At Another New Low, Is Hugoton Royalty Trust Worth Buying?

Shares of Hugoton Royalty Trust (NYSE: HGT  ) hit a 52-week low again on Wednesday. Let's take a look at how it got there and see whether cloudy skies are still in the forecast.

How it got here
Hugoton Royalty Trust, which owns an 80% net-profit interest in oil and natural gas wells located in Wyoming, Kansas, and Oklahoma, and is operated by XTO Energy -- which was itself purchased by ExxonMobil (NYSE: XOM  ) -- has faced a triple-domino effect that has crushed its stock.

First, natural gas prices are slumping, which is bad news for Hugoton. XTO Energy's wells are heavily reliant on natural gas production and, with prices slumping, the possibility that Hugoton's pristine dividend could begin to contract is seeming very real.

Second, a recent article from Seeking Alpha deems that the Trust is overvalued based on its fixed amount of reserves in the ground and the shrinking selling price of natural gas. The author's contention is that without any additional wells being added to the Trust, and natural gas prices remaining weak, the stock (at the time of the article) was 40% overvalued. Since then it has fallen nearly 50%.

Finally, Hugoton is dealing with lawsuits and litigation related to a settlement from XTO Energy that will require it to pay 80% (its net interest) of the costs, or nearly $30 million. Hugoton has stated that the settlement costs will outweigh its net profits from its Oklahoma and Kansas properties for the next 18 months!

Other trusts are also finding themselves in the hot seat, including San Juan Basin Royalty Trust (NYSE: SJT  ) , which has been hit with lawsuits and separate allegations from Seeking Alpha that it too is grossly overvalued.

How it stacks up
Let's see how the Hugoton Royalty Trust stacks up next to its peers.

HGT Chart

HGT data by YCharts

None of the natural-gas-heavy trusts have done particularly well, but San Juan and Hugoton, which are both facing legal woes, have suffered much worse.

Company

Price/Book

Trailing P/E (TTM)

Dividend Yield

Hugoton Royalty Trust 2.4 5.1 9.3%
San Juan Basin Royalty Trust 49.7 9.5 5.2%
SandRidge Mississippian Trust I (NYSE: SDT  ) 2.7 14.2 11.8%
Chesapeake Granite Wash Trust (NYSE: CHKR  ) 2.1 38.5 13.7%

Sources: Morningstar, Yahoo! Finance. TTM  = trailing 12 months. All yields are projected.

Trying to compare the underlying fundamentals of royalty trusts can sometimes be almost as pointless as trying to compare clinical-stage biotechnology company metrics against one another -- but nonetheless, we'll dig a bit deeper.

Both SandRidge Mississippian Trust I and Chesapeake Granite Wash Trust, which hold interests in SandRidge's and Chesapeake Energy's wells, respectively, have both taken to upping their reliance on oil production and are moving at least partly away from their reliance on natural gas production. For SandRidge, it's contending with high debt levels that could compromise its trusts' dividends down the road, while Chesapeake is dealing with the PR gaffe of the decade.

Hugoton and San Juan Basin have markedly different problems. Not only do they not have the luxury of switching to higher oil production since the majority of their well holdings are tied up in natural gas reserves, but both, as we've witnessed, are dealing with lawsuits and questions regarding their true valuation given the rapid decline in natural gas sales volumes and prices.

What's next
Now for the $64,000 question: What's next for Hugoton Royalty Trust? That answer is going to depend very much on whether natural gas prices stabilize, and whether investors are willing to wait around long enough for that to happen. The potential for future lawsuits relating to its recent price action also have to be a concern.

Our very own CAPS community gives the company a three-star rating (out of five), with 95% of members who've rated it expecting it to outperform. I've personally not made a CAPScall in either direction on Hugoton because I'm completely confused as to which way it could head next.

On the bright side, Hugoton has had an incredibly swift drop that may have actually undervalued its 1,200-plus wells. In addition, I find it unlikely that natural gas prices won't at least partially close the huge gap between themselves and oil prices per barrel, which should be good for Hugoton's net profits. On the other hand, Hugoton is facing the potential of more lawsuits when it's already forking over nearly $30 million in settlements and is seeing profit and volume declines in both its natural gas and oil production. Although the yield is enticing at 9%, I'd much rather pass altogether here until the dust settles and instead get into a trust like Chesapeake Granite Wash Trust, which I talked positively about yesterday.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

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Read/Post Comments (3) | Recommend This Article (6)

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 June 02, 2012, at 10:17 AM, DrDuru wrote:

    This article didn't answer the original question. Moreover, it didn't add anything that has not been listed elsewhere. Plus, I was hoping for another perspective... For example, do you agree with the valuation numbers that have been thrown around?

  • Report this Comment On June 03, 2012, at 10:11 AM, spirts wrote:

    "The author's contention is that without any additional wells being added to the Trust, and natural gas prices remaining weak, the stock (at the time of the article) was 40% overvalued. Since then it has fallen nearly 50%"

    So it's a buy now and the price does seem to have bottomed.

  • Report this Comment On June 07, 2012, at 1:16 PM, DiversifyFool wrote:

    HGT faced only one lawsuit, which has been settled. BAC and XOM might have liability to unitholders as the only disclosure of the lawsuit said there were good defenses AND there was NO mention that the lawsuit could have a material effect.

    That is a potential bonus. By the bearish author's own figures, because of the drop, HGT is undervalued.

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