Seeking Alpha
Dividend investing, REITs, master limited partnerships, oil & gas
Profile| Send Message|
( followers)  

On January 30, 2014, Sandridge Mississippian Trust II (NYSE: SDR) announced its quarterly distribution for the three-month period ended December 31, 2013 (which primarily relates to production attributable to the Trust's interests from September 1, 2013 through November 30, 2013) of $24.2 million, or $0.568 per Common Unit and $0.239 per Subordinated Unit. The Trust makes distributions on a quarterly basis approximately 60 days after the end of each quarter. The distribution is expected to occur on or before February 28, 2014 to holders of record as of the close of business on February 14, 2014. You can get this return if you buy in before 14 February.

The down side to the lower production level is there were no new wells opened I 4Q, 2013. However, there are 13 new wells currently awaiting completion. This should increase production above 2013 production rates and increase and/or stabilize the dividend for another year into the future. Sandridge has approximately 940 horizontal wells in the formation and 25 drilling rigs. SandRidge plans to add three additional rigs to the Mid-Continent region during the second quarter of 2014 and near 30 additional gross wells compared to the previous budget. Sandridge has 6 areas of concentration and assessing 3000 potential locations, which many include multi-level wells. These multi-level wells have the potential to tap multiple layers of oil from one site that reduces drilling costs, extraction and delivery costs. Here is a representation of a site that has more than one well on the same site to reduce costs and targets different layers of oil.

(click to enlarge)

These wells are to be produced in the Area of Mutual Interest (AMI). The AMI is limited to the Mid-Continent Mississippian formation and consists of approximately 81,200 gross acres (53,000 net acres) held by SandRidge Energy, Inc. (NYSE: SD) (parent to SDR), is depicted by the area identified in the prospectus. The Development Wells in the AMI by started by December 31, 2015 and is obligated to complete such drilling by December 31, 2016. Until SandRidge is satisfied with the drilling obligation of the trust, it will not be permitted to drill and complete any wells for its own account within the AMI. After the completion of all the agreed wells in the AMI, SD and SDR will be authorized to drill additional wells. SDR has an extended life capability by building additional wells into the future.

The following two maps display the location of the AMI for SandRidge Energy, Inc. and Sandridge Mississippian Trust II. The first is the states of Texas, Oklahoma and Kansas, the second is the Mid-Continent Mississippian formation in Oklahoma and Kansas.

(click to enlarge)

(click to enlarge)

The news release continues with production information about the three-month production period ended November 30, 2013, total sales volumes were lower than initial Trust estimates and lower than the previous period. This was mainly driven by well performance and no development wells brought on production during this period. The production resulted in quarterly income available for distribution of $0.486 per unit, which is below the subordination threshold. As a result, the distribution per common unit is the subordination threshold of $0.568 for the period.

It is important to read the prospectus before investing because it provides guidance, direction and guarantees for investors to understand how the Trust will pay distributions. Reading further into the article it quotes the prospectus:

As described in the Trust's filings with the Securities and Exchange Commission (the "SEC"), the amount of the quarterly distributions is expected to fluctuate from quarter to quarter, depending on the proceeds received by the Trust as a result of actual production volumes, oil and natural gas prices and the amount and timing of the Trust's administrative expenses, among other factors. Although there is no assurance of any minimum distribution in any quarterly period, holders of Common Units will be entitled to receive an amount up to the "Subordination Threshold" (which varies from quarter to quarter) prior to any distribution being made for that quarter in respect of the Subordinated Units, all of which are held by SandRidge Energy, Inc. If the amount available for distribution in any quarterly period is sufficient to distribute an amount equal to the Subordination Threshold to the holders of all units (including the Subordinated Units), any additional balance is distributed to holders of all units pro rata, up to the amount of the Incentive Threshold for the quarter. Trust units are entitled to receive 50% of any cash available for distribution in excess of the Incentive Threshold for the quarter. The Trust's quarterly income available for distribution to all Trust units was $0.486 per unit, which was below the Subordination Threshold for the Common Units of $0.568 per unit for the quarter. As a result, the distribution to the Subordinated Units was decreased to $0.239 per unit in order to permit a distribution per Common Unit equal to the Subordination Threshold for the quarter.

To clarify, the Common Unit Trust shares are required to meet the Subordination Threshold (read: mandatory) for 50% of the cash distribution, which the junior shares (Subordinate Units) surrender the amount to allow the Common Units full distribution. This is important to appreciate the security of payment. The Subordinate shares are held by Sandridge Energy, Inc. This is a hidden plus as the parent company's distribution falls off dramatically if the production drops and cash is taken from the Subordinate shares to pay the full entitlement to the Common Units. Sandridge Energy, Inc. wants the production to increase, which will directly increase their share of the distributions.

Current wells in production now in production will continue the decline in production as all wells decrease production over time. SDR has 13 wells ready to begin production and 30 new wells in 2014, the amount of production should increase and provide a bump in total production for the year, and subsequently, each quarter. With SDR's unit price being driven down through 2013, the distributions look more attractive now at a yield near 24%. SDR's unit price will climb slightly until February 14, at the ex-date, then the price will fall. Long term investors could invest now and enjoy the distribution, or wait until the price drops and buy in near the end of the month. The right plan is to buy in, now or later, but don't pass up an investment paying distributions of 24% returns.

Source: Sandridge Mississippian Trust II: Oversold And Returns 24% Dividend