Sabine Royalty Trust: A High-Quality Trust But Wait For A Better Entry Point
Summary
- SBR is a high-quality trust, which is recovering from the pandemic.
- SBR is offering a 6.3% distribution yield.
- However, the price of oil has more downside risk than upside potential from its current level.
About five months ago, I stated that Sabine Royalty Trust (NYSE:SBR) is a great candidate for the portfolios of income-oriented investors. Since then, the stock has rallied 30% thanks to the ongoing recovery from the pandemic but it is still offering a 6.3% distribution yield. Therefore, the big question is whether the trust remains attractive or investors should wait on the sidelines for a lower entry point.
Business overview
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.
Sabine Royalty Trust faced a severe downturn last year due to the pandemic, which caused a collapse in the price of oil. However, thanks to the massive distribution of vaccines, the pandemic has begun to subside and the energy market has begun to recover. According to the latest report of the Energy Information Administration [EIA], global oil consumption is expected to surge from 92.4 million barrels per day in 2020 to 97.4 million barrels per day this year. It is also expected to return to the pre-pandemic level of 101.0 million barrels per day next year.
Distribution
The ongoing recovery has greatly benefited Sabine Royalty Trust. The trust has offered remarkably high distributions in each of the last six months and thus it has offered total distributions of $2.46 per unit in the last 12 months. These distributions correspond to a distribution yield of 6.3%.
On the one hand, this distribution yield is attractive, at least on the surface, particularly given the rich valuation of the broad market and the resultant 1.2% dividend yield of the S&P 500. In addition, the distributions of $1.65 per unit offered by Sabine Royalty Trust in the last six months correspond to an annualized yield of 8.5%. In other words, as long as the prices of oil and gas remain around their nearly 3-year highs, the trust will be offering an exceptionally high yield.
On the other hand, oil and gas trusts are different from stocks, as they offer a different distribution every month, depending on their actual net income. Moreover, trusts have static assets, i.e., they do not add new properties in their portfolios. As a result, they suffer from the natural decline of their oil and gas fields in the long run.
On the bright side, when Sabine Royalty 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 remained positive 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 indicates that Sabine Royalty Trust has good chances of remaining in place for a few more decades.
However, the long-term risk of declining production should not be ignored by investors. Moreover, the price of oil seems to have limited upside from its current level. OPEC and Russia have agreed to gradually increase their production to pre-pandemic levels until the end of next year. Furthermore, there is a negative secular trend, namely the shift from fossil fuels to renewable energy sources. This trend, which has greatly accelerated since the onset of the pandemic, is likely to take its toll on the price of oil at some point in the future.
To cut a long story short, while the price of oil may remain favorable for Sabine Royalty Trust in the short run, it has more downside risk than upside potential in the long run. Given also the risk from the natural decline of the producing fields of the trust, investors should be prepared for lower distributions in the long run.
Final thoughts
Sabine Royalty Trust is a high-quality trust, which has exceeded the initial expectations regarding the duration of its reserves by an impressive margin. It has also benefited from the recovery of the energy market from the pandemic and thus it is currently offering an exceptionally high distribution yield, particularly if only the last six months are taken into consideration.
However, just like all the other oil and gas trusts, Sabine Royalty Trust has an inherent risk, namely the long-term decrease of its production due to the natural decline of its fields. In addition, the price of oil is characterized by dramatic cycles and seems to be much closer to the peak of the cycle than its bottom right now. As a result, investors should be well prepared for lower distributions from Sabine Royalty Trust at some point in the future. Therefore, they should probably wait on the sidelines for a more opportune entry point, close to the technical support of $30.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.