Right now, you can buy one of my favorite royalty trusts at an
incredible price. In fact, I think the opportunity is so good, I've
decided to include this security as one of my
Top 10 Stocks
for July 2012.
If you're unfamiliar with royalty trusts, then you can read my
previous analysis here.
In a nutshell, royalty trusts exist for one reason... to take in
millions of dollars in royalties and pass that money to investors
in the form of distributions.
So far, this strategy has been extremely successful. In the past
decade, I've seen royalty trusts return as much as 687%...
1,558%... and even 2,730%.
Those weren't some "one-off" opportunities that you had to be
lucky to find either. In just six months, the
royalty trust
I'm about to tell you about returned 80% after I added it to my
Top 10 Stocks
portfolio last October.
And I think a similar opportunity is setting up once
again...
The trust I'm referring to is
SandRidge Mississippian Trust (NYSE:
SDT
)
, one of 27 active oil and gas royalty trusts trading on U.S.
exchanges.
As a royalty trust, SandRidge Mississippian Trust owns a stake
in dozens of wells run by its
parent company
,
SandRidge Energy (NYSE:
SD
)
.
SandRidge Energy takes care of the drilling, production,
marketing, and selling of the oil and gas produced (production is
split roughly 40/60 between oil and gas). The royalty trust -- SDT
-- is passive in the relationship. It doesn't have to do a thing.
In return for the initial investment when it went public, its
investors get a cut of all the oil and natural gas sold from the
wells.
For the Mississippian Trust, SandRidge Energy packaged a 90%
interest in 36 of its oil and natural gas wells in Oklahoma. In
other words, for every dollar in oil or gas pumped by these more
than three dozen wells, owners of the royalty trust are entitled to
90 cents in royalties.
But that's just the start...
That's because in addition to the 36 wells it owned at its
inception, the trust also gets a bonus. Between its inception in
December 2010 and December 2015, parent company SandRidge must
drill an additional 123 wells, of which SDT will own a 50% stake.
(Already, the trust has drilled 66 of the 123 wells.)
In other words, over the next several years each unit of this
trust will have a stake in an increasing number of wells. And there
is a powerful incentive in place for the parent company to get
those wells drilled... and increase distributions... sooner rather
than later.
As is common practice, SandRidge Energy retained ownership of
over 10 million of the 28 million outstanding units of SDT. But
most of those (7 million units) are subordinated
shares
.
Unlike the shares we're investing in, those subordinated shares
don't receive dividends unless regular common unitholders get a
predetermined minimum payment each quarter. If the distribution
falls below that threshold, the payments to the subordinated shares
will be reduced to make up the difference to the regular units.
This means these shares have a built-in buffer to ensure we see
strong distributions going forward. And to also help keep
distributions high, the trust hedges its production. For instance,
about 60% of SDT's projected oil production this year is hedged at
an average price of $104 per barrel.
While the trust is fairly new, SDT has paid an average quarterly
distribution of $0.80 per unit, giving a
yield
of more than 12% at today's price.
Keep in mind that because it is tied to oil and natural gas
prices, you can expect the trust to move alongside energy
prices.
Now, you'd expect that opportunities to pick up royalty trusts
at good prices would be next to impossible. After all, who doesn't
want a stake in an oil field... especially when that stake throws
off a yield of 12% or more?
But there are opportunities that appear time to time. Due to the
recent
market
pullback, and the fall in oil prices, shares of SDT have sold off
recently.
Also weighing on the trust is a sale SandRidge made to
Morgan Stanley (NYSE:
MS
)
last week. All told, SandRidge sold close to one million shares of
SDT to the
investment bank
in order to raise additional capital. Since SDT is thinly traded,
the stock price took a hit as a result.
But nothing has materially changed with the trust itself. So to
me, this is not a reason to panic. It's an opportunity.
The last time SDT sold off like this was during the market
downturn in the fall of 2011. From the middle of June to the
beginning of October, the stock fell from $29 a share to $19 as
panicked investors dumped their holdings.
At the time I saw an opportunity and added shares of SDT to my
Top 10 Stocks
portfolio. Within months, my subscribers and I were up over
80%.
Today, the shares have fallen from the upper $30s to the current
price of $24.60, boosting the yield to 12.9%. If history is any
indicator, SDT could have tremendous upside from here.
Risks to Consider:
Don't get me wrong. Royalty trusts aren't risk-free (nothing
short of a
savings account
is). And as you've seen, they can be volatile.
Action to Take -->
But it's the opportunities that appear during a sell-off like this
that I believe can make you the most money. With SDT trading close
to its 2011 lows, paying a rare double-digit yield, and supported
by 7 million subordinated shares, I think this stock looks like one
of the best opportunities to
profit
in the coming months.
[
Note:
One stock has raised dividends 463% since 2004... another has $9.00
per share in cash (53% of its share price)... another has returned
17 times more than the S&P in the past five years. These are
the type of investments that make up my
Top 10 Stocks for July 2012
report.
To learn more about these top picks for the coming year,
visit this link
.]
-- Paul Tracy
Paul Tracy does not personally hold positions in any securities
mentioned in this article. StreetAuthority LLC owns shares of SDT
in one or more if its "real money" portfolios.