SBR - San Juan Basin Royalty Trust Has Become Reasonably Valued

2023-09-22 15:09:37 ET

Summary

• San Juan Basin Royalty Trust is a gas trust with properties in northwestern New Mexico.
• The trust has greatly benefited from the war in Ukraine, but faces long-term threats from the shift to renewable energy sources.
• The trust has vastly underperformed the S&P 500 over the last decade. It is not a buy-and-hold stock.

San Juan Basin Royalty Trust ( SJT ) is essentially a gas trust, as it produces a negligible amount of oil. It was formed in 1980 and has a market capitalization of $321 million . All its producing properties are in northwestern New Mexico, in the San Juan Basin. The assets of the trust are static, i.e., no further properties can be added.

Just like most gas producers, San Juan Basin Royalty Trust was severely hurt by the coronavirus crisis, which led the price of natural gas to plunge in 2020. The trust posted a 10-year low distributable income per unit of $0.159 in that year. However, in 2021, the trust recovered strongly from the pandemic thanks to the reopening of the economy, and thus it grew its distributable income per unit to $0.77 in 2021.

Even better, San Juan Basin Royalty Trust greatly benefited from the outbreak of the war in Ukraine last year. The U.S. and the European Union imposed strict sanctions on Russia, which was producing about one-third of natural gas consumed in Europe until that time. As a result, Europe began to import LNG cargos from the U.S. at a record pace and hence the U.S. natural gas market became extremely tight. Consequently, the price of U.S. natural gas surged to a 13-year high last year. The positive effect on San Juan Basin Royalty Trust was evident, as the trust more than doubled its annual distribution per unit, from $0.77 in 2021 to a 10-year high of $1.66 in 2022.

Unfortunately for the trust, the price of natural gas plunged earlier this year due to an abnormally warm winter weather. As a result, San Juan Basin Royalty Trust cut its monthly distribution by 96% , from $0.4097 in March to $0.0170 in June. The extremely wide variations in the distributions of the trust just confirm the high sensitivity of the trust to the gyrations of the price of natural gas.

It is also important to note that the production of San Juan Basin Royalty Trust is likely to decrease over the long run due to the natural decay of its gas fields. Other oil and gas trusts, such as Cross Timbers Royalty Trust ( CRT ) and Sabine Royalty Trust (SBR), have provided guidance for a 6%-8% average annual decline in their production in the long run. San Juan Basin Royalty Trust has not provided any guidance but investors should be aware of this risk factor, which is likely to form a significant headwind in the long run.

On the bright side, the outlook of the U.S. natural gas market has greatly improved in recent months. As per the latest Short-Term Energy Outlook of the Energy Information Administration [EIA], the U.S. consumption of natural gas in September is expected to grow 5% over the prior year’s period, to a new all-time high, thanks to exceptionally warm weather. If this forecast proves correct, September will mark the third consecutive month with record gas consumption.

In addition, the average U.S. natural gas consumption in the full year is expected to rise 1%, from an all-time high of 88.6 Bcf per day in 2022 to a new all-time high of 89.7 Bcf per day. The strong demand for natural gas has resulted in a 40% increase in the price of natural gas, from about $2.00 in April to $2.80 now. As a result, San Juan Basin Royalty Trust recently more than doubled its monthly distribution, from $0.0207 in August to $0.0538 in September.

The distribution in September corresponds to an annualized yield of 9.3%. In order to be on the safe side, the average distribution of August and September corresponds to an annualized yield of 6.5%, which is still high. On the other hand, it is important to note that oil and gas trusts almost always offer much higher yields than the broad market due to their aforementioned inherent risk of declining production in the long run. To be sure, San Juan Basin Royalty Trust has offered an average distribution yield of 8.3% over the last decade. Therefore, its current yield seems to be largely in line with its historical yield.

Of course, given the dramatic cyclicality of the price of natural gas and the distribution of San Juan Basin Royalty Trust, the stock is suitable only for investors who can stomach this high cyclicality. As mentioned above, the trust offered a 10-year low annual distribution of $0.159 in 2020 and thus its average stock price was $2.65 in that year. This stock price is 62% lower than the current stock price. It is thus evident that great patience and strong conviction in a recovery in gas prices is required whenever the gas market incurs a downturn.

It is also important to note that San Juan Basin Royalty Trust is facing a significant long-term threat, namely the secular shift from fossil fuels to renewable energy sources. This trend has greatly accelerated since the onset of the coronavirus crisis, in 2020. In fact, the energy crisis, which was caused by the war in Ukraine and put millions of households under immense pressure last year, led nearly all countries to invest in renewable energy projects at a record pace.

Last year marked the first time in history in which the global investment in renewable energy sources ($1.1 trillion) became equal to the global investment in oil products, gas and coal.

Source: TIME Magazine

The above chart shows that the global investment in green power projects has gone parabolic in the last three years. This trend certainly poses a threat to the producers of fossil fuels.

Fortunately for San Juan Basin Royalty Trust, natural gas is considered a cleaner fuel than oil products and coal and hence its consumption is not likely to plunge anytime soon. Moreover, as the fierce energy crisis proved last year, the transition from fossil fuels to clean energy sources is likely to take longer than initially anticipated. Nevertheless, whenever all the green power projects that are being developed begin to generate energy, they are likely to take their toll on gas prices. The impact is hard to quantify but the boom in green energy projects certainly poses a threat to San Juan Basin Royalty Trust.

The bottom line

After a 30% decline this year, the stock price of San Juan Basin Royalty Trust seems to have become reasonably valued, in line with its historical yield. If the positive momentum in gas consumption and prices remains in place during the winter, the stock is likely to reward investors from its current price.

However, the near-term path of the stock will be largely determined by the winter weather and hence it is unpredictable, though we are unlikely to experience an abnormally warm winter for a second year in a row. Those who want to benefit from a potential cold winter are likely to be rewarded by the somewhat low entry point of San Juan Basin Royalty Trust right now.

On the other hand, investors should always remember that the gas trust is not a buy-and-hold stock due to its dramatic cyclicality and its declining output in the long run. Its vast underperformance vs. the S&P 500 over the last decade ( -57% vs. +157% ) is a testament to the outsized risk of this trust. Those who seek to make a short-term profit from this stock by betting on a cold upcoming winter should probably take their profits at the technical resistance around $8.50, which is 23% higher than the current stock price.

Overall, the stock seems reasonably valued right now, but it is suitable only for investors who want to make a short-term profit over the next few months. It is certainly not a buy-and-hold stock.

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