Updated on March 7th, 2023 by Aristofanis Papadatos
Hugoton Royalty Trust (HGTXU) has a high dividend yield of 23.4% based on the total distributions of $0.41 per unit in 2022. This places Hugoton on the high dividend stocks list. You can see all 200+ 5%+ yielding stocks here. Hugoton also pays dividends on a monthly schedule, which means investors receive their dividends more frequently than the traditional quarterly schedule.
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Royalty trusts have unique characteristics and risk factors which investors should consider before investing. But they could be appealing for income investors thanks to their high yields. Also, investors looking for exposure to the oil and gas industry may find them attractive.
This article will discuss the business model of Hugoton and why investors anticipating higher oil and gas prices may want to give this royalty trust a closer look.
Business Overview
Hugoton Royalty Trust was formed on December 1, 1998, when XTO Energy conveyed 80% net profits interests in specific predominantly gas-producing properties in Kansas, Oklahoma, and Wyoming to the trust. Net profits are calculated by subtracting revenues from production, development, and labor costs.
Source: Annual Report 2021
When all these costs exceed revenues, the trust does not pay any distribution to unitholders. This means that Hugoton does not offer any distribution to its unitholders during periods of low prices of natural gas or high development costs. Hugoton is a small-cap stock with a market capitalization of only $70 million.
Hugoton has a key difference from other well-known oil and gas trusts, such as Sabine Royalty Trust (SBR) and Cross Timbers Royalty Trust (CRT), as it is primarily a gas producer. In 2021, gas comprised 88% of the production of Hugoton, while oil comprised the remaining 12%. In the first nine months of 2022, gas comprised 86% of the production of Hugoton, while oil comprised the remaining 14%. As a result, Hugoton is extremely sensitive to the gyrations of the price of natural gas.
Moreover, just like the other well-known oil and gas trusts, Hugoton is negatively affected by the natural decline of its producing wells in the long run. Its total production has declined by 5% per year in the last three years on average. This is a strong headwind for future growth prospects.
The most recent forecasts are for remaining reserves of 120.5 million cubic feet of gas and 1.5 million barrels of oil. Given this level of proven reserves of Hugoton and its current production rate, the trust has an estimated life of reserves of roughly 10-11 years. However, investors should be aware that the estimated life of reserves significantly changes with gas prices, as the producer has a strong economic incentive to apply additional techniques and boost production from a given property at higher gas prices.
Hugoton does not have a specified end date, but it would probably terminate if net profits collapsed for an extended period. To provide a perspective, between April 2018 and October 2020, the operating and development costs of Hugoton exceeded its revenues by a wide margin due to low gas prices. As a result, the trust suspended its distribution throughout that period.
Even worse, when the price of natural gas began to recover from the downturn caused by the pandemic, Hugoton did not reinstate its distribution, as it had to wait for its profits to offset the losses incurred during the downturn.
On July 2nd, 2021, Hugoton announced that it had agreed to be sold to XTO Energy for $6 million ($0.165 per unit) in cash. In the special meeting held on December 10th, 2021, unitholders did not approve the deal.
The latter were very fortunate, as the above deal would have resulted in devastating losses for the vast majority of unitholders. To be sure, the price of the deal was about 90% lower than the price of the stock in the beginning of 2018.
Even better for the unitholders, two months after the rejection of the deal, the global gas market became extremely tight thanks to the sanctions of Europe and the U.S. on Russia for its invasion in Ukraine. Before this crisis, Russia was providing about one-third of natural gas consumed in Europe. Due to the sanctions, Europe was forced to import a record number of LNG cargos from the U.S. Thus, the U.S. natural gas market became extremely tight. This led the U.S. gas prices to rally to a 13-year high. As a result, Hugoton resumed paying monthly distributions in August 2022 after more than four years without a single payment of the distribution.
In mid-November, Hugoton reported (11/14/22) financial results for the third quarter of fiscal 2022. Its realized oil and gas prices recovered strongly over the prior year’s quarter thanks to the aforementioned tailwind from the sanctions of western countries on Russia. As a result, even though the oil and gas output of the trust decreased, its distributable income per unit recovered from $0.00 to $0.22. It was the best quarterly performance of Hugoton since the third quarter of 2014.
Thanks to the exceptionally favorable gas prices which prevailed last year, Hugoton posted an 8-year high distributable cash flow per unit of $0.41. This distribution corresponds to an annualized distribution yield of 23.4% at the current stock price.
The sanctions of western countries on Russia are not likely to be withdrawn anytime soon. However, it is important to keep in mind the extreme sensitivity of the trust to the cycles of the price of natural gas.
Due to an abnormally warm winter in the U.S. and Europe, the price of natural gas has plunged nearly 75% off its 13-year high, which was posted last summer. Consequently, Hugoton is likely to reduce its distributions sharply in the upcoming months, though there is a lag between the benchmark prices and the distributions of the trust.
Growth Prospects
The biggest growth catalyst for Hugoton is rising oil and gas prices. Supportive commodity prices are critical for the trust’s ability to generate higher net profits, which yield higher distribution payouts. As oil and gas prices both rallied to multi-year highs in 2022, Hugoton posted blowout results and offered an 8-year high distribution last year.
However, the cash flows of Hugoton are highly cyclical due to the dramatic swings in the prices of oil and gas, which have resulted in a markedly volatile performance record. Moreover, the multi-year high oil and gas prices that have prevailed in the last 12 months have caused a global energy crisis. Numerous people are striving to pay for their energy bills.
Consequently, most countries are doing their best to transition from fossil fuels to renewable energy sources. To this end, there are a record number of clean energy projects under development. When all these projects come online, in 2-4 years, they will take their toll on the prices of oil and gas. This is a significant risk factor for Hugoton to keep in mind.
Given the high comparison base formed by the 8-year high distributable cash flow per unit of $0.41 in 2022, the natural decline of producing wells and the secular headwind of the global transition from fossil fuels to clean energy sources, we expect a 12.0% average annual decline of distributable cash flow per unit over the next five years.
Dividend Analysis
Hugoton Royalty Trust pays a monthly distribution. The record date each month is usually the 30th day. Distributions are paid no later than 17 calendar days after the monthly record date.
The distribution of Hugoton fluctuates depending on the direction of oil and gas prices. During favorable periods, the trust has distributed $0.50-$1.50 per unit annually. Thanks to favorable commodity prices, the trust offered an 8-year high distribution last year.
The distribution history of Hugoton over the past 11 years is as follows:
- 2012 distributions of $0.58 per unit
- 2013 distributions of $0.86 per unit
- 2014 distributions of $1.10 per unit
- 2015 distributions of $0.19 per unit
- 2016 distributions of $0.05 per unit
- 2017 distributions of $0.11 per unit
- 2018 distributions of $0.01 per unit
- 2019 distributions of $0.00 per unit
- 2020 distributions of $0.00 per unit
- 2021 distributions of $0.00 per unit
- 2022 distributions of $0.41 per unit
During the last decade, Hugoton has offered its unitholders an average distribution yield of only 4.3%. This yield is far lower than the average yield of the other oil and gas trusts. To be sure, Sabine Royalty Trust and Cross Timbers Royalty Trust have offered average distribution yields of 7.9% and 8.8%, respectively, over the last decade. The poor distribution yield of Hugoton has resulted primarily from the suspension of distributions between early 2018 and mid-2022.
Hugoton distributed $0.41 per unit in 2022. This equates to a distribution yield of 23.4% at the current stock price. While this yield is certainly enticing, it is impossible to predict future distributions due to the unknown path of oil and gas prices.
Moreover, natural gas prices have plummeted lately due to an abnormally warm winter in the U.S. and Europe. Consequently, Hugoton is likely to drastically reduce its distributions later this year. Furthermore, given the multi-year high oil and gas prices that have prevailed in the last 12 months, investors should expect much lower distributions from Hugoton in the long run, especially given the aforementioned secular shift of most countries from fossil fuels to renewable energy sources.
As the market is always a forward-looking mechanism, whenever the market focuses on the potential impact of all the clean energy projects under development on the energy market, the oil and gas prices will probably decline sharply.
Final Thoughts
Royalty trusts like Hugoton are essentially a bet on commodity prices. Due to its pure upstream nature and its focus primarily on natural gas, the trust is extremely sensitive to the cycles of the price of natural gas.
The price of natural gas rallied to a 13-year high last year due to the sanctions imposed by the U.S. and Europe on Russia, but it has slumped nearly 75% off its peak lately due to an exceptionally warm winter. As a result, Hugoton will probably reduce its distributions later this year.
Moreover, we believe that oil and gas prices will fall even further at some point in the future, in line with their proven cyclical behavior. Whenever the next downturn of the energy sector shows up, Hugoton will have significant downside risk while it will also reduce its distributions.
The suspension of distributions between early 2018 and mid-2022, the 95% plunge of the stock between 2018 and 2021, and the failed attempt of Hugoton to dissolve in 2021 are stern reminders of the excessive risk of this trust. If the trust experiences a prolonged downturn in the future, it may dissolve this time. Investors should be prepared for this risk, and thus they should allocate a limited portion of their cash to this trust if they decide to include it in their portfolio.
High-risk stocks sometimes offer outsized profits but can also cause devastating losses. In the long run, they usually underperform the broad market. During the last decade, Hugoton has dramatically underperformed the S&P 500, as it has plunged 78%, whereas the index has rallied 160%. Overall, investors should carefully review the risks and unique considerations that go along with investing in volatile royalty trusts.
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