1 Fat, High-Energy Dividend

Today I'm back with one of my favorite special situations -- a monster dividend stock that can drive a stock price up quickly. In fact, I think the stock could return as much as 50% in the next year. The ticker is SDR. But you won't be able to find the company on the exchanges. It hasn't yet held its IPO, but I'll give you the name in a moment.

What's so special about that?
If you've been following me on Fool.com, then you know I love special situations. Special situations are unusual investment opportunities that come about irregularly but often hold a lot of value for nimble investors. The most popular of such situations include spinoffs, reorganizations, and IPOs. The more superficially complex, the better, since this complexity deters many investors, making stocks cheaper for you and me. Better still, public finance sites often don't report the latest information for months, creates a lot of confusion and leaves you time to get into the stock.

Today, I'm going to lay out a case for the IPO mentioned above. The company is called SandRidge Mississippian Trust II, and it's a soon-to-be spinoff of SandRidge Energy (NYSE: SD  ) . The parent company is packaging a series of its oil and gas assets into the spinoff and then selling shares to the public. But SandRidge Mississippian Trust II is not your average company; instead, it's a royalty trust, an organization whose entire mission in life is to pay out all its cash flow as dividends every quarter.

Now that sounds interesting. How's it work?

SandRidge Mississippian Trust II is structured similarly to other SandRidge royalty trust spinoffs paying fat dividends, SandRidge Mississippian Trust I (NYSE: SDT  ) and SandRidge Permian Trust (NYSE: PER  ) . Monetizing such assets allows the highly leveraged SandRidge to gain cash now in exchange for a stream of royalties later.

Mississippian II owns a royalty interest in 67 producing wells in the Mississippian region of Oklahoma and southern Kansas, and 206 to-be-drilled wells in the same formation.

The royalty interest allows the trust to receive 70%-80% of the proceeds (excluding production and development costs, but not post-production costs) from the sale of oil and gas located in the wells. The proved reserves consist of 46.8% oil and 53.2% gas, which means that revenues have solid exposure to oil (which has had much stronger pricing recently) and won't be bogged down by very soft gas prices. Plus, oil prices should continue to benefit as the global economy grows.

A huge payout
The prospectus clearly lays out the expected distributions for the next six years. For 2012, the royalty trust is targeting $2.18 per share in distributions, with the first distribution around May 30, meaning, of course, that the IPO will occur before then.

Now, we can't figure the yield, because we don't have the stock price, but recent royalty trusts have come public around $18-$22 per share, and that's about where I peg the Mississippian II IPO to be priced based on its assets. So, $20 per share puts the yield at a tasty 10.9%. And that's not the best part.

The target payout in 2013 is expected to grow 26%, which should give a further boost to the stock price, and 2014 should see a further climb of 9%. The expected payout tops out in 2015, at least according to the oil and gas price and production assumptions used in the calculations.

If we see the stock open around $20, then I won't be surprised to see it run up 50% over the next year or so. That would be pretty comparable to what we've seen in this space. Look at the yield and stock gains for some recent trust IPOs, including Chesapeake Granite Wash Trust (Nasdaq: CHKR  ) , and one of the granddaddies of the form, BP Prudhoe Bay Trust (NYSE: BPT  ) .

Company

Yield

Year-over-Year Gains

SandRidge Mississippian Trust I 9.3% 54%*
Sandrirdge Permian Trust 9.4% 40%**
Chesapeake Granite Wash Trust 11.5% 52%***
BP Prudhoe Bay Trust 8.4% 17%

Source: S&P Capital IQ and Yahoo! Finance. * Since IPO on April 7, 2011.  ** Since IPO on August 11, 2011. *** Since IPO on November 14, 2011.

For me, the way to play the Mississippian II is to forget the buy-and-hold mantra. Like most royalty trusts, Mississippian II has a finite life, extending for the next 20 years. But, well before that, the distributions could drop substantially, as production declines markedly beyond 2016. Instead, I expect to invest with a one- or two-year holding period and expect to sell if I see the stock run 50% or so, given a $20 IPO price.

But how safe is that payout? Well, there's at least one protection. SandRidge Energy is retaining 25% of the Mississippian II units as subordinated units. These units will receive nothing if Mississippian II does not meet the minimum distribution payout for common shareholders, which equals $1.75 for 2012 and $2.19 for 2013. So to earn a distribution, SandRidge will have to make sure it at least performs to this minimum standard. But as I noted, it's aiming for much higher payouts.

And like all investments, SandRidge Mississippian Trust II has risks. The most obvious one is common to all commodity industries -- high price volatility. But that could be a good thing if you believe energy prices are going higher in the long term. Still, it could make for a bumpy ride in the stock. Prices will be hedged, but the levels have not been announced yet.

Other risks remain. Actual production may be less than estimated, and its hedging arrangement may result in the trust paying substantial cash. Both would reduce cash available for distribution.

Now, I think this new spinoff has a good probability of success over the next year, as investors become aware of the high and growing dividend. But I don't envision this stock as a long-term holding. If you're looking for high-yielding stocks that can grow their dividends indefinitely, consider the 11 names from a brand-new, free report from Motley Fool's expert analysts called "Secure Your Future With 11 Rock-Solid Dividend Stocks." To get instant access to the names of these 11 high yielders, simply click here -- it's free.

Jim Royal, Ph.D., does not own of any company mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (23) | Recommend This Article (114)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 21, 2012, at 5:16 PM, rdj1234 wrote:

    Hi Jim,

    Are there any tax consequences like with MLP'S? I have been looking into Investments like MLP'S BDC'S and MREIT'S but I haven't found a good source of info on the tax consequences for my IRA.

    Thanks for any insight you can provide

    Roger

  • Report this Comment On February 21, 2012, at 6:43 PM, rockythesquirell wrote:

    I did at one time hold shares in Chesapeake and SandRidge but after doing some research on Fracking. I just couldn't support the companies involved with the practice. I elected to sell for moral reasons. I suggest if you are of moral nature do some research as well.

  • Report this Comment On February 21, 2012, at 7:22 PM, mrtavs wrote:

    How does one get in on this IPO?

  • Report this Comment On February 21, 2012, at 7:43 PM, agileLakies wrote:

    I'd like to know how to get this too!

  • Report this Comment On February 21, 2012, at 7:58 PM, 7mmmag96 wrote:

    Hello, how do I get in on the IPO?

  • Report this Comment On February 21, 2012, at 8:04 PM, clevelandrudge wrote:

    @ rockythesquirell

    A virtual high five to you for letting your principles be your guide in the marketplace. There are plenty of ways to make money without supporting companies that despoil the environment, produce highly addictive carcinogens or feed the gluttanous war machine.

  • Report this Comment On February 21, 2012, at 8:43 PM, haywool wrote:

    @ aqileLakies and mrtavs and 7mmmag96

    I don't (haven't yet) bought any IPO. In the short time that the initial IPO trades, volatility can go nuts !!

    What I do is give some time for the market to adjust to the new company THEN buy. I may very well miss the initial upthrust but I won't loose my shirt in the first few hours or days of trading either.

  • Report this Comment On February 21, 2012, at 11:10 PM, TOM48 wrote:

    When is this IPO likely to come to market?

  • Report this Comment On February 22, 2012, at 1:03 AM, akfiredawg wrote:

    Sounds good, but Morgan Stanley estimates the IPO to be priced $26, not $20, with dividends to begin in 2016. How does this fit in to the prospect of this?

  • Report this Comment On February 22, 2012, at 6:33 AM, Poodge wrote:

    I too would like to know how to get in on the IPO.

  • Report this Comment On February 22, 2012, at 10:31 AM, TMFRoyal wrote:

    Hi, Roger,

    According to the prospectus, "The trust will be treated as a partnership for U.S. federal income tax purposes. Consequently, the trust will not incur any U.S. federal income tax liability. Instead, trust unitholders will be allocated an amount of the trust's income, gain, loss or deductions corresponding to their interest in the trust, which amounts may differ in timing or amount from actual distributions."

    So you should expect to get a K-1 form for tax purposes, as you do for MLPs. And like MLPs, some of the distribution is expected to be a return of capital, and so not taxable. You can find more in the prospectus.

    As always, please consult your tax adviser.

    Foolish best,

    Jim

  • Report this Comment On February 22, 2012, at 10:34 AM, TMFRoyal wrote:

    Hi, akfiredog,

    I don't know where you found your information. I'm using the prospectus filed in early February. And it clearly states that first payout should occur around May 30, 2012 to shareholders of record May 15 or so.

    Jim

  • Report this Comment On February 22, 2012, at 1:19 PM, fodico1 wrote:

    can this IPO be purchased without a broker?

  • Report this Comment On February 22, 2012, at 11:28 PM, LAVol wrote:

    Rockythesquirrel,

    Your "moral reasons" are totally unfounded. Oil and gas companies have been utilizing fracking techniques for over 50 years. It's not new. There is NO WAY, I repeat NO WAY that horizontal fracking is harming water tables. it's just not possible. (Do the research on the technique, how and where it is employed and you'll see why). The incursion in the water supplies comes from one of two sources: (1) natural incursion (it happens in nature, and this is most likely in most cases of contamination), and (2) from VERTICAL drilling where wells are not encased properly. I don't think you'll find a single case where a reputable driller has caused this--maybe a wildcatter who has no morals or sense of responsibility, but no responsible driller. It amazes me at how many people take the word of "environmentalists" who have an anti-hydrocarbon agenda at the expense of common sense.

  • Report this Comment On February 23, 2012, at 10:19 AM, egrusky wrote:

    Roger:

    Check out this site for additional info on tax consequences of holding a royalty trust in/out of an IRA.

    http://www.investingdaily.com/14675/energy-investing-eagerly...

  • Report this Comment On February 23, 2012, at 4:19 PM, agileLakies wrote:

    did some checking and with ameritrade at least you have to register to be able to participate in IPO then you have a short period of time starting when pricing information becomes available to 'offer to buy at that opening price. You may or may not be alocated shares. Makes sense to register interest in the IPO then see where that leads!

  • Report this Comment On February 23, 2012, at 5:05 PM, ALLWIN wrote:

    Jim you wrote "For me, the way to play the Mississippian II is to forget the buy-and-hold mantra. Like most royalty trusts, Mississippian II has a finite life, extending for the next 20 years.............................................................. Instead, I expect to invest with a one- or two-year holding period and expect to sell if I see the stock run 50% or so, ............"

    Question:- Is this the way you would also play SandRidge Mississippian Trust I and / or Sandrirdge Permian Trust? Or is this play specific to Mississippian II ?

  • Report this Comment On February 23, 2012, at 6:26 PM, TMFRoyal wrote:

    Hi, Allwin,

    Because of the depleting assets and declining payouts of these trusts (after the first 4-5 years or so), they're not something I would want to hold for the long term. To make up for the declining production, you'd have to rely on quickly climbing oil/gas prices, and there are safer ways to play that near-certainty. The prospectuses lay out the expected payouts for the first five or six years, so you can get some idea there.

    Foolish best,

    Jim

  • Report this Comment On February 24, 2012, at 9:32 PM, vireoman wrote:

    It is possible that one needn't worry about getting in on the IPO. Under different market conditions in 2011, per Morningstar data, SDT hovered around the opening price of $25 from 4/7-10/26 before climbing to the present price (as of 2/24) of $33.13 (up 37%), and PER worked the $18 range from 8/12-11/10 before climbing to the present price of $23.77 (up 32%).

  • Report this Comment On February 24, 2012, at 9:55 PM, ThePlate wrote:

    As a spinoff, will SD shareholders get any shares without purchasing them in the IPO?

  • Report this Comment On February 25, 2012, at 5:23 PM, ALLWIN wrote:

    Jim, Much thanks for your reply.

  • Report this Comment On February 28, 2012, at 11:48 AM, Truth2Power wrote:

    Hey Jim,

    At what price would you say this IPO was overbought? $22? $26? $30? Thanks!

  • Report this Comment On March 15, 2012, at 6:59 PM, thidmark wrote:

    I'm always leery of people who boast about their morals. They turn out to be the biggest hypocrites.

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