Rising Star Buy: Sandridge Mississippian Trust II

In an earlier article, I outlined the investment case for Sandridge Mississippian Trust II (NYSE: SDR  ) . This royalty trust is a recent spinoff by IPO of Sandridge Energy (NYSE: SD  ) and offers investors the chance for a sizeable yield and capital gains. So I'll be buying this stock for my Special Situations portfolio, allocating an initial $1,000 to the position.

As I explained in greater detail in the February article, Mississippian II is structured similarly to other royalty trusts, including Sandridge Mississippian Trust I (NYSE: SDT  ) and Chesapeake Granite Wash Trust (Nasdaq: CHKR  ) . It owns a collection of oil and gas assets and then pays out all of its cash flow (net of post-production and administrative expenses) to investors. Mississippian II owns 67 producing wells in Oklahoma and southern Kansas as well as 206 wells that Sandridge is obligated to drill.

The royalty trust's reserves consist of 46.8% oil and 53.2% gas, giving the trust heavy exposure to oil, whose pricing has been strong. But despite the production mix, because of oil's strong pricing, the last three quarters of the year should see oil revenue comprise some 87% of total revenue. And oil prices should benefit as the global economy grows, even if we have a blip in the short term.

The revised prospectus laid out potential distributions. For 2012, the target payout is $1.88. At a price of about $22 per share, that works out to a yield of 8.5%. Next year it gets better, with a payout per share of $2.72 -- an increase of 45% -- and a yield of 12.4%. The company just confirmed its first payout of nearly $0.27 per share, slightly above its initial estimate for the quarter.

Sandridge (the parent) continues to own 25% of the royalty trust as subordinated units, which will not receive a distribution unless the trust pays out a minimum of $1.51 per share in 2012, moving to $2.18 per share in 2013. The subordinated units will forgo payment until other holders receive at least the minimum. So that provides some downside protection.

I expect the rising dividend to drive this stock higher over the next one to two years as investors become aware of the dividend. As yet, the trust has not paid out a dividend, and so shares do not appear as a dividend-paying investment on public screens or brokers' screens yet. So I'm getting into the stock before this first payout on May 30. I expect the stock could rise as much as 50% from these levels and still provide an attractive yield to investors. So I'll be buying $1,000 for my Special Situations portfolio on the next business day.

Interested in Sandridge Mississippian Trust II, or have another stock to share? Join Jim on his discussion board and follow him on Twitter (@TMFRoyal).

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Jim Royal, Ph.D., owns no shares of any company mentioned here. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.


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