that will payout over time to investors. They get their money and the investors get a cash flow based on the profitability of the holding in the trust. Both are projected to win when all goes well.

One concern for the investor is when the investment runs out, there is no more income. Any assets remaining in the trust will be sold off and the trust dissolved. Important for the investor to know is how long the trust will remain, or will the income producer remain or run out? One particular trust I have written on in the past is Great Northern Ore (NYSE:GNI).

GNI will terminate with the final payment in April 2015. When the trust terminates, the investors get their last check and the shares are worthless. The details are in the article, but knowing when to get out is important to a good investor.

With many commodities, another question is what are the effects on the price of goods, and how will the market affect them? Does the price go up or down? What are the many factors in the market? A simple example could be a hurricane effect on the oil producing Gulf Coast. Multiple storms through one season could drive the price way up, or damage wells belonging to the trust and cost millions in repairs. All of these are unknown future effects.

With many investments, trusts are evaluated daily in the market and bought and sold based on the perceived value. A trust with a higher rate of return may be signaling that the investment has some issues. In my opinion, a 10% return on your investment per year is good. Those that provide a higher rate sometimes indicate risk. Buyers would bid the price up if it were a great buy. The higher rates are not bad, but most should be seen for what type of investment they really are. Many trusts are smaller entities, with little to no ability to react and adjust their business operations because of the requirements written into the trust.

I have selected several trusts to highlight in this article and will write follow up articles as available. Trusts included here are WHX, WHZ, and CHKR, with SDT, PER, ECT, NYMT, MVO, NDRO AND ROYT displayed in the chart as other trusts with interests. In the chart I cover some basic information investors want to know.

Whiting USA Trust I (NYSE:WHX) was formed in October 2007, by Whiting Petroleum Corporation. Whiting Petroleum Corporation's wholly-owned subsidiaries, Whiting Oil and Gas Corporation and Equity Oil Company, conveyed a term net profits interest to the trust that represented the right to receive 90% of the net proceeds from Whiting's interests in certain existing oil and natural gas producing properties. The net profits interest entitled the trust to receive 90% of the net proceeds from the sale of production of 9.11 million barrels of oil equivalent (MMBOE), which is equivalent to 8.20 MMBOE attributable to the net profits interest, after which the trust will terminate. In the company quarterly report, as of September 30, 2013 on a cumulative accrual basis, 6.86 MMBOE (84%) of the Trust's total 8.20 MMBOE have been produced and sold (of which proceeds from the sale of 260 MBOE, which is 90% of 288 MBOE, will be distributed to unitholders in the Trust's forthcoming November 2013 distribution) and a cumulative reserve quantity of 0.02 MMBOE have been divested. The remaining reserve quantities are projected to be produced by June 30, 2015, based on the reserve report for the underlying properties as of December 31, 2012.

At the currently estimated end date of Jun 2015, the trust will pay 7 more dividends. The last dividend was $0.534, making the estimated total payout of $3.73 until the termination of the trust. With the stock price at $6.30 today during midday trading, I would look to this stock as overpriced and stay clear of this investment. The price should decrease every quarter until June 2015, when it should reach zero. To buy in, the price would need to be $3.00 or below to get my initial capital back with a 10% return.

Whiting USA Trust II (WHZ) was formed in December 2011 by Whiting Petroleum Corporation to own a term net profits interest in certain long-lived, predominantly producing properties located primarily in the Rocky Mountain, Permian Basin, Gulf Coast and Mid-Continent regions of the United States. The trust will end on December 31, 2021 or when 11.79 million barrels of oil equivalent (MMBOE) have been produced. The net profits interest will entitle the trust to receive 90% of the net proceeds from Whiting's interests in the underlying properties. The trust will make quarterly cash distributions of substantially all of its quarterly cash receipts of net proceeds attributable to the trust, after deduction of fees and expenses for administration of the trust, to holders of its trust units during the term of the net profits interest. With just two year of current production and the latest dividend of $0.739 per share, I would expect some profitability from the trust. Here is my math: $0.70 (ease of calculating) x 4 quarters = $2.80 per year. With 8 years of dividends, that would bring about $22.40 leading to the closure of the trust. At $14.42 per share price this would create about a 7% return on my money. Two factors that really determine if this would be profitable are the sale price of the oil, and the speed the oil is taken from the ground. If the price goes up, a higher profit margin could lead to a higher quarterly payout. If the oil is pumped faster, the number of payouts would be reduced, because the end point is based on a date, or amount of oil. The current dividend to price pays an excellent return, but don't plan on holding until the end. A buy now and a hard review when the company pumps over 60% would be a strong consideration. You cannot forget about trusts, as your principal will evaporate. You must continue to monitor the value and pull the trigger to get out before the market sells and there are no buyers left.

Chesapeake Granite Wash Trust (NYSE:CHKR) was formed by Chesapeake Energy Corporation (NYSE:CHK) in June 2011 and owns royalty interests in certain oil and natural gas properties in the Colony Granite Wash play in Washita County, Oklahoma. 90% of the proceeds attributable to Chesapeake Energy Corporation's net revenue interest in the sale of production from 69 horizontal producing wells; and 50% of the proceeds attributable to Chesapeake's net revenue interest in the sale of production from 118 horizontal development wells to be drilled by Chesapeake Energy Corporation.

The Trust will make quarterly distributions of the cash receipts attributable to the royalty interests, after deducting the Trust's expenses, through the quarter ending June 30, 2031, when the trust terminates. The current quarterly dividend is $0.69 and a current stock price of $12.60. With 18 years left and planning for a dividend stabilizing over the current 5 years then decreasing over the life (general life estimation) one could expect about $14.00 in the first 5 years, the another $15.00 over the remaining 13 years. This looks more profitable, with a 20% return in the near term.

Projecting into the future becomes even more difficult and as I recommended above, keep your eyes open and conduct an annual review. At a current stock price of $12.60, I would recommend a buy and watch for this stock. Holding for a 5 year period looks good, but evaluate each year to ensure the production of the wells does not decrease beyond the threshold to turn a profit. Holding through 12 years of the 18 would not be unreasonable, but conduct your annual check.

As you can see, the trust funds can be profitable, but you must invest your time to understand all the nuances in the trust fund before you lose your principal. I will be adding these trusts to my watch list and you can review these and other stocks at

Disclosure: I am long CHKR, NDRO. 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.

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