Published on June 14th, 2019 by Aristofanis Papadatos
There are many investors who want to gain exposure to the unprecedented oil boom in the Permian Basin.
PermRock Royalty Trust (PRT) is an oil and gas producer with all of its properties in the Permian Basin. It offers an 11% dividend yield and distributes its dividends on a monthly basis.
Beyond its high dividend yield, PermRock also pays monthly dividends, instead of the traditional quarterly distribution schedule. Monthly dividend payments are highly superior for investors that need to budget around their dividend payments (such as retirees).
There are nearly 40 companies with monthly dividend payments. You can see the full list of monthly dividend stocks below:
As these features are particularly attractive for income-oriented investors, we will analyze how attractive the stock is.
PermRock Royalty Trust is a trust formed in November 2017 by Boaz Energy, a company whose expertise is on the acquisition, development and operation of oil and natural gas properties in the Permian Basin.
The trust owns properties in the Permian Basin. It receives 80% of the net profits from the sale of oil and natural gas produced in its properties and distributes all those net profits in dividends every month.
Source: Investor Presentation
According to EIA, Permian Basin is the most prolific oil producing area in the U.S. This area extends over 75,000 square miles in West Texas and Southeastern New Mexico. Since its discovery in 1921, it has produced more than 30 billion barrels of oil and more than 75 Tcf of natural gas.
PermRock Royalty Trust owns four operating areas in the Permian Basin, with very promising growth prospects. In 2018, the trust produced 1,646 barrels of oil equivalent per day on average, with oil comprising 83% of the output.
The properties of the trust have distinct advantages. They consist of long-life reserves in mature, conventional oil fields, with a reliable production profile.
Source: Investor Presentation
Thanks to the mature nature of these oil fields, production and reserve estimates are highly reliable. This is in sharp contrast to the estimates of unconventional fields, which are characterized by a higher degree of uncertainty.
At the end of last year, PermRock Royalty Trust had 6.4 million barrels of proved reserves. Those reserves are sufficient for approximately 10 years of production at the current production rate. However, the trust can enhance its output via water-flooding techniques while it will also discover new reserves in the area. As a result, management expects the trust to produce oil and natural gas economically for at least 75 years. Such a long reserve life should be sufficient to satisfy even the most demanding investors.
It is also worth noting that the properties of the trust are characterized by remarkably high operating margins. For instance, in 2017, which was characterized by lower oil prices than 2018, the operating expenses in the properties of the trust averaged $12.24 per barrel. As the average realized price of oil and natural gas was $44.25 per barrel of oil equivalent, the operating margin was a healthy $32.01 per barrel.
As the future path of the price of oil is highly unpredictable, oil producers need to grow their production consistently year after year in order to grow their earnings in the long run. PermRock Royalty Trust expects to grow its production by 4% per year on average.
Source: Investor Presentation
Even better, management is confident that it can grow production at a higher rate via water-flooding techniques and new development opportunities that presumably will arise in the future in this promising production area.
As mentioned above, PermRock Royalty Trust pays a variable dividend every month, depending on its underlying net profits. In 2018, the trust paid a total of $1.28 per share in dividends and its average dividend yield was 9.5% in the year.
The trust has had a weak start in 2019, having paid only $0.32 in dividends in the first five months. However, we expect greater dividends in the upcoming months thanks to higher oil prices than those that prevailed at the end of last year (there is a lag between earnings and dividends) and in the beginning of the year.
Even if the trust continues paying the same average amount of dividends per month in the remainder of the year, it will offer total dividends of $0.77 this year for a dividend yield of 9.5% at the current stock price. We expect improved results and dividends in the upcoming months and thus we expect an approximate 11% average dividend yield this year, based on the current stock price.
Overall, PermRock Royalty Trust offers an exceptionally high dividend yield, though investors should keep in mind that dividends may greatly vary from month to month, depending on the underlying oil prices.
Competitive Advantages & Risks
PermRock Royalty Trust is a pure producer of oil and natural gas in Permian Basin, the most prolific production area in the U.S. This is a strong competitive advantage, as this area is characterized by long production profiles and slow, predictable decline rates.
On the other hand, as the trust has a pure upstream business model, it is much riskier than the well-known integrated oil majors, such as Exxon Mobil (XOM), Chevron (CVX) and BP (BP). In the most recent fierce downturn of oil prices, which lasted from 2014 to 2016, even those integrated oil majors suffered. Exxon Mobil saw its earnings per share plunge 75% while Chevron and BP posted losses in 2016.
If a similar downturn shows up in the future, PermRock Royalty Trust will suffer much more than the oil majors due to its pure upstream character. It thus carries a much greater amount of risk than the oil giants.
The risk of the trust is far greater, not only due to its non-diversified business model, but also due to its extremely small scale; its production is about 2000 times lower than that of Exxon Mobil.
Conversely, PermRock Royalty Trust will benefit much more than the oil majors if the price of oil rises significantly from its current level due to geopolitical issues or other factors. Therefore, the trust is ideal for those who are confident in higher future oil prices and want to gain exposure to the oil boom in the Permian Basin.
In summary, the trust is much more leveraged to the price of oil than the integrated oil companies and hence it has much more upside in the positive scenario (higher oil prices) and much more downside in the event of a downturn in the energy sector.
Valuation and Expected Returns
PermRock Royalty Trust is currently trading at a price-to-earnings ratio of 9.0. This valuation level may seem too cheap to some investors, particularly given the full valuation of the broad market after a decade-long bull market. However, it is important to note the short history of the trust, the high cyclicality of its results and its excessive downside risk in the event of a downturn. Given all these factors, we consider the current valuation of the trust to be fair.
Assuming that the price of oil will remain around its current reasonable levels in the upcoming years, one can expect PermRock Royalty Trust to grow its earnings per share by approximately 4% per year on average thanks to its 4% annual production growth.
Given this growth rate and the expected 11% dividend yield for this year, PermRock Royalty Trust is likely to offer an approximate 15% average annual return in the upcoming years. This is certainly an attractive expected return, though investors should always keep in mind the significant downside risk in the event of a prolonged downturn.
PermRock Royalty Trust has had a weak start this year but it is likely to improve its performance in the back half of the year. The trust offers an exceptionally high dividend yield and operates in the most prolific oil producing area in the U.S., with promising growth prospects.
As we do not expect another downturn in the energy sector, like the one between 2014 and 2016, we believe that the trust will offer attractive returns in the upcoming years. Nevertheless, due to the non-diversified business model of the trust and its dramatic reliance on the price of oil, investors should not allocate a great portion of their portfolio on this stock. Moreover, the trust’s short history leaves much to be desires for investors seeking reasonable levels of safety and consistency.