For an investment that yields over 12%, you would think that investors looking for income would be more excited about the Enduro Royalty Trust (NYSE:NDRO). However, based on the trust's share price since its inception in 2011 that doesn't seem to be the case.
So why are investors so pessimistic about the Enduro Royalty Trust when it pays such a hefty dividend, and on a monthly basis to boot? Let's take a look at the Enduro Royalty Trust and why you might not be that interested in it if you are looking for that stable monthly dividend payment.
Brushing up on Royalty Trusts
Let's get one thing straight, the Enduro Royalty Trust is not like other stocks you buy on the open market. Instead of having an equity stake in a company, you are buying interest in a property with mineral rights, and therefore you receive a percentage of the revenue from the minerals extracted from that property, in this case oil and gas.
One big perk for owning shares of a trust is that the IRS considers them pass-through entities like a master limited partnership, so there is no double taxation on earnings and capital gains. The difference between a trust and an MLP, though, is you pay the capital gains tax rate instead of the income tax rate. You also get the benefits of depreciating those assets to lower your cost basis to delay taxes.
In exchange for the reduced taxes, though, there is no company making strategic decisions like capital allocation and hedging strategies to protect against the change in commodity prices. Aside from the first year of operation, the Enduro Trust and almost every other trust sells its commodities on the spot market without the protection of a futures contract, so revenue can change wildly from month to month. The other thing to consider is that once all the natural resources on a trust are exhausted, that's it. This means that eventually over time the share price of a trust will go to zero. The investment thesis is that the distribution payments over time will cover the loss in share price.
Breaking down the Enduro Royalty Trust
On the surface, the Enduro Royalty Trust passes the three things that you should look for in a trust. It has a pretty balanced production mix of 58% oil from prolific oil basins in both East and West Texas. With 23 million barrels of proved reserves and annual production of about 2.3 million barrels, it has an approximate shelf life of just over 10 years. And finally, based on today's current yield, an investor should expect to earn back his or her original investment in about 7.9 years. These three factors should suggest that the Enduro Trust is an OK investment by royalty trust standards.
There is one thing that really stands out here, though, that separates the Enduro Royalty trust from most other successful trusts: the properties it has rights to are mostly in shale oil and gas development. It's not that shale wells are a bad investment per se, it's just that shale wells have a very high decline rate and it requires the constant development of new wells to maintain production levels. This isn't really compatible with the basic structure of a trust, which is looking for slow declining assets that will have predictable cash flows for many years down the road. In fact, even with 37 new wells coming online in the fiscal year 2013, total production from the Enduro Trust declined by 15%. As the few remaining properties left that are still undeveloped come online, it's very possible that the annual production will decline quicker and the cash distributions from the trust will become much smaller than what they are today.
What a Fool Believes
Based on the share price performance of the Enduro Royalty Trust, it looks as though several people are skeptical of how the trust will perform since it is based on shale wells rather than tried and true conventional resources. Also, most of the company's reserves and payback period are based on the trusts past 12 months performance when oil prices were considerably higher than they are now. If oil prices were to remain at the levels they are at today for an extended period of time, you can bet that the payback period for the trust will get much longer.
Because there is so much volatility in the monthly dividend payments from the Enduro Royalty Trust and the uncertainty about the future performance of shale wells, it's probably not in investors' best interests to buy shares of this trust if they need a constant monthly dividend payment to supplement their income.