Despite the coronavirus crisis, the S&P 500 (SPY) has nearly doubled off its lows about a year ago and thus it is now trading at a new all-time high, at a sky-high trailing price-to-earnings ratio of 36.0. As a result, it has become particularly challenging for investors to identify stocks with an attractive dividend and resilience to the pandemic. Sabine Royalty Trust (NYSE:SBR) is a bright exception, as it is offering a 6.8% distribution yield and has proved one of the most resilient oil stocks to the pandemic. Therefore, income-oriented investors should put this stock on their radar.
Sabine Royalty Trust is an oil and gas trust that was founded in 1982. It has royalty and mineral interests in producing properties and proved oil and gas properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. The trust has no operations or capital expenses. It just distributes the royalties it receives from its produced commodities (minus general and administrative expenses, which consume 5%-8% of royalties) to its unit holders.
The energy sector is one of the most severely beaten sectors due to the coronavirus crisis. The pandemic caused an unprecedented 9% plunge in the global demand for oil products, from 99.7 million barrels per day in 2019 to 91.0 million barrels per day in 2020. This decrease in demand resulted in suppressed prices of oil and refined products and thus it is only natural that all the oil majors and refiners either incurred losses or saw their earnings collapse in 2020.
Sabine Royalty Trust was not immune to the pandemic but it proved one of the most resilient oil companies. In the full year, its average realized prices of oil and gas decreased 19% and 25%, respectively, over the prior year. However, the trust grew its production of oil and gas by 0.5% and 7%, respectively, and thus its distributable cash flow per unit decreased only 25%, from $3.02 to $2.28. Given that most oil companies posted losses or saw their earnings collapse, the performance of Sabine Royalty Trust in one of the fiercest downturns in the history of the energy market was certainly outstanding.
Even better, the pandemic is likely to subside in the second half of this year thanks to the massive vaccination program underway. In addition, the price of oil has already recovered to pre-pandemic levels thanks to the aggressive production cuts of OPEC and Russia. Sabine Royalty Trust will greatly benefit from these two tailwinds this year.
As the distributable cash flow of Sabine Royalty Trust depends on the underlying prices of oil and gas, the trust is sensitive to the dramatic swings of these prices. This is clearly reflected in the volatile performance record of the trust.
Investors should also note that the trust has a striking difference from the well-known oil and gas producers, such as Exxon Mobil (XOM) and Chevron (CVX). The trust has static assets, i.e., it cannot invest in new properties. As a result, it is vulnerable to the natural decline of its oil and gas properties in the long run.
On the bright side, when the trust was formed, in 1982, its reserves had an expected lifetime of 9-10 years. As the trust has now become 39 years old, it is evident that the reserves have exceeded the initial expectations by an impressive margin. Moreover, the trend of the reserves of the trust has been quite promising in recent years. Instead of declining, the proved developed reserves of oil and gas of Sabine Royalty Trust have grown 4% and 16%, respectively, since the end of 2017. This trend signals that this high-quality trust has good chances of remaining in place for a few more decades.
Sabine Royalty Trust has generated an average annual distributable cash flow per unit of $3.18 over the last decade. Thanks to the aforementioned tailwinds of the massive vaccination program and the elevated oil prices, it is reasonable to expect the distributable cash flow per unit of the trust to recover from $2.28 in 2020 to $3.18 in the next two years.
Sabine Royalty Trust differs from the well-known oil majors in that it offers a different distribution every month, depending on the actual royalties it receives. The trust has always offered generous distribution yields. Even in 2020, in one of the fiercest downturns in its history, the trust offered a total distribution of $2.40 per unit, which corresponds to an average distribution yield of 6.8% at the current stock price.
Even better, the trust is likely to improve its distributable cash flow per unit towards its historical average of $3.18 in the upcoming years thanks to the expected recovery of the pandemic and the elevated oil prices. When this happens, the trust will offer a 10.6% distribution yield at its current stock price. This is certainly an attractive distribution yield.
As mentioned above, there is an important risk factor to consider before purchasing Sabine Royalty Trust, namely the natural decline of its reserves. According to the existing reserves (about 6.3 million barrels of oil and 39.9 billion cubic feet of gas) and the current production rate of the trust, its reserves are expected to last for another 7-8 years. If this estimate proves correct, then the current distribution yield is less attractive than it seems on the surface.
However, it is important to note that Sabine Royalty Trust was formed nearly four decades ago and its reserves were expected to last only for 9-10 years back then whereas the trust is still alive, 39 years later, with an expected lifetime of another 7-8 years. Even better, its remaining proved developed reserves have increased in the last three years. This is not typical for reserves that are near the end of their lifetime. Overall, there is high uncertainty over the exact duration of the reserves of this trust but it is reasonable to expect the trust to remain in place for more than a decade.
With the market at an all-time high and at a rich valuation level, it has become really challenging for investors to identify stocks with attractive yields. Sabine Royalty Trust is a great candidate for income-oriented investors thanks to its generous distribution yield, its resilience to the pandemic and the impressive extension of its lifetime. Nevertheless, due to the uncertainty over the lifetime of its reserves, investors are advised to wait for an approximate 10% correction of the stock, towards the technical support of $27.50, before purchasing the stock, in order to enhance their margin of safety.