Don’t Trust These Huge Dividends for Steady Income in 2014

Photo credit: SandRidge Energy.

Royalty trusts like SandRidge Permian Trust (NYSE: PER  ) can pay investors very well. The problem is that these payouts can fluctuate wildly from quarter to quarter. Worse yet, at some point in the future the payouts will end and leave an investor with nothing but memories. That's why I'm not very fond of royalty trusts and believe investors looking for steady income in 2014 are better off looking elsewhere.

The SandRidge Permian Trust has actually been a steady income producer over the past year, paying an average quarterly distribution of $0.59 for a total payout of $2.35 in 2013. At the present unit price that's a staggering 20% yield, which is why investors are drawn to owning its units.

Still, I'm not a fan of trusts in general, and when it comes to the SandRidge Energy (NYSE: SD  ) trio of trusts I have three specific issues that keep me from ever considering adding any of these units to my portfolio. To start, these trusts were created to benefit SandRidge Energy first and foremost. As a SandRidge Energy investor I'm completely on board with that idea as the company needed drilling capital and creating the trusts was a creative way of accessing the capital markets. However, these trusts, which also include SandRidge Mississippian Trust I  (NYSE: SDT  )  and SandRidge Mississippian Trust II  (NYSE: SDR  ) , were created to fuel the growth of SandRidge Energy above all else.

The second issue I have with trusts like SandRidge Permian is that there is no future growth after SandRidge Energy completes its drilling obligation between now and March 31, 2016. It's really all downhill after that, as the production from the wells SandRidge drilled will simply continue to naturally decline, with no new production coming online to offset that decline. Further, the trusts aren't allowed to grow organically or through acquisition as an upstream master limited partnership like LINN Energy (NASDAQ: LINE  ) can.

While the payout can grow in the interim as SandRidge Energy drills new wells, in addition to income growth from rising commodity prices, the growth of the trust is capped beyond that. In fact, the Permian Trust is scheduled to dissolve and begin to liquidate in 2031. While that's a long way off, having an expiration date and no growth isn't the ideal combination for a long-term investor. Especially when an MLP option such as LINN Energy is likely to still be steadily growing its distribution to investors at that time.

The third and final reason why I personally wouldn't trust these big payouts in 2014 is the fact that SandRidge Energy is actively selling down its position in all three trusts. SandRidge created the trusts to fund its drilling program and continues to use the trusts as currency to keep on drilling for its own account. For example, earlier this year SandRidge Energy sold 1 million shares of both the SandRidge Permian Trust and SandRidge Mississippian Trust II for a total of $30 million. It was the fourth time since the trusts' initial public offerings that SandRidge harvested some of its units. There will be a constant overhang on the units until SandRidge Energy sells all of the units it owns.

These reasons are on top of the fact that the actual distributions of these trusts have typically underperformed the targeted distribution. As an investor who prefers a steady payout, these fluctuating distributions aren't something I want in my portfolio. There are just so many other rock-solid income stocks that an investor can own, which is why I wouldn't trust any of these trust-funded dividends in 2014.

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  • Report this Comment On December 18, 2013, at 4:49 PM, PatO wrote:

    The author fails to mention the substantial minimum distributions of the SandRidge Energy Trusts. For example, SDR is scheduled to distribute a minimum of $9.23 per share from 2014 through 2017 (see 10K). The closing price today is $8.63. That's a minimum built in profit of $.60 even if the stock falls to zero (unlikely) and distributions between 2017 and 2031 are also zero (also unlikely). Natural Gas is on an uptrend and, if media reports are correct, that uptrend is expected to continue. Even a continuation of today's environment will likely provide distributions from 2018 through 2031 and a corresponding residual value to the shares. Perhaps the authors commentary was appropriate when the share price was much higher, but not with the price structure that we are experiencing today.

  • Report this Comment On December 19, 2013, at 5:25 PM, Usurped wrote:

    Nice post PatO

  • Report this Comment On December 27, 2013, at 8:06 PM, jmp4 wrote:

    I've been buying SDR. At current prices around $8.80 a basic discounted cash flow analysis assuming distributions miss targets by 60% would still give a 9% return. The last distribution missed it's target by 20%. The type curve for these wells have been coming in more nat gas and less oil. There is significant risk, but substantial return.

    PatO, I think you need to read the final prospectus again, as the subordinated minimum distributions are set to expire 4 full quarters after the drilling program ends ( they show a subordination sched through 2017). They appear to be on track to finish drilling in the next few months putting the expiration in early 2015 instead of 2017.

    I still think it's worth it!

    Happy New Year!

  • Report this Comment On January 28, 2014, at 6:29 PM, mrconnors0531 wrote:

    The recent increase in Nat Gas could be a boom for SDR unless they are hedged out but if they are spot market prices have shot up 40%. this winter.

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