Cross Timbers Royalty Trust: A Modest Income Play (NYSE:CRT)

Investment Thesis

Cross Timbers Royalty Trust (NYSE:CRT) is an undercovered stock that substantially outperformed the market in the previous 52 weeks and YTD with 70.48% and 35.48% total returns, respectively. Even though the returns are meaningfully lower than my previously covered trust, Sabine (SBR), the outperformance to market is still material.

The Trust’s annual dividend yield of 8.5% makes it an attractive asset for income investors despite lower total returns. Moreover, for a brief overview of the positive correlation between energy stocks and inflation, take a quick look at the Sabine article. Additionally, for the tax benefits of investing in such a vehicle, the comments section of this article is quite relevant.

I am bullish on the Trust because it offers a great dividend yield and is accumulating positive price returns in an industry moving upward with inflationary and geopolitical pressures.

Company Overview

CRT generates its distributable income from 2 sources:

• 90% net profits interests: These entitle it to receive 90% of the net proceeds from producing and non-producing properties in Texas, Oklahoma, and New Mexico. These are substantially all royalty or overriding royalty interests.
• 75% net profits interests: These entitle it to receive 75% of the net proceeds from working interests in 4 underlying properties in Texas and 3 in Oklahoma. These are subject to all production expenses and development costs.

The underlying properties include over 2,900 producing properties with proved reserves of 2.5 million Bbls of oil and 14.3 Bcf of natural gas. The Trust’s most lucrative asset is the San Juan Basin. Its gas production accounted for about 78% of the net profits interests’ gas sales volume and 41% of the net profits income for 2021.

Based on the projected production levels in 2022, the Trust’s reserves should last for over a decade.

Distributions

In 2021, the distributions were almost 43% higher than in 2020, primarily because of the soaring fuel prices, which were partially offset by higher costs and lower production volume.

Despite a wildly fluctuating dividend and the dramatic plunge in the wake of the pandemic, the company has a 4-year average dividend yield of 10.20%, a 5-year average dividend growth rate of 5.82%, and a forward yield of 12.50%.

Given the positive market outlook and the Trust’s lucrative properties, the dividends are sustainable and are not likely to suffer a drop anytime soon.

What’s Up With the Diminished Book Value?

The Trust’s initial net book value (NBV) of the net profits interests was $61.1 million, amortized on a unit-of-production basis using proved reserves and charged directly to the “Trust corpus.”

Due to significantly lower oil prices in 2020, which are used for calculating the net profits interests proved reserves, the amortization charge of $4.2 million, a 6.7 times increase from 2020 ($638,730), ramped the accumulated amortization from $53,577,384 in 2020 to $57,834,093 in 2021, significantly reducing the NBV to $3.27 million.

Even though this amortization does not impact the unitholder distributions or the determination of proved reserves, it substantially increases the Trust’s price to book value ratio, seemingly making it extremely expensive.

Risks

Since the severely depressed levels of April 2020, crude oil prices have meteorically shot up to nearing one of their all-time high points. The Russia-Ukraine conflict and other uncontrollable factors have facilitated this rise, and due to any reason whatsoever, if the prices dip, the trust’s distributable income will be materially affected. However, in accordance with my previous prognosis, this is unlikely.

Additionally, just like Sabine, the Trust has static assets as it is prohibited from acquiring new income-producing assets. This limits its income-generating ability to the extent of the complete depletion of its current reserves. According to the Trust’s recent 10-K filing, the estimated annual rate of decline for natural oil and gas production on the underlying properties is about 6% to 8%.

Like Sabine, the reserves have been generating distributable income for decades without any prominent signs of significant depletion. Nevertheless, the risk remains and needs to be acknowledged.

Conclusion

CRT is a great investment vehicle for income investors looking for an inflation hedge and a great monthly income source. Given the stock operates in a cyclical industry, the rebounding economy is a great time for investment.

Even though I have rated the stock a buy because it undoubtedly presents a great opportunity for yielding some tax-advantaged income; I still think that Sabine Royalty Trust (SRT) offers a better alternative as it’s a much safer play pertaining to its topline arrangement.