Sabine Royalty Trust Stock Analysis

Description

Sabine Royalty Trust SBR 0.00%↑ is an oil and natural gas royalty trust that was founded in 1982. A royalty trust owns land that contains oil, but instead of drilling it themselves, third parties develop the land and the royalty trust gets a cut. Since the royalty trust is not spending capital to develop wells, there no operating expenses, just some administrative expenses. This means that nearly all the revenue the trust receives gets paid out as a dividend. The high dividend is what caught my eye with Sabine. I do not know much about the energy sector, but there are a couple of companies like Sabine and Vitesse that have seemingly attractive dividends, so I’ve been spending some time looking at these stocks. Additionally, if you have the view that inflation will be persistent, then it might make sense to own some oil assets (although now it seems like inflation is chilling out).

Sabine has oil and natural gas properties in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. When the trust was formed in 1982, it was estimated to have 9 million barrels of oil and 62 billion cubic feet of gas, with a lifespan of 9-10 years. Over the course of the proceeding 43 years, 24 million barrels of oil and 307 billion cubic feet of natural gas have been produced. Apparently they keep finding more oil.

During 2023, oil production stood at 467,000 barrels, and natural gas production was 8,924,000 thousand cubic feet (McF). In SBRs annual report, third party consultants estimated current reserves are 7.9 million barrels of oil and 46.4 billion cubic feet of natural gas, estimated to last about 8-10 years. The stock price peaked at $88 in 2023 and has been hovering around the $62 area for the past 9 months. Sabine’s dividend yield is 9.4%, but the distribution is monthly and constantly changes depending on production and oil prices.

For me, the royalty structure seems simple since they own the land and get paid when other people produce oil and gas. This is more straightforward than oil futures, refiners, or multinational oil conglomerates. Often times, oil companies are known for taking on a lot of debt, drilling a ton when times are good, then going bankrupt when oil prices collapse. With Sabine, that is someone else’s problem.

Valuation

Since I am pretty unfamiliar with energy companies, it was a bit of a challenge to value SBR, then add on that it is a royalty company instead of a traditional business. One way to value an oil producer is to estimate the value of their oil and gas reserves, then try not to pay a premium for that. According to the third party consultant report in Sabine’s annual report, estimated future revenue from proved developed reserves is $524M. The fair value of this future revenue at 10% discount rate is $258M. These figures are subject to the quantity of oil and gas in the reserve, and estimated prices for these commodities. Both of those inputs are constantly changing, so each year SBRs reserve value is going to fluctuate. Based in these assumptions, SBR is currently trading for like 4x the value of its reserves. However, if you look back 10 years, the quantity of oil and gas in the reserves are about the same. This seems to indicate that there are unproven reserves that keep getting developed, although maybe I’m misunderstanding things.In the end, valuing based on reserves might not make sense for Sabine if producers keep finding more oil on undeveloped land.

The other way to try to value Sabine is to average out how much dividends it pays shareholders and compare that to current rates. Over the last 5 years, average distribution per unit (trusts use units instead of shares) is $4.78. This compares to the 2023 distributions of $6.19. Royalty income was very high in 2022, so the distribution was $8.65 and the share price peaked at $88. For additional reference, 2019 had distributions of $3.02, and the stock price ranged between $40 and $50, so 6-7.5% yield. Looking at this year, Q1 distribution was $1.27 compared to $1.73 previous year. If distributions were at the 5 year average then SBRs yield would be 7.5% at its current price of $64.

After slicing these distributions every which way, it becomes clear that the amount of royalty income, and therefore distributions tracks oil and gas prices. If one assumes the current oil price of $70-80 is normal, then SBR is paying out a nice dividend. On the up side, if oil prices go past $100 a barrel, then Sabine could be yielding 13% based on its current stock price and see shares rise 25% similar to 2022. The downside is, if oil went back to $40 a barrel, then Sabine’s distributions would probably be cut in half and stock price would suffer.

I have no idea what oil prices will do in the near term, but they will probably do well long term as evidenced by Warren Buffett constantly buying shares in Occidental Petroleum. At the end of the day, it does not look like there is huge profit potential with SBR. However, it could make sense if inflation sticks around and oil stays above $70 a barrel. In that case, maybe I would view SBR as a weird bond that provides growing income and modest price gains if inflation persists, but without downside protection if there is a recession and oil prices fall. There could be a role of something like Sabine in my portfolio to replace some of my allocation to short term treasuries, but I would need to chew on this more.