Updated on April 13th, 2022 by Aristofanis Papadatos
Investors can buy stock in companies of all shapes and sizes thanks to the diverse offerings available in the stock market. Companies with market capitalizations of $10 billion or more are considered large cap stocks. Small-caps have market capitalizations below $2 billion.
However, there are even smaller companies that trade in the United States. For example, micro-caps are generally companies with market capitalizations of $300 million or less.
Cross Timbers Royalty Trust (CRT) is a micro-cap, and a tiny one at that—it has a market capitalization of just ~$80 million. Its market capitalization is minuscule, but its dividend is quite large. Cross Timbers stock has a high dividend yield of 8.5%.
Plus, Cross Timbers pays a monthly dividend. Sure Dividend has compiled a database of 50 monthly dividend stocks (along with important financial metrics such as dividend yields and payout ratios) which you can access below:
Despite its high yield and monthly dividend payouts, Cross Timbers has a highly uncertain outlook. The company has a very risky business model, and its annual dividend payouts have declined steadily since 2014.
Therefore, only the most risk-tolerant investors should consider buying Cross Timbers.
Cross Timbers Royalty Trust was created on February 12, 1991, and it makes money from two sources. First, income is derived from a 75% net profits interest from seven oil-producing properties in Texas and Oklahoma, operated by established oil companies.
In addition, income is generated from a 90% net profits interests from gas-producing properties in Texas, Oklahoma, and New Mexico. The primary-gas producing field is the San Juan Basin in northwestern New Mexico.
The trust was created to collect net income, then make distribution payments to unitholders based upon that income. Net income received by the trust on the last business day of each month is paid by XTO Energy, a subsidiary of ExxonMobil (XOM).
CRT’s 75% net profits interest is reduced by production and development costs, while the 90% net profits interest is not subject to these costs. Without production and development costs, the 75% net profits interest income is usually only affected by changes in sales volumes or commodity prices.
CRT had royalty income of $5.3 million in 2020, and $7.4 million in 2021.
In late March, CRT reported (3/29/22) financial results for the full fiscal 2021. Production of oil and gas plunged -54% and -24%, respectively, over the prior year, primarily due to the natural decline of the fields. However, the average realized prices of oil and gas grew 57% and 132%, respectively, thanks to the strong recovery of the energy market from the pandemic. As a result, distributable cash flow per share grew 43%, from $0.77 in 2020 to $1.10 in 2021.
Calculation of Net Profits Income
The following is a summary of the calculation of net profits income received by the Trust:
Source: Investor Presentation
Due to the high sensitivity of the results of CRT to the prevailing prices of oil and gas, the trust does not provide any guidance for the running year. CRT will benefit from the rally of the prices of oil and gas to a 13-year high this year.
The rally of the price of oil has resulted from the recovery of global consumption from the pandemic, tight global supply and the invasion of Russia in Ukraine. The sanctions of western countries on Russia have tightened the oil market even further, as Russia exports about 5 million barrels of oil per day (~5% of global supply).
The rally of the price of natural gas has resulted from the sanctions of western countries on Russia. Europe generates 31% of its electricity from natural gas provided by Russia but it is now doing its best to diversify away from Russia. As a result, there has been a steep increase in the exports of LNG from the United States to Europe.
Consequently, the U.S. natural gas market has become markedly tight and hence the price of U.S. natural gas has rallied to a 13-year high lately. Overall, the current environment is ideal for CRT, which is extremely sensitive to the prices of oil and natural gas.
One of the major catalysts for Cross Timbers moving forward would be higher oil and gas prices. Falling commodity prices weighed on the income derived by the trust in recent years. On the other hand, now that the prices of oil and gas have surged to 13-year highs, CRT is likely to enjoy a strong recovery this year. Strong commodity pricing will boost distributable income, and therefore, the share price. It is not accidental that the stock is currently hovering around its 5-year highs.
Cross Timbers has very minimal operating expenses since it is a royalty trust. This means that its operating leverage is huge when revenue rises. As stated above, if oil prices continue to rebound, Cross Timbers will accrue significant benefits.
Because of this, oil and gas prices are absolutely critical for the trust’s distributable income, and therefore, its growth is almost entirely dependent upon commodity prices.
As of December 31st 2021, proved reserves for the underlying properties were estimated to be 1.3 million barrels of oil and 12.6 billion cubic feet of natural gas. Both of these figures are 13% lower than they were at the end of 2020 and thus they are stern reminders of the long-term decline of the reserves of the trust. CRT has repeatedly stated that it expects a natural production decline of 6%-8% per year in the long run.
As the production of oil and gas of CRT decreases due to the natural decline of the fields, investors should expect the distributable cash flow per share to decrease in the long run, especially given the 13-year high commodity prices prevailing right now.
On the bright side, the ongoing upcycle is somewhat different in that most oil producers are hesitant to invest in new growth projects due to the secular shift of the world from fossil fuels to clean energy sources. However, U.S. oil producers are boosting their output at a fast pace. We also believe that other producers will eventually boost their output at such high prices and thus the global supply will outpace demand at some point in the future. When that occurs, the next downcycle of the energy market will begin. The results of CRT will be greatly affected whenever the next downcycle shows up.
There isn’t much the trust can do to impact growth, so shareholders should certainly be aware of this. Cross Timbers is a passive play on collecting royalty income and by extension, oil and gas prices.
Since Cross Timbers is a trust, its dividends are classified as royalty income. And since the distributions are considered ordinary income, they are taxed at the individual’s marginal tax rate.
Cross Timbers’ dividends are declared 10 calendar days prior to the record date, which is the last business day of each month. The company’s dividend payouts have declined steadily over the past few years, a reflection of weak commodity prices, with the exception of 2021, when commodity prices recovered.
In 2018, Cross Timber paid cumulative dividends of approximately $1.43 per share. However, 2019 saw distributions fall to $0.88 per share, followed by a further decline to $0.78 per share in 2020.
Fortunately, distributions partly recovered in 2021, as oil and gas prices rallied considerably off the pandemic lows. As a result, CRT offered total distributions of $1.10 per share in 2021 for an average annual distribution yield of 10.0% in that year.
There is no doubt that Cross Timbers is a high dividend stock. But it has a variable payout that can swing wildly, depending almost entirely on the direction of oil and gas prices.
These payments highlight the variable nature of Cross Timber’s distribution – since it is based upon current income for the trust – as well as the impact of declining oil and gas prices. With the rebound in oil and gas prices, we’d expect Cross Timbers to be able to pay at least $0.08 per share monthly for the foreseeable future, so its yield will remain high.
However, we note that the trust is entirely dependent upon commodity prices it has no control over. The trust continues to distribute essentially all of its income, as it has since its inception. Dividend coverage is never going to be strong given that Cross Timbers is required to distribute basically all of its income.
Future distribution growth is reliant upon higher distributable income. As a result, the trust’s dividend growth potential is essentially a bet on oil and gas prices. If commodity prices continue to rise, there is a good chance for distribution growth through 2022. However, we note the high cyclicality of the prices of oil and gas and their excessive downside risk off their current multi-year highs in the long run.
The bottom line for Cross Timbers’ distribution is that it is very unpredictable and while the headline yield is enticing, keep in mind there is significant variability in any particular month’s payout, depending on commodity prices and production levels. Investors should keep in mind the risk and volatility associated with oil and gas royalty trusts before buying Cross Timbers.
Cross Timbers gives investors a unique way to play potentially higher oil and gas prices in the future, all while realizing monthly income along the way. At the same time, there are risks and unique characteristics that investors should take into account before buying shares of a royalty trust.
Cross Timbers is a micro-cap, meaning it is more volatile and thinly-traded than larger companies. It is also a royalty trust, which carries its own risks.
Finally, Cross Timbers is not a long-term ‘sleep well at night’ dividend growth stock. Future results are dependent upon oil and gas prices and the true amount of reserves in the properties it has interests in.
As a result, Cross Timbers is only a recommended stock for investors who accept the risks of royalty trusts and micro-caps.
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