The “Royal” Treatment–Income Trusts

Dimitri got our new backtesting software up and running–finally! I was hoping to include the results of our “dumpster diving” (we’ve been looking at pink sheet garbage) in today’s blog but although the software is a boon, it isn’t nearly as fast as we had hoped. I’m not going to make promises anymore as to when I’ll have results but hopefully it will be in the next few days. (Keeping my fingers crossed.)

So today I won’t be talking trash to you. Instead, we’ll be looking towards the other end of the spectrum at income producing stocks. In particular, royalty trusts.

What is a royalty income trust? A royalty income trust is a passive entity, meaning that it doesn’t produce anything itself. It operates by buying the rights to royalties on the production and sales of a natural-resource company (mostly oil and gas, but some also hold coal and mineral rights, too) and it passes on the profits to the holders of the trust. The reason they exist at all is because they offer more attractive financing to companies wishing to sell their cash-flow producing assets as compared with more conventional financing methods. Companies may need additional financing to help fund new oil exploration or for other capital improvements. Some trusts may be privately held, but others trade just like stocks (most are listed on the NYSE). Royalty trusts are similar in nature to real-estate investment trusts (REITs) and unit investment trusts (UITs), FYI.

So why should you like them? There are several good reasons. The first and foremost one is that their payout ratio is high compared with stocks and bonds. Annual yields on the trusts I’ll be showing you are currently averaging 6-15%. What’s not to like about that? Because of these high yields, royalty trusts make a great addition to any tax-sheltered account. They can also be used to generate income–most of them pay a monthly dividend although a few of them pay out quarterly. Unless you’re already heavily weighted in energy stocks, royalty trusts also lend a bit of portfolio diversity. Since the profits of the trust are related to the current price of oil and gas, their stocks having been doing very well lately (for the most part).

Now that I have you salivating, let’s talk turkey. Here’s a table of some royalty trusts that I’ve unearthed, listed in order of dividend yield. (Note: The dividend yield is calculated by dividing the annual dividend rate (the amount of money you receive per trust unit you own in a year) divided by the current price multiplied by 100.) I’ll tell you which trusts I like the most in a minute.

I can’t get the table to format properly (GRRRR!!!!!), so here’s what you’re looking at: Stock Symbol, Current Price, Annual Dividend($), Dividend Yield(%), 5-yr Dividend Growth(%), 5-yr Div. Yield Growth(%), Pay-Out (Monthly/Quarterly)

LRT* 2.16 0.71 33.0 -31.2 8.1 M
BPT 84.28 12.18 14.4 25.4 10.0 M
SBR 48.41 5.78 12.0 8.2 8.4 M
PBT 18.40 2.21 12.0 10.7 8.1 M
CRT 47.70 5.52 11.7 12.4 7.3 M
NRT 32.80 3.04 9.3 9.0 7.9 Q
MTR 69.24 5.66 8.2 -1.6 8.1 M
WTU 9.60 0.72 7.5 -11.7 9.8 Q
SJT 38.20 2.67 7.0 11.1 8.0 M
HGT 26.93 1.83 6.7 N/A 7.2 M
TRU 10.26 0.62 6.0 -15.0 13.5 Q

*LRT was making monthly payouts until last year. The last payout was in October and the one before that was in March. No new payouts will be made as the trust is currently being liquidated due to a substantial decrease in yearly revenues. This is one caveat of owning a trust as I hope you will note.

Now that you have this information, which stocks should you own? Should you just dive into the ones with the best dividend yields? The answer is no. Don’t forget, these trusts trade like stocks and they act like stocks, too. Not only is dividend yield a factor but so is stock appreciation. My two top favorites in both departments are Permian Basin (PBT) and BP Prudhoe Bay (BPT). PBT is making a new high today and BPT is nearing a new high. Both stocks have been consistently moving higher for 8-10 years. I also like Cross Timbers (CRT) and Sabine (SBR), although they both have been range-bound for a couple of years. If there’s one dog of the group, it would be Williams Coal (WTU) which has lost more than half of its value since 2006. Its price decline is reflected by the negative dividend growth rate.

You wanna see just how profitable these trusts have been? As an example, if you had bought BPT five years ago in January 2005, you would have paid about $15/share. Since then, the stock has risen 69 points and amassed more than $34/share in dividends. That gives it a 5-year rate of return of 687%, or an average annual rate of 137%! Not too shabby, eh?

There are a few caveats to note: 1. The price of oil could drop substantially, and 2. The oil wells that pay the royalties could dry up, like in the case of LRT. If you do elect to own some of these trusts, you must watch them periodically. If their share prices and/or dividend rates begin to decline, that’s when you might want to put your nest eggs into a different basket. But until then, sit back and watch the royalties roll in.

Posted by Dr. Kris at 1:36pm PST

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