Protected Principal Retirement Strategy: Retiring Without A Million-Dollar Nest Egg - Part V

by: Akaralph

It has truly been a good quarter for [MLP] distributions. I try to follow about 60 of them. Of those that have announced, 32 have increased distributions, 20 have kept their distributions at the same level as last quarter, and only one (RNO) has cut their distribution. A few have yet to report.

In this article we turn to a discussion of Royalty Trusts - vehicles that afford the opportunity of investing in commodities while receiving monthly or quarterly distribution payments that offer a yield typically greater than that of MLPs. Unlike MLPs, Royalty Trust distributions tend to fluctuate, and are dependent on the underlying production of the commodity meeting expectations.

A Royalty Trust can be defined as a corporation designed to receive royalties (net profits) from a specific group of assets such as oil, natural gas, metals or mining. Royalty Trust primarily exist in the United States, Canada and, to a lesser extent overseas.

U.S. trusts do not have employees, do not own land, their profits are not taxed, they typically pay out at least 90 percent of profits, and these distributions are taxed as personal income. A U.S. trust cannot acquire additional properties and typically have a finite life, after which the trust is dissolved with no terminal value.

Canadian trusts on the other hand can have employees, expand land holdings and develop new resources. Distributions paid from Canadian trusts to U.S. investors are subject to a 15 percent foreign tax (recoverable in taxable accounts on one's income taxes). Canadian trusts changed substantially as result of the "Halloween Massacre of 2006". Canadian Finance Minister Flaherty supported a measure whereby Canadian trusts would be taxed as a regular corporation beginning in 2011. As a result, over 90 percent have since converted to corporations.

In the evaluation of a Royalty Trust three metrics are extremely important: the life of the trust; the quarterly distribution forecasts; and hedging (derivative) contracts. Over the past few years the number of publicly traded U.S. trusts has grown at a fair rate. The finite life can vary, depending on estimates to recover all of the commodity resources. Typically, the termination of a trust is either stated in years, can be subject to a vote of a certain percentage of trustees, or can be based upon failure to achieve a prescribed annual production level, or a combination thereof.

Information on any given trust is found in their S-1 registration filing with the SEC [EDGAR]. I would not advise purchasing of trust shares without a thorough review of their S-1. The S-1 will provide specific information about the life of the trust, dissolution criteria, estimated payouts to trust holders, and any hedging contracts in place.

As previously mentioned, trusts typically pay distributions monthly (primarily Canadian ones) or quarterly (U.S. trusts). Each trust has a schedule of target distributions published in the S-1. Distributions are subject to a "subordination threshold" and an "incentive threshold". The subordination threshold is typically a level that is 80 percent of the target distribution and the incentive threshold is a level 120 percent of the target distribution. If the distribution is below the subordination threshold, the amount established as the subordination threshold will be paid. If the actual distribution amount exceeds the incentive threshold, the parent company receives 50 percent of the amount above the incentive threshold, and the balance is distributed to shareholders of the trust.

Many trusts use hedging as a means to guarantee commodity price levels for a specific number of years. The majority of the ones that I am invested in are typically hedged out for a two to three year period. Usually, after this period ends new hedging contracts are negotiated.

Typically, energy trust distributions begin at an attractive level (perhaps an eight percent yield) and then increase quarterly for the first three years of the trust's life, and then begin to decrease in a manner commensurate with the depletion of the trust's resources. After the ramp up period, the stocks price will begin to decline over the remaining years of the trust's life, and theoretically reach zero when the trust expires. The typical life span of recently issued trusts is 20 years. When purchasing shares, generally it is wise to look towards liquidation close to the end of the distribution ramp up period - this is when the stock price might be at, or close to its maximum value.

My current allocation to Royalty Trusts is at 15 percent, 12 percent to U.S. trusts, and three percent to Canadian trusts. Let's look at some of the more popular U.S. trusts. Information on many of these can be found at The Yield Hunter (dividend and the Dividend Detective (, and on many other financial websites.

U. S. Royalty Trusts

Although currently invested in only four, I follow about 13 U.S. energy trusts. The following table affords information on many of these. The percentage breakdowns of production are approximate.

Chesapeake Granite Wash CHKR 2031 20 30 50
Cross Timbers CRT By Vote (80%) 38 0 62
ECA Marcellus ECT 2030 100 0 0
Hugoton HGT By Vote (80%) 80 0 20
Enduro NDRO By Vote (75%) 25 0 75
Permian Basin PBT None 16 0 84
Sandridge Permian PER 2031 2 0 98
Sandridge Mississippian I SDR 2031 15 0 85
Sandridge Mississippian II SDT 2030 25 0 75
MV Oil MVO 50 Years Remain 2 0 98
San Juan SJT By Vote (75%) 98 0 2
VOC Energy VOC 2030 0 0 100
Whiting USA II WHZ 2021 Or Production Cap 6 0 94

As part of my strategy I have sought to invest in a range of trusts that will afford me exposure to natural gas, natural gas liquids and oil. My choices were: CHKR, ECT, PER and VOC. You might have other ideas; if fact I am not married to any of them. However, they have attractive hedges in place and I believe that over the next two to three years I will be rewarded by the distribution payments, and some price appreciation.

Since the quarterly distributions fluctuate, and since some will not announce distributions until August, I can only provide estimated annual yields. (from Yahoo Finance).

CHKR - 12.50%

ECT - 11.20%

PER - 11.40%

VOC - 12.00%

Canadian Royalty Trusts (Corporations)

I presently try to follow six Canadian trusts (corporations), and I will readily admit that it is a much easier task to research the U. S. trusts. The following table presents a summary of these.

Eagle Trust ENYTF Trust Oil/Gas Production Monthly
Freehold Royalties FRHLF Trust Oil/Gas Production Monthly
Just Energy JE Corporation Canadian/U.S. Utility Monthly
Petrobakken PBKEF Corporation Oil/Gas Production Monthly
Phoenix Energy PHXHF Corporation Drilling Services Monthly
Veresen FCGYF Corporation Midstream/Pipelines Monthly

A few words about these are needed before we discuss their yields.

First of all, any foreign stock whose symbol ends in an "F" usually means that even a discount broker will have a commission surcharge. For example Schwab routinely charges $50 to buy, and $50 to sell. Some brokers do not levy this surcharge.

Secondly, before buying any of these, research them on their corporate websites - you can access financials, historic distributions and other information much easier than on Yahoo Finance.

Finally, I used to own other Canadian trusts (ERF, PGH, and PWE), but recent commodity price weakness has resulted in severe distribution cuts and, for the time being I am not considering them.

Here are the estimated current yield for each of the five that I follow or own:

ENYTF - 11.20% (Unique as they are a Canadian trust yet their properties are located in the U.S.)

FRHLF - 8.77%

JE - 11.47%

PBKEF - 7.79% (Quite volatile price movements)

PHXHF - 8.70% (One of the few showing earnings increases)

FCGYF - 8.29%

At present I personally own shares of FRHLF and PBKEF, which constitute my allocation to Canadian trusts (corporations).

I believe that Royalty Trusts as an asset class deserve a place in the Protected Principal Retirement Strategy portfolio; however, these do require a greater level of research than do MLPs, and as such they are not for everyone.

Disclosure: I am long ECT, PER, CHKR, VOC.

Additional disclosure: It is not my intention to recommend purchase of any of the stocks mentioned in this article. I am not a registered adviser, nor do I wish to coerce anyone into purchasing a stock. These articles represent a strategy that I use and my sole purpose is to share ideas and concepts. In addition to the above long positions I also am long Freehold Royalties and Petrobakken.