Permian Basin Royalty Trust Has Become Less Attractive
Summary
- PBT has rallied 37% since I recommended purchasing the stock about four months ago.
- PBT is now offering a 10-year low distribution yield of 3.6%.
- Also, given its lackluster distributions in the last three months, despite the favorable prices of oil and gas, investors should take their profits.
About four months ago, I recommended purchasing Permian Basin Royalty Trust (NYSE:PBT) for its attractive distribution and its cheap valuation. Since then, the stock has rallied 37% and hence its distribution and its valuation have become less attractive. Even worse, the distributions of PBT in the first quarter of this year have remained depressed despite the rally of the price of oil and gas to pre-COVID levels in recent months. As a result, PBT has become less attractive and thus investors should take their profits and wait on the sidelines for a more opportune entry point.
Business overview
Permian Basin Royalty Trust holds overriding royalty interests in some oil and gas properties in the U.S. It holds a 75% net overriding royalty interest in Waddell Ranch properties, in Texas, and a 95% net overriding royalty interest in the Texas Royalty Properties, which include various oil fields. Overriding royalty interests are not subject to the costs of development, operation and maintenance of the properties. PBT has a striking difference from the well-known oil producers, such as Exxon Mobil (XOM) and Chevron (CVX), namely its static assets. In other words, the trust cannot add new properties to its portfolio.
The energy sector is one of the most severely beaten sectors by the coronavirus crisis. The pandemic caused the sharpest decrease in the global demand for oil products in decades, 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 last year and thus all the oil majors and refiners either incurred losses or saw their earnings collapse in 2020.
PBT was inevitably hurt by the pandemic. In the full year 2020, its average realized prices of oil and gas plunged 24% and 44%, respectively, over the prior year. In addition, the trust reduced its oil production by 5%, though it grew its gas production by 5%. Overall, due to the suppressed commodity prices, PBT posted a 43% plunge in its distributable income per unit, from $0.42 to $0.24.
This performance does not seem disappointing on the surface, particularly given that the energy sector went through one of the fiercest downturns in its history last year. However, PBT underperformed its peer Sabine Royalty Trust (SBR) by a wide margin. SBR saw its average realized prices of oil and gas decrease 19% and 25%, respectively, last year and thus its distributable net income per unit decreased only 25%, much less than the 43% decrease reported by PBT.
The primary reason behind the underperformance of PBT was its depressed realized gas prices. The natural gas market has been affected by the pandemic much less than the oil market and hence the benchmark price of natural gas (Henry Hub price) has remained fairly resilient throughout the pandemic. It is thus disappointing that PBT incurred such a steep decline in its average realized gas price.
Even worse, PBT has offered dismal distributions in the first three months of this year. During the first quarter, the trust has offered total distributions of just $0.04 per unit, which correspond to an annualized yield of 3.9%. While this yield may seem attractive to some investors, it is too low for a trust which has a limited lifetime due to the natural decline of its reserves. The distributions of PBT in the first quarter of 2021 become even more disappointing given the steep rally of the prices of oil and natural gas to pre-COVID levels in recent months. As these prices have remained at pre-COVID levels for more than three months, the depressed distributions of PBT this year are certainly disappointing.
On the bright side, the prices of oil and natural gas are likely to remain elevated for the rest of the year thanks to the massive vaccination program, which is likely to put the pandemic under control in the second half of the year. Moreover, the price of oil is strongly supported by OPEC and Russia, which have implemented aggressive production cuts in response to the pandemic. Therefore, it is reasonable to expect PBT to catch up with the benchmark prices of oil and gas later this year and thus eventually benefit from these favorable prices.
Distribution
PBT has offered generous distributions to its unit holders most of the time but it is currently offering a 10-year low distribution yield of 3.6%.
During the last decade, the trust has offered an average annual distribution of $0.71 per unit. However, the distribution has remarkably decreased in the last six years, in which it has averaged $0.45 per unit. As the prices of oil and natural gas are not likely to return to the high levels recorded in 2014 anytime soon, the 6-year average distribution of PBT is much more reliable than its 10-year average.
Given the expected recovery from the pandemic, the distribution of PBT can be reasonably expected to rise from its depressed level of $0.24 per unit in 2020 to its 6-year average of $0.45 per unit in the next two years. If this materializes, PBT will be offering a 10.9% distribution yield at its current stock price.
However, investors should realize that the trust cannot add new properties to its asset base and hence it is vulnerable to the natural decline of the production of its oil wells and gas wells. Given the natural decline of its fields, the long-term downtrend in its distributions should be expected. This risk factor is clearly reflected in the downtrend of the proved developed reserves of PBT. In the last three years, its proved oil and gas reserves have decreased 3% and 39%, respectively. On the bright side, the proved reserves of both oil and gas decreased in 2018 and 2019 but they increased in 2020. Nevertheless, it is prudent to keep the long-term decline of the reserves in mind.
Valuation
PBT is currently trading at a price-to-distributable income of 17.2 (=4.12/0.24), which is higher than the average price-to-distributable income of 15.3 of the stock over the last decade. On the one hand, PBT is likely to recover from the pandemic later this year and thus its distributable income will increase and its valuation will become more reasonable. On the other hand, given the aforementioned natural decline of its production in the long run, investors should pay special attention on the valuation of the stock in order to have a wide margin of safety.
Final thoughts
PBT has offered generous distributions to its unit holders most of the time but it is now offering a 10-year low distribution yield of 3.6%. Due to its 37% rally in less than four months and its lackluster distributions in recent months, despite the high oil and gas prices, investors should probably take their profits and wait on the sidelines for a more attractive entry point.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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