Sabine Royalty Trust: Leveraging Energy And Inflation
Summary
- SBR has gained over 85% in the previous 1 year and over 50% YTD on the back of rising oil & gas prices.
- The trust offers good dividends that are aligned with inflationary pressures and are sustainable with the fuel price projections.
- Russia Ukraine crisis is putting inflationary pressure on the US, as well as increasing oil & gas prices.
- I rate the stock a buy because it stands to benefit from rising inflation and oil & gas prices while distributing solid payments.
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Investment Thesis
Sabine Royalty Trust (NYSE:SBR) has gained about 85% in the previous 52-weeks and around 50% YTD. As the trust distributes income received as royalties from its vested interests in producing and proven oil & gas properties in the United States, its total returns directly correlate to the movement in oil and gas prices. So it is crucial to understand the oil and gas market to shed light on SBR stock.
Sabine Royalty Trust Annual Report 2021
Oil and gas prices are currently at their highest level since 2014, with the monthly average Brent crude oil spot rate at $117 per barrel (b) in March, a $20 per barrel increase from the previous month. The average Henry Hub natural gas spot price for March was $4.90 per million British thermal units (MMBtu), up from $4.69/MMBtu in February.
In times of inflation, the energy sector is historically the best performer, beating inflation over 7 out of 10 times. However, the Russian invasion of Ukraine has been a primary driver of the recent oil and gas price fluctuations, and due to the circumstantial uncertainty, the short-term forecasts and projections are highly volatile and do not follow a conventional pattern.
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The Energy Information Administration (EIA) expects the Brent price to average at $108/b in the current quarter and $102/b in the second half of 2022, with the average price falling to $93/b in 2023. Similarly, the Henry Hub prices are expected to be $5.95/MMBtu for April, $5.68/MMBtu for the current quarter, $5.23/MMBtu for 2022, and $4.01/MMBtu for 2023. The entity claims to have taken Russia's production stoppages and other related factors into account, but the overall outlook remains ambiguous.
If the oil and gas prices declined per the above forecast, the firm's distributions and the stock price would follow the same path. However, given the current price levels, it would still result in significant YoY growth, as evident by its Q1 2022's declared distributions of $ 1.71833
Investors need to carefully assess their risk appetite before stepping into a highly volatile market and consider whether they can stomach the short-term volatility because a decline in oil and gas prices is inevitable in a rather uncertain timeframe.
Still, I rate the stock as a buy because of its unlikeliness of collapsing and hurting SBR's soaring performance without at least ample warning signals.
Energy & Inflation: Two Peas In A Pod
Oil & gas prices are closely tied to inflation because of their integral role in the macroeconomic environment. In fact, the energy sector is the biggest contributor to the Consumer Price Index (CPI), with an 18.3% rise in the gasoline index in March, accounting for over half of the 1.2% monthly increase.
Bureau of Labor Statistics
In his Semiannual Monetary Policy Report to the Congress, the Fed's Chairman Jerome Powell said that generally, inflation rises by 0.2% for every $10/b crude oil price hike, setting the economic growth back by 0.1%. He emphasized that Russia's invasion of Ukraine, which has disturbed the global oil & gas market, will put additional inflationary pressures on the U.S economy.
It is also crucial to note that the relationship works both ways; the higher the inflation, the higher the oil prices. With the two factors directly correlated, it is apparent why it would be a good idea to leverage energy stocks in times of high inflation.
The Trust
Sabine Royalty Trust has vested royalty and mineral interests in producing and proven oil and gas properties in Oklahoma, Louisiana, Mississippi, New Mexico, Texas, and Florida. The trust's wells on these properties are operated by many companies, including BP Amoco, Chevron, ConocoPhillips, and ExxonMobil. The trust distributes its post-expense income every month after receiving royalties from the produced commodities of these wells.
After a depressed market in the wake of the pandemic, the energy sector surged in the second half of 2021, and as such, the S&P 500 Energy is up almost 69% in the previous 12-months, while SBR has outpaced that with almost 109% total returns.
The weighted average price obtained by the Trust in 2021 was $57.95/bbl for oil and $3.2/Mcf for natural gas, a YoY increase of 39.2% and 88.2%, respectively. The high prices resulted in almost $61 million in annual revenue, up from $36 in 2020, a YoY growth of 68%. The distributable income was almost $58 million or $3.97 per unit, up from $33.3 million or $2.28 per unit, a YoY growth of about 74%.
Sustainable Distributions
The company's Q1 2022 distributions of $1.71833 per unit are already over 3 times higher than Q1 2021, and the $0.73019 per unit distribution declared for April is also 2.5 times higher than the $0.293880 declared in April 2021.
These distributions are highly sensitive to and sway with the oil and gas prices. Therefore, a reasonable estimate of the future oil prices is essential in determining the sustainability of the company's distributions. Otherwise, an annualized yield based on present numbers holds no value to potential investors.
As mentioned above, currently, the primary issue pertaining to oil price projections is Russia. Still, as can be seen, the current average crude oil price of $112.4 is almost double the weighted average price in 2021. If the oil and gas industry pushed up its productions to meet the demand issues caused by the Russia-Ukraine crisis, the prices would crash, repeating "the 2014 massacre."
The industry would yearn to avoid that at all costs, leading to either maintained prices at almost its 8-year high level or a controlled decline, hand-in-hand with inflation. These scenarios ensure a sustainable yield of at least 7% to 8%.
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Despite the recent rally, the high yield is attractive to potential investors. With the added benefit of growth prospects in line with its past and the macroeconomic conditions, the trust offers a nice incentive to use it as an anti-inflation stock.
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Risks Of Depleting Assets
The major risk to consider when buying into the trust is the company's royalty-producing assets. The trust's balance sheet primarily only contains current assets and liabilities because the trust is prohibited from acquiring any new income-producing assets. This makes the trust susceptible to long-term depletion of assets.
The trust's estimated reserves in 1982, when it was first formed, were around 9 million barrels of oil and 62 billion cubic feet of gas, with an expected depletion date of 1993. However, the trust has produced about 23.1 million barrels of oil and 288 billion cubic feet of gas in the previous 40 years, resulting in a cumulative unitholder distribution of almost $1.5 billion.
The company produced almost 5.7 billion cubic feet of natural gas and over 431 thousand barrels of oil in 2021. Currently, the reserves are estimated to be 6 million barrels of oil and 42.7 billion cubic feet of gas, with an estimated life of 8 to 10 years.
Historically, the estimated useful life has been extended for almost 3 decades now. Still, if the company's assets were depleted earlier than expected, the stock would've been valued and acquired at much higher prices than its intrinsic value.
Conclusion
Energy stocks are a lucrative investment in times of high inflation, and SBR is akin to a high dividend-paying energy stock. The stock has moved up with the energy market and will keep moving along the lines of the oil & gas market. With global speculation on the oil & gas sector, predominantly distorted by Russia, a consensus number is hard to be acquired.
However, given the current prices, a rapid decline in prices without crashing the whole market seems unlikely, meaning the company's topline will endure at least through the year.
Meanwhile, higher inflation translates to higher commodity prices and vice versa, translating to higher earnings for the company and a better yield for the investors.
However, I would emphasize again that the high volatility should be a strong reason for conservative investors to monitor the market closely before deciding to jump into this stock because of the uncertainty surrounding the oil & gas market.
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. Business relationship disclosure: This article was researched and written by Waleed M. Tariq.