(Published by Bob Ciura on June 20)
San Juan Basin Royalty Trust (SJT, Financial) has a high dividend yield over 7% based on its distributions over the past 12 months.
It is one of 416 stocks with a 5%-plus dividend yield.
You can see the full list of established 5%-plus yielding stocks here.
This is a very enticing payout considering the S&P 500 Index has a 2% dividend yield right now.
This means San Juan offers more than three times as much dividend income as the average stock in the S&P 500.
The company also pays its dividend each month rather than each quarter like most other stocks. This gives investors who reinvest dividends the benefit of slightly faster compounding.
San Juan is one of only 29 stocks with a monthly dividend.
You can see the entire list of all 29 monthly dividend stocks here.
The company dividend may not be as attractive as it seems, however.
Investors should view royalty trusts like San Juan Basin with a fair dose of skepticism.
Business overview
Established in November 1980, San Juan Basin is a royalty trust. The trust is entitled to a 75% royalty interest in various oil and gas properties across 151,900 gross acres in the San Juan Basin of northwestern New Mexico.
Burlington Resources Oil & Gas Company LP, a subsidiary of ConocoPhillips (COP, Financial), owns and operates the properties.
More than 90% of the trust’s production is comprised of gas, with the remainder consisting of oil.
Source: Investor Relations
The trust does not have a specified termination date. It will terminate if royalty income falls below $1 million per year over any consecutive two-year period.
2016 was a very difficult year for San Juan. Not surprisingly, this was due to lower oil and gas prices.
Natural gas fell from an average of $2.60 per thousand cubic feet in 2015 to $1.89 per thousand cubic feet in 2016. The average price for oil declined from $47 per barrel in 2015 to just $30.01 per barrel in 2016.
In addition, natural gas production declined by 3.9% in 2016 due to field declines. At the end of 2016, proven reserves were estimated at 78,739 million cubic feet of natural gas and approximately 188 million barrels of oil.
Source: 2016 Annual Report, page 6
Collapsing commodity prices wreaked havoc on San Juan’s financial performance.
In 2016, royalty income declined 14% to $16.79 million.
From 2014 to 2016, royalty income fell 73%.
The company estimates, using a 10% discount rate, the net present value of future cash flows is $93.5 million.
Growth prospects
There are only two significant growth catalysts for San Juan moving forward. The first is higher commodity prices, which would help the company generate higher cash flows.
Specifically, higher gas prices would be a huge boost for the company since gas accounts for the vast majority of production.
The other major growth catalyst would be if the trust’s oil and gas properties produced for longer than is currently expected.
San Juan is not exactly sure of the lifespan of the trust.
It has hired independent petroleum engineers, who conservatively estimated the trust is likely to continue to produce for least another 10 to 15 years.
These two factors will determine whether the company is a good investment.
The trust is not permitted to engage in any business activity, which includes using any portion of the trust estate to acquire additional properties.
If the trust lasts 10 to 15 years at the 2016 distribution rate, investors would receive approximately $2.99 to $4.48 per unit in distributions.
On June 19, the trust's shares closed at $6.93 per unit.
Higher distributions could significantly improve San Juan’s investment prospects, however.
Conditions have improved considerably to start 2017. The company’s first-quarter gas prices rose 63% from the same quarter last year. Average oil prices increased 30% year over year.
This more than offset the impact of a continued decline in production. Royalty income distributed to the trust nearly tripled to $8.61 million.
Aside from higher commodity prices, San Juan could receive a boost if it receives a favorable outcome from its July 2014 lawsuit against Burlington.
San Juan is claiming breach of contract and is seeking in excess of $12 million. The company claims Burlington failed to pay certain royalty interests to the trust.
A non-jury trial date was moved out to Jan. 16, 2018, to give the companies an opportunity to settle. Discussions are ongoing and are something investors should keep an eye on moving forward.
Higher commodity prices to start 2017 led to significant improvement last quarter, which resulted in higher dividends as well.
Dividend analysis
As a trust, San Juan’s dividends are classified as royalty income. Distributions are considered ordinary income and are taxed at the individual’s marginal tax rate.
Since oil prices are so important to royalty trusts’ cash flow, it is no surprise the company's dividends have declined substantially in the past two years.
San Juan Basin made the following distributions from 2012 to 2016:
- 2012 distributions per share of 71.8 cents.
- 2013 distributions per share of 78.2 cents.
- 2014 distributions per share of $1.28.
- 2015 distributions per share of 36.4 cents.
- 2016 distributions per share of 29.8 cents.
Declining commodity prices caused San Juan’s fundamentals to deteriorate since 2014. In turn, this led to lower dividend payments.
The good news is distributions have increased so far in 2017. Through the first five months of the year, San Juan distributed 26.4 cents per unit.
At this rate, the company would pay out approximately 63.4 cents per unit. This payout level would represent a yield of 9.2% based on the current unit price.
As a result, if oil and gas prices can maintain current levels or continue to recover, San Juan’s dividends could increase to a level that makes the stock attractive.
For example, if the trust lasts another 10 years, investors will want a dividend yield well in excess of 10% annually to make San Juan Basin a successful investment.
Final thoughts
Investing in San Juan Basin right now is essentially making a bet on two things—higher oil prices and a longer-than-expected lifespan of the trust.
Royalty trusts can be a good source of dividend income due to their high yields, but investors need to make sure the trust’s assets will not run out before the initial investment is paid back.
It appears San Juan investors will need significantly higher oil and natural gas prices in order to make the stock a good investment.
Disclosure: I am not long any of the stocks mentioned in this article.
