SBR - Sabine Royalty Trust: The Tailwind From OPEC Is Fading

2023-12-07 17:13:26 ET

Summary

• Sabine Royalty Trust stock has underperformed the market, offering a total return of -1% compared to the S&P 500's 20% rally.
• The recent meeting of OPEC and Russia suggests that the price of oil may fall below $70 and remain low in the upcoming months.
• Sabine Royalty Trust is highly sensitive to the prices of oil and gas and does not have a catalyst for growth in the foreseeable future.

In 2020, I recommended purchasing Sabine Royalty Trust (SBR), as I considered the plunge of the stock due to the pandemic overblown. The stock nearly tripled in the following two years. However, about a year ago, I recommended selling the stock due to its high cyclicality and my expectations for lower oil and gas prices. Since that article, the stock has pronouncedly underperformed the broad market, as it has offered a total return of -1% whereas the S&P 500 has rallied 20%. I reiterated my bearish thesis on the stock six months ago. Since then, the price of oil has decreased 7% but Sabine Royalty Trust has offered a total return of 11%, more than the 3% total return of the S&P 500.

However, investors should not be misled by the recent outperformance of the oil and gas trust. The recent meeting of OPEC and Russia is likely to prove a game changer. The price of oil has fallen towards $70 three times in the last 12 months, and it has bounced strongly every time thanks to the several production cuts announced by OPEC. However, this strategy seems to have exhausted its potential. The lack of ammunition of OPEC was prominent in its latest meeting, a few days ago. The price of oil has revisited the level of $70 due to the absence of a meaningful decision in that meeting. Therefore, investors should be aware that the price of oil may fall below $70 and remain below that level in the upcoming months. Given also the recent forecasts for mild winter weather, which will probably take its toll on the price of natural gas, Sabine Royalty Trust has a significant downside. Even if fundamentals improve in the short term, the stock is risky from a long-term perspective.

Business Overview

Sabine Royalty Trust is an oil and gas trust that was set up in Texas, 41 years ago. It has royalty and mineral interests in some oil and gas-producing properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma, and Texas. The trust generates approximately 50% of its revenues from the sale of oil and the other 50% from the sale of gas. Therefore, it is critical to examine both the oil market and the natural gas market before purchasing the stock.

Just like all the other oil and gas trusts, Sabine Royalty Trust is prone to a material decrease in its production over the long term. This decrease results from the natural decay of the producing oil and gas fields, as the trust is not allowed to expand into new areas. On the bright side, Sabine Royalty Trust has performed far better than expected in this aspect. To be sure, when the company was founded, in 1982, it had an expected lifetime of about 10 years, but it is still producing meaningful amounts of oil and gas, 41 years after its foundation. Overall, it is a high-quality oil and gas trust.

On the other hand, investors should not underestimate the risk related to the long-term decline of the output of the trust. Due to this risk and the extremely high cyclicality of the prices of oil and gas, Sabine Royalty Trust is not a buy-and-hold stock. Instead, investors should consider buying the stock only when they view a potential catalyst in place. This is not the case right now.

The prices of oil and gas skyrocketed to 13-year highs last year due to the sanctions imposed by the U.S. and European Union on Russia for its invasion of Ukraine. However, the price of natural gas has plunged 75% off its peak last year, mostly due to an abnormally mild winter weather, both at the beginning of this year and now. The price of natural gas fell to a 3-month low yesterday due to forecasts for mild winter weather in the upcoming weeks.

While the short-term path of gas prices is unpredictable, it is safe to assume that gas prices will not revert anywhere close to their blowout levels recorded last year, as the impact of the Ukrainian crisis has been absorbed and the U.S. is producing natural gas at a record pace. According to the latest report of the Energy Information Administration [EIA], U.S. gas production is expected to grow from 99.6 billion cf/day to an all-time high of 103.7 billion cf/day this year and a new all-time high of 105.1 billion cf/day in 2024. Overall, there is no visible catalyst in the natural gas market.

A similar picture is evident in the oil market as well, but with one major difference; OPEC has been doing its best to support the price of oil. The price of oil peaked shortly after the invasion of Russia in Ukraine, at $130, and has declined to $70, as Russia has circumvented the sanctions by increasing its sales to China and India. The price of oil has fallen to its current level three times in the last 12 months but it has bounced swiftly in all the instances, as OPEC has implemented several rounds of production cuts throughout this period.

However, OPEC cannot maintain such a strategy, as it has been losing market share to non-OPEC members, primarily the U.S. and Canada, which are producing oil and gas at a record pace. The output of OPEC is expected to decrease by 500,000 barrels per day this year while the output of non-OPEC members is expected to grow by 1.9 million barrels per day.

The inability of OPEC to sustain its strategy was prominent in its meeting last week. None of the members was willing to reduce its output further. As a result, the price of oil has declined to a critical level. If the technical support of $70 is broken, the price of oil may stabilize at much lower levels, particularly given the global economic slowdown and the ongoing boom in green energy projects.

Global investment in energy projects is expected to grow 8% this year, from $2.6 trillion to $2.8 trillion. This growth is the result of the boom in clean energy projects. The total investment in clean energy projects is expected to exceed $1.7 trillion this year and thus exceed the investment in fossil fuel projects by about 70%. When all the clean energy projects begin generating energy, they are likely to take their toll on the prices of oil and gas.

Overall, there seems to be no catalyst for the price of oil for the foreseeable future. The strategy of OPEC seems to have exhausted its potential, while a record number of clean energy projects is expected to come online within the next 3-5 years. Therefore, Sabine Royalty Trust, which is highly sensitive to the prices of oil and gas, does not seem to have a catalyst in place.

In the third quarter, Sabine Royalty Trust reported a 16% decrease in its oil sales and a 23% decrease in its gas sales over last year's quarter, primarily due to the timing of cash receipts. Moreover, its average realized prices of oil and gas significantly decreased vs. abnormally high levels in the prior year's period amid the core of the Ukrainian crisis. As a result, the distributable income per unit of Sabine Royalty Trust slumped 65%, from $2.68 to $0.94. Given the absence of a catalyst in the oil and gas markets, it is prudent for investors not to expect a sustained recovery in the distributable income of Sabine Royalty Trust in the upcoming quarters.

Valuation

Sabine Royalty Trust distributes all its net income to its unitholders, i.e., it has a payout ratio of 100%. Therefore, there is no need to examine price-to-earnings ratios, as the evaluation of the stock can be simply based on the distribution yield of the stock.

Sabine Royalty Trust has offered an average distribution yield of 8.5% over the last decade. During the last 12 months, the stock has offered total distributions of $6.31, which corresponds to a 9.0% yield at the current stock price. Therefore, the stock appears reasonably valued, as its current valuation is roughly in line with its historical valuation.

However, there are two potential risk factors. First of all, just like all the other oil and gas trusts, Sabine Royalty Trust bears the risk of declining production in the long run. This means that its future distributions will almost certainly be hurt by lower production volumes. While this is a long-term risk factor, it should not be undermined by investors.

The other risk factor is the dim outlook of the oil market. As mentioned above, the price of oil may decrease significantly in the upcoming years due to the exhaustion of the ammunition of OPEC and the unprecedented boom in green energy projects. As a result, Sabine Royalty Trust may be hurt by lower oil prices in the upcoming years. To cut a long story short, the stock is reasonably valued based on its current earnings, but its earnings may decrease significantly in the upcoming years.

Final Thoughts

Sabine Royalty Trust is a high-quality trust, which has surpassed its initially expected lifetime by an impressive margin. However, as a pure upstream company, it is inevitably sensitive to the dramatic cycles of the prices of oil and gas. As the price of oil seems to have a significant downside risk of its artificially supported (by OPEC) level, the stock has material downside risk.

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