Updated on March 5th, 2023 by Felix Martinez
Income investors looking to buy oil and gas stocks may want to gain exposure to the booming Permian Basin. PermRock Royalty Trust (PRT) is an oil and gas producer with all of its properties in the Permian Basin, and the stock currently yields nearly 14.3%.
Beyond its high dividend yield, PermRock also pays monthly dividends, instead of the traditional quarterly distribution schedule. Monthly dividend payments are superior for investors who need to budget around their dividend payments (such as retirees).
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PermRock is instantly appealing based on its nearly double-digit dividend yield. But as always, investors need to understand the underlying business to ensure the dividend payout is sustainable.
This is where oil and gas royalty trusts become especially risky, which is why only investors with a high-risk tolerance should consider purchasing PermRock.
Business Overview
PermRock Royalty Trust is a trust formed in November 2017 by Boaz Energy, a company whose expertise is in acquiring, developing, and operating 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 monthly dividends.
According to the 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.
Source: Investor Relations
The properties of the trust have distinct advantages. They consist of long-life reserves in mature, conventional oil fields with a reliable production profile.
Thanks to the mature nature of these oil fields, production, and reserve estimates are highly reliable. This sharply contrasts the estimates of unconventional fields, which are characterized by a higher degree of uncertainty.
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. 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.
Growth Prospects
The trust reported third-quarter 2022 results that ended on September 30th, 2022. Net profits income received by the trust was $3.53 million for the quarter, compared to $2.27 million in Q3 2021. Significant increases in oil and natural gas sales prices led to a strong year-over-year improvement, offset by reduced sales volumes.
The average realized sale price of oil ($/Bbl) was $107.75 during the quarter, a 59% increase compared to the price of $67.82 in the prior year period. The average realized sale price of natural gas also shot up massively, from $4.29 to $8.95 per Mcf. Distributable income for the trust came to $3.36 million, up from $2.10 million in Q3 2021.
Distributable income per unit of $0.28 increased from $0.17 in the prior year. The trust paid out all distributable income to shareholders as distributions for a payout ratio of 100%. Total cash reserves as of September 30th, 2022, were $1 million, identical to the end of 2021. The trust did not miss a distribution payment in 2022. In fiscal 2022, the trust has so far declared $0.9307 in distributions
On the bright side, the price of oil has rallied to a 13-year high this year, primarily thanks to the invasion of Russia in Ukraine and the resultant sanctions of western countries on Russia. The latter produces ~10 million barrels of oil daily and exports ~5 million barrels daily (~5% of global supply).
Moreover, the price of natural gas has rallied to a 13-year high this year for a similar reason, namely the sanctions of western countries on Russia. Europe, which generates 31% of its electricity from natural gas provided by Russia, is currently ramping up its efforts to diversify away from Russia.
As a result, there has been a great increase in the number of LNG cargos directed from the United States to Europe. This development has rendered the U.S. natural gas market extremely tight; hence, the price of U.S. natural gas has recently rallied to a 13-year high.
To cut a long story short, the current business environment is ideal for PermRock. In the last three months of 2022, PermRock has distributed $0.2645 per unit to its shareholders. It is thus on track to grow its annual distribution from $0.86 in 2022 to at least $1.05 this year.
On the other hand, the natural decline of the fields of PermRock is a strong headwind for its results in the long run. In addition, oil and gas prices are well-known for their dramatic cyclicality. U.S. oil and gas producers are currently boosting their output at a fast pace thanks to the multi-year high prices prevailing right now. The supply will outpace demand at some point, and the next down cycle of oil and gas prices will begin.
Overall, it is prudent not to rely on PermRock growing its distribution significantly in the upcoming years off this year’s high base.
Dividend Analysis
As mentioned above, PermRock Royalty Trust pays a variable monthly dividend depending on its underlying net profits. In 2022, the trust paid a total of $0.86 per share in dividends. Based on this, the stock would have a high dividend yield of 12.2%.
The trust has accelerated its performance in 2022 thanks to the aforementioned tailwinds, having declared distributions of $0.1308 per share in the first two months of this year. This level of distribution corresponds to an annualized yield of 14.3%.
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. The extremely weak oil prices of 2019-2020 were a significant challenge for PermRock, which suspended its dividend for five consecutive months in 2020.
Conversely, PermRock Royalty Trust will benefit much more than the larger oil majors if the price of oil rises significantly from its current level. Indeed, the rebound of oil prices from the pandemic has allowed PermRock to resume growing its dividend since last year.
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.
The properties of PermRock are in the Permian Basin, the most prolific oil producing area in the U.S. However, an oil royalty trust is a poor way to gain exposure to the booming production in this area. We believe investors would be much better off in a traditional oil and gas producer, or midstream company. The suspension of the dividend of PermRock for five months in 2020 is a stern reminder of the risk of an oil and gas royalty trust.
Final Thoughts
PermRock Royalty Trust has had a number of challenges in the past few years, including the weak oil price environment and the coronavirus pandemic, which suppressed global oil demand. 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 in the near-term, we believe that the trust will offer a consistently high dividend yield. 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 to this stock.
In addition, investors should be aware of the risks associated with investing in such a pure upstream player with commodity prices at 13-year highs. Whenever the next down cycle of the energy market shows up, PermRock will have excessive downside risk.
Moreover, the trust’s short history leaves much to be desired for investors seeking reasonable levels of dividend safety and consistency.
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