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Royalty Trusts: Maintaining Income in a Volatile Market

by: Fritz Hottinger September 07, 2008 | about stocks: CRT / DOM / HGT / PBT / SBR / SDS    

Fritz Hottinger

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With all due respect to those optimistic market prognosticators who still see the glass as half-full, we offer you some continuing words of caution:

There is more pain to come. The fat lady has not yet sung. In fact, she has more lives than a cat. And, the ping-pong ball has not yet reached the bottom of the stairwell - it occasionally gets carried up a few flights by well-meaning passers-by - but gravity will prevail.

We wish there were something on the horizon to erase our pessimism, but from our viewpoint economic storm clouds continue to gather like hurricanes off the Atlantic Coast: as soon as one blows itself out, another appears. Just when the market thought the real estate crunch had been factored into reality, more studious gurus decided it was only the residential segment of the market that had been revalued - now we must watch commercial real estate plunge as strip malls go empty, trend and big box stores close, and factories disappear.

Add more bad news: miserable unemployment numbers and its negative effect on gross disposable income; growing doubts about the financial strength of Fannie (FNM) and Freddie (FRE) and their now not so inevitable Federal rescue; continuing turmoil in the automotive, airline, and financial sectors. It all adds up to more volatility and a continuing loss of confidence in the market.

We do not expect things to settle down until after the November election, when the economic direction of the country will be more clearly defined. Meanwhile, our crystal ball still shows the Dow dropping down to the 10,000 level.

For those investors watching their principal shrink with these 3-digit Index plunges like the one on Sept 4, (Dow down over 300 points), there is still time to put out an anchor to windward with some contra funds. We like SDS, which moves up twice the percentage of a drop in the S&P 500. (A cautionary note: it also drops twice as fast when the S&P 500 rises.)

For those investors seeking to maintain revenue in the face of dividend reductions and the insidious inflation which erodes purchasing power, we suggest royalty trusts such as Dominion Resources Black Warrior Trust (DOM), Permian Basin Royalty Trust (PBT), Sabine Royalty Trust (SBR), Cross Timbers Royalty Trust (CRT) and Hugoton Royalty Trust (HGT). (Note: PBT and HGT were recently removed from Dividend Daily's recommended list, but still carry better than 3 stars out of 5).

Price

Div

Yield

CRT

48.68

3.91

8.03%

DOM

22.75

2.61

11.47%

HGT

29.29

2.73

9.32%

PBT

23.61

2.13

9.02%

SBR

63.15

5.05

8.00%

These strong, well-managed natural resource trusts should be able to increase dividend flow as inflation raises the value of their underlying assets. However, investors seeking to add such stocks to their portfolios should time their purchasing with a channel, band, or E-Zone System. There is no wisdom in paying too much for any stock, no matter what its dividend might be.

Disclosure: Long SDS, PBT and HGT.

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This article has 23 comments:

  •  
    Sep 07 04:33 PM
    The 600 pound gorilla in the room on all income oil and gas stocks is this year's election. The Dems need money and they are already opposed to drilling, next will be non-W-2 income streams, such as Royalty Trusts.Wait and see first then move.
    Reply
  •  
    Sep 07 06:01 PM
    steve: let me ask you this question: what is better, to save 5% or so on your tax rate and have the US dollar drop 40% and inflation running at 6%, or, paying a little bit more in taxes, having a strong currency, and paying less toward inflation. the US stock market is showing that the bush tax policy and virtually every other bush economic policy is a complete and utter failure of fiscal responsibility. net-net: the US investor is taking it in the shorts. bigtime.
    Reply
  •  
    Sep 07 08:18 PM
    what fitzman said
    Reply
  •  
    Sep 07 09:02 PM
    I own these trusts and they are best in a IRA, and if not there then in a taxable account since the yield and potential depreciation exceed anything either candidate is going to get thru congress without an income test. I say buy now while there is not oil shortage for the day when that is found to be an error.
    Reply
  •  
    Sep 08 12:33 AM
    Uh Fitz; Why do you believe that paying that extra 5% in taxes will restore the value of the dollar and cure inflation?
    Reply
  •  
    Sep 08 07:06 AM
    I think fitz is suggesting that "borrow and spend" is worse than "tax and spend", as there are no interest payments involved in a tax and spend approach.
    Reply
  •  
    Sep 08 07:51 AM
    It seems to me that the div % mentioned are significantly below todays quotes. Click on the links for these symbols above
    Reply
  •  
    Sep 08 08:48 AM
    There is another trust that is excellent but not on the above list. It is San Juan Basin Royalty ( SJT ). Check it out.
    Reply
  •  
    Sep 08 08:53 AM
    fitzman - right on. bush/cheney have added new dimensions to the concept of reckless - irresponsible cowboy behavior.
    < jack
    Reply
  •  
    Sep 08 11:04 AM
    Part of the income from a royalty trust is tax deferred because of the depletion deduction. Owning them in an IRA wastes this deduction
    Reply
  •  
    Sep 08 11:47 AM
    Cut to the botom line: Isn't 9% - 11% dividend better than 2% - None...??
    Reply
  •  
    Sep 08 12:06 PM
    I have most of these, plus other trusts, and they have been carrying me through while my financial stocks wallow in the mud. If they can carry me through till the Canadian tax change in 2011, and in some cases beyond that, I'll take the money and run with it. One of my comparisons is the piss-poor dividend of companies like JPM - terrific company, reliable, sturdy, and I have a bunch of it, but the dividend is lousy and the value hasn't been going in the right direction lately. I'll hold it, maybe sell a little here and there, but the trusts stay with me. When the banks perk up more, I'll take another look.
    Reply
  •  
    Sep 08 01:57 PM
    I wouldn't put all my money in these trusts. Sure oil and gas could go up.. But since these trusts do not pay a stable monthly dividend it tends to fluctuate a lot depending on their monthly operating performance.
    Try buying some dividend aristocrats instead. They would yield 2%-4% now, but the yield on cost is much more probable to grow in the future..
    Reply
  •  
    Sep 08 03:20 PM
    Dividend Growth Investor: I guess it depends on how long you're willing to wait for your return. If you bought XOM several years ago (I did) then you're looking pretty good, but if you bought a year ago you're looking lousy, both with that crummy 2% dividend and with the recent share price. At my age (78) I don't have another 20 years to wait on the long term dividend growth. Better to get the 6 to 8% return on MLPs and 10 to 15% return on Canroys, tankers, etc. now while I can use it. Also I boost the current returns by selling covered calls. That has increased the yield on those XOM shares to double digits.
    Reply
  •  
    Sep 08 03:26 PM
    Scared Stiff: "borrow and spend is worse than tax and spend as there is no interest on tax and spend"

    Yes, but you get to pay back that borrowing with 10 cent dollars.
    Reply
  •  
    Sep 08 04:22 PM
    The problem with both is the spend part.


    On Sep 08 03:26 PM henarl wrote:

    > Scared Stiff: "borrow and spend is worse than tax and spend as there
    > is no interest on tax and spend"
    >
    > Yes, but you get to pay back that borrowing with 10 cent dollars.
    Reply
  •  
    Sep 08 07:58 PM
    You mentioned Dividend Daily's Recommended List. Please identify how to access this list..
    Reply
  •  
    Sep 08 11:14 PM
    Richandmer;
    dividend.com/dividend-...
    Reply
  •  
    Sep 09 01:31 AM
    A stable monthly dividend does not exist unless you ladder a portfolio of Bonds,PFds or stocks (which usually pay less than the rate of inflation).

    I'd rather get paid about 15% monthly on my money for at least the next 2 years regardless of the tax increases the Democrats will inflict, Removal of a Tax Credit is equivalent to an increase. At least I will be ahead of the inflationary curve. Meanwhile, at least the CanRoys are not dollar related.

    LIBOR jumped big after the Frannie news, implying more not less risk in the Financial Sector. CDOs, SWAPs, Option ARMs, Credit Card Debt, nothing has changed except the expected.

    Do the Internationals sell their products overseas priced in the local currency? Of course.

    When this currency is converted into USD, the expected continuation of stellar overseas profit will have vanished. This combined with the ongoing problems in the Financial Sector and the deflation of commodities will send the PE ratio of the S&P soaring. What will this do to the Wealth Destruction currently in progress, slow it down or accelerate it?

    The glass isn't even close to half full. Since the 80's, most recessions have been mild. None have had the headwinds currently in progress. The Mid Point of the Peak to Trough prior to the 80's was around 24 months; some less, some more. If you Use the S&P peak, then I suggest that another year of tough sledding lies in front.

    How many of you were employed during the 50s -70s. Unemployment reached 12%, this happened inspite of the strength of the Unions during that time frame.
    Reply
  •  
    Sep 09 08:20 AM
    To Fitzman: My word of caution to nbvestors was soley based on a narrow view of the investment itself not a macro view of tax amd monetary policy.

    The reason we are all getting these lush dividends as compared to Treasuries is the risk factor of changing commodity prices. There is risk here beyond what I see in the Blogs. Yes, I own some of these as well but I'm not loading up--yet.
    Dems need money pure and simple. The FICA witholding on W-2's will not hold up. They will sooner or later repeal tax incentives for Trusts as they wish to repeal such incentives for oil companies. Trusts will be next.Additionally, expect FICA witholding on trademark, copyright and other royalty streams of income as well as rent.

    If that strengthens the dollar so be it. It's just going to happen in my opinion.
    Reply
  •  
    Sep 09 08:38 AM
    On a fundemental basis I see a strange paradox in investor opinion on gas stocks in general. We have energy portfolio managers in Canada and the US loading up on gas stocks, primarily those that have an increase in productio, but they gladly acknowledge that a tremendous amount of new supply is comming on stream in the US next year.

    Also, industry journals have sounded alarm bells on the few LNG port facilities we have in the US for the import of LNG may well be underutilized for several years due to the large volumes of gas comming on stream next year and in 2010.

    Due we expect a hard winter? Do we expect CNG to be widely implemented? To we expect a global price for gas like oil? That would eliminate any fears of over supply and lower royalty payouts.
    Is that realistic? I just find it ironic that experts are plowing into gas all the while warning of large increases in volumes.
    Reply
  •  
    Oct 02 11:53 AM
    Consider: 1. USGS estimated Barnett Shale ultimate recovery @ 30 TCFe, actual < 6 TCFe. 2. Sunspot Cycle 24 delayed due to lack of sunspots (50-year low e.i., 200 spotless days this year, with sun dimmest in 50 years.) 3. Rigs drilling for gas on the decline, frac proppants, casing, etc. in short supply. 4. Where is all the shale gas? Weekly storage injections should be 150 BCF/week! 2007 average weekly injection 76 BCF/Week.

    I consider this a buying opportunity ahead of rising gas prices with an expected cold winter.
    Reply
  •  
    Oct 02 12:30 PM
    One additional consideration: U.S. imports of liquefied natural gas (LNG) have been severely hampered by global LNG demand growth and higher relative prices in the Asia-Pacific region and Europe. For 2008, LNG imports are expected to total about 350 billion cubic feet (Bcf), a decline of more than 50 percent, or 420 Bcf, from 2007, and then to total about 450 Bcf in 2009 as new global LNG supply is added to the market.
    Reply
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