Sabine Royalty Trust Maintains Its Sell Rating, Despite Its Vast Underperformance

seekingalpha06-07

Sabine Royalty Trust has underperformed the market, offering a total return of -4% compared to the S&P 500's 40% rally.The outlook for the natural gas market is not favorable, with prices expected to ...

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Indeed, the stock approximately tripled in the 21 months following my article. However, in the fall of 2022, I recommended selling the stock, after its rally to new all-time highs amid 13-year high prices of oil and gas. Since that article, the stock has dramatically underperformed the market, as it has offered a total return of -4% whereas the S&P 500 has rallied 40%. I last reiterated my bearish thesis about six months ago. Since that article, the stock has declined 5% whereas the S&P 500 has rallied 16%. After such a vast underperformance, some investors may be prone to conclude that conditions have become ripe for Sabine Royalty Trust to begin to outperform the broad market, particularly given the high cyclicality of the stock. However, the oil and gas trust remains highly risky, as the outlook of the oil and gas markets is not favorable. As a result, the stock maintains its sell rating. Overview of the natural gas market Sabine Royalty Trust is an oil and gas trust that was founded in Texas in 1983. It generates approximately 60% of its royalty income from the sale of oil and the remaining 40% from the sale of gas. Therefore, it is important to examine the outlook of both the oil and gas markets before initiating a position in the stock. The price of natural gas rallied to a 13-year high in 2022 due to the sanctions imposed by the U.S. and the European Union on Russia after the invasion of the latter in Ukraine. Until that point, Russia was providing about one-third of natural gas consumed in Europe. The sanctions rendered the global gas market extremely tight, and thus the price of natural gas skyrocketed two years ago. However, the price of natural gas has returned to normal levels since early last year, as the global gas market seems to have absorbed the impact of the war in Ukraine, partly due to abnormally warm winter weather in 2023 and 2024. In addition, according to the outlook provided by the U.S. Energy Information Administration [EIA], total U.S. gas production is likely to remain close to an all-time high level this year. As a result, the average price of natural gas is expected to decrease 12%, from $2.50 in 2023 to $2.20 this year. On the one hand, the short-term price of natural gas is infamous for its sensitivity to unexpected changes in weather conditions. On the other hand, given the nearly all-time high production of gas in the U.S., there is no visible catalyst for a sustained rally of the price of gas. On the contrary, due to the severe energy crisis caused by the war in Ukraine two years ago, nearly all the countries are running an unprecedented number of clean energy projects in an effort to reduce their dependence on fossil fuels. According to a report, global investment in clean energy projects jumped 17% last year, to a new all-time high of $1.8 trillion.   Global Investment in Clean Energy (Bloomberg) Source: Bloomberg It is impressive that global investment in green power has nearly doubled in just three years. As all these projects will take a few years to come online, they are likely to provide a strong headwind to the price of natural gas in the upcoming years. Overall, the outlook of the natural gas market for the upcoming years is not favorable for Sabine Royalty Trust. Overview of the oil market Due to the Ukrainian crisis, the price of oil skyrocketed to a 13-year in 2022, just like the price of natural gas. The price of oil has declined nearly 50% off its peak but it remains above average, currently hovering around $74. The global oil market has absorbed the impact of the war in Ukraine, as Russia has managed to find alternative customers for its oil now that the western countries have imposed sanctions on the country. More precisely, Russia is now selling millions of barrels of oil per day to China, India and a few other Asian countries. As a result, it would be natural to expect the price of oil to decline even further. However, OPEC has adopted an aggressive stance in the last three years. The cartel has implemented many rounds of production cuts, and thus it has provided a strong support to the price of oil. This is the reason behind the solid floor of $70 of the price of oil in the last two years. Unfortunately for OPEC, its strategy seems to have exhausted its potential. The U.S. and Canada, which are outside the cartel, have taken advantage of the deep production cuts of OPEC, and thus they have boosted their production to record levels. In this way, they have gained market share in global oil output, whereas OPEC has seen its market share decline in recent years. More precisely, while the cartel has maintained a global market share between 30% and 40% for decades, its market share has plunged to 26% (=27,000,000/102,000,000) lately. Due to the loss of market share, most members of OPEC are unwilling to maintain their reduced production quotas for much longer. To be sure, Angola exited the cartel early this year, as it found it more beneficial for its own interest to boost its production without any limitations. This exit followed the exits by Qatar in 2019 and Ecuador in 2020 and thus left the cartel with just 12 members. To cut a long story short, due to the ability and willingness of the U.S. and Canada to grow their oil production to new all-time highs, it is becoming increasingly hard for OPEC to convince its members to maintain their reduced quotas. That’s why OPEC recently decided to begin to gradually phase out its production cuts later this year. Such a development does not bode well for future oil prices, particularly given the aforementioned boom in global investment in renewable energy projects. Recent performance of Sabine Royalty Trust Almost a month ago, Sabine Royalty Trust released its financial results for the first quarter of the year. The company grew its production of oil and gas by 8% and 16%, respectively, over the prior year’s quarter, primarily thanks to the timing of cash receipts. However, the average realized price of oil remained essentially flat, while the average realized price of gas slumped 53%. As a result, distributable income per unit declined 27%, from $1.73 to $1.27. As Sabine Royalty Trust is a pure upstream oil and gas company, it is more sensitive to the swings of the prices of oil and gas than the well-known oil majors, such as Exxon Mobil (XOM) and Chevron (CVX), which are integrated companies, with a significant downstream (mostly refining) segment. The sensitivity of Sabine Royalty Trust was evident in its results in the first quarter, as the decline in gas prices more than offset the effect of much higher output. Thanks to 13-year high prices of oil and gas in 2022 amid the Ukrainian crisis, the trust posted 13-year high distributable income per unit of $8.65 in 2022. In 2023, the trust posted its second-best distributable income per unit ($6.38) in the last 13 years. Given an 18% decrease in its distributable income per unit in the first five months of this year and the lackluster outlook of the oil and gas markets, the trust is likely to see its bottom line decrease further this year. Distribution yield Thanks to the above average price of oil this year, Sabine Royalty Trust has offered a total distribution per unit of $2.40 in the first five months of the year. This distribution corresponds to an annualized distribution yield of 9.0%, which may appear attractive for income-oriented investors, at least on the surface. However, the monthly distributions of the trust are highly sensitive to the prevailing prices of oil and gas. If the price of oil reverts to the normal levels it was during 2018-2019, the distribution of the trust is likely to revert towards its level in those two years. Sabine Royalty Trust offered a distribution of $3.42 in 2018 and $3.02 in 2019. It is also important to keep in mind the long-term decline of the production of the trust due to the natural decay of its producing wells. If the distribution of the trust reverts to $3.42, it will correspond to a yield of only 5.3%. This is too low a yield for a trust with the risks related to a declining output over the long run and the cyclicality of oil and gas prices. The stock has offered an average annual distribution yield of 8.9% over the last four years. Investors have demanded such a high yield from the trust in order to be adequately compensated for the risks related to the declining output and the high sensitivity to the prices of oil and gas. If the distribution decreases to its level in 2018 ($3.42), the stock is likely to decline towards $38 in order to yield 8.9%, in line with its historical yield. In other words, the stock will have an approximate downside of 40% in such a scenario. Therefore, the stock remains highly risky. As long as the price of oil remains above $70, the stock is likely to have limited downside. However, whenever the price of oil falls below its support of $70, it is likely to exert great pressure on the stock of Sabine Royalty Trust. It is also important to note that the stock has dramatically underperformed the S&P 500 over the last two years, even though the price of oil has remained above average throughout this period. Overall, the trust is likely to continue to perform poorly if the price of oil declines or remains flat. Therefore, there is hardly any reason for investors to buy this oil and gas trust around its current price. Upside risk As mentioned above, due to the weakening position of OPEC and the record number of renewable energy projects under development, the outlook for the prices of oil and gas is not favorable for Sabine Royalty Trust. However, this is not written in stone. The price of oil has proved highly sensitive to any unexpected factor that significantly affects the supply or demand of the global oil market. If an unforeseeable geopolitical event causes a disruption in global oil supply, the price of oil will increase. The price of oil may also increase if the global economy accelerates from its latest slowdown, which has resulted from the aggressive interest rate hikes of most central banks. If the price of oil rallies for one of these two reasons, the stock of Sabine Royalty Trust is likely to appreciate. No-one can exclude the emergence of a geopolitical event or strong growth of oil demand as a result of accelerated economic growth. However, investors should be aware that these are not the base-case scenarios. Final thoughts  Sabine Royalty Trust is a well-managed oil and gas trust, with a strong performance record. When it was set up, it was expected to last for about a decade, but it has surpassed expectations by an impressive margin, as it has reached 41 years of life. On the other hand, the stock has significantly underperformed the broad market over the last two years and is likely to continue to do so due to the unfavorable outlook of the oil and gas markets. Therefore, the stock maintains its sell rating.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.28.1","shortVersion":"4.28.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2441872540"}