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 (UNKNOWN:SD.DL) 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 (NASDAQOTH:LINEQ) 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.
Fool contributor Matt DiLallo owns shares of Linn Energy, LLC and SandRidge Energy. Matt DiLallo has the following options: short January 2014 $6 puts on SandRidge Energy. The Motley Fool owns shares of SANDRIDGE MISSISSIPPIAN TR II COM. 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.