Updated on February 22nd, 2023 by Aristofanis Papadatos
Investors can buy stock in companies of all shapes and sizes thanks to the diverse offerings available in the stock market. Companies with market capitalizations of $10 billion or more are considered large cap stocks. Small-caps have market capitalizations below $2 billion.
However, there are even smaller companies that trade in the United States. For example, micro-caps are generally companies with market capitalizations of $300 million or less.
Cross Timbers Royalty Trust (CRT) is a micro-cap, and a tiny one at that—it has a market capitalization of just $145 million. Its market capitalization is minuscule, but its dividend is quite large. Cross Timbers stock has a high dividend yield of 8.8%.
Plus, Cross Timbers pays a monthly dividend. Sure Dividend has compiled a database of 50 monthly dividend stocks (along with important financial metrics such as dividend yields and payout ratios) which you can access below:
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Despite its high yield and monthly dividend payouts, Cross Timbers has a highly uncertain outlook. The company has a very risky business model, and its annual dividend payouts declined steadily between 2014 and 2020.
Therefore, only the most risk-tolerant investors should consider buying Cross Timbers.
Business Overview
Cross Timbers Royalty Trust was created on February 12, 1991, and it makes money from two sources. First, income is derived from a 75% net profits interest from seven oil-producing properties in Texas and Oklahoma, operated by established oil companies.
In addition, income is generated from a 90% net profits interests from gas-producing properties in Texas, Oklahoma, and New Mexico. The primary-gas producing field is the San Juan Basin in northwestern New Mexico.
The trust was created to collect net income, then make distribution payments to unitholders based upon that income. Net income received by the trust on the last business day of each month is paid by XTO Energy, a subsidiary of ExxonMobil (XOM).
CRT’s 75% net profits interest is reduced by production and development costs, while the 90% net profits interest is not subject to these costs. Without production and development costs, the 75% net profits interest income is usually only affected by changes in sales volumes or commodity prices.
CRT had royalty income of $5.3 million in 2020, $7.4 million in 2021, and $9.5 million in the first nine months of 2022.
In mid-November, CRT reported (11/14/22) financial results for the third quarter of fiscal 2022. Production of oil decreased 12% due to the timing of sales and natural decline while production of gas edged up 1% over the prior year’s quarter. The average realized prices of oil and gas grew 63% thanks to the sanctions of western countries on Russia, which sent the benchmark prices of oil and gas to multi-year highs. As a result, distributable cash flow (DCF) per unit jumped 63%, from $0.38 to $0.62.
Calculation of Net Profits Income
The following is a summary of the calculation of net profits income received by the Trust:
Source: Investor Presentation
Due to the high sensitivity of the results of CRT to the prevailing prices of oil and gas, the trust does not provide any guidance for the running year. Since early 2022, CRT has greatly benefited from the sanctions of western countries on Russia, which triggered a rally of the prices of oil and gas.
The sanctions of western countries on Russia have tightened the oil market, as Russia was producing about 10 million barrels of oil per day (~10% of global supply) before the sanctions. As a result, the price of oil rallied to a 13-year high last year and remains above normal levels.
The rally of the price of natural gas last year resulted primarily from the sanctions of Europe on Russia. Europe generates 31% of its electricity from natural gas provided by Russia, but it is now doing its best to diversify away from Russia. As a result, there has been a steep increase in the exports of LNG from the United States to Europe.
Consequently, the U.S. natural gas market became markedly tight and hence the price of U.S. natural gas rallied to a 13-year high last year. However, due to warm winter weather in the U.S. and Europe, the price of natural gas has plunged lately. This is likely to negatively affect the results of Cross Timbers this year.
Growth Prospects
One of the major catalysts for Cross Timbers moving forward would be higher oil and gas prices. Falling commodity prices weighed on the income derived by the trust in 2014-2020. On the other hand, thanks to the rally of oil and gas prices to 13-year highs last year, CRT achieved 8-year high DCF per unit last year. Strong commodity pricing will boost distributable income, and therefore, the share price. It is not accidental that the stock is currently hovering around its 8-year highs.
CRT has very minimal operating expenses since it is a royalty trust. This means that its operating leverage is huge when revenue rises. Because of this, oil and gas prices are absolutely critical for the trust’s distributable income, and hence its growth is almost entirely dependent upon commodity prices.
As of December 31st 2021, proved reserves for the underlying properties were estimated to be 1.3 million barrels of oil and 12.6 billion cubic feet of natural gas. Both of these figures are 13% lower than they were at the end of 2020 and thus they are stern reminders of the long-term decline of the reserves of the trust. CRT has repeatedly stated that it expects a natural production decline of 6% to 8% per year in the long run.
As the production of oil and gas of CRT decreases due to the natural decline of the fields, investors should expect the distributable cash flow per unit to decrease in the long run, especially given the high comparison base formed in 2022 amid multi-year high commodity prices.
It is also important to note that the global energy crisis, which has been caused by the rally of oil and gas prices, has led most countries to accelerate their secular shift from fossil fuels to renewable energy sources. To this end, a record number of clean energy projects are being developed right now. When all these projects come online, they will take their toll on the prices of oil and gas and thus they will hurt the results of CRT.
There isn’t much the trust can do to impact growth, so shareholders should certainly be aware of this. Cross Timbers is a passive play on collecting royalty income and by extension, oil and gas prices.
Dividend Analysis
Since Cross Timbers is a trust, so its distributions are classified as royalty income. And since the distributions are considered ordinary income, they are taxed at the individual’s marginal tax rate.
Cross Timbers’ distributions are declared 10 calendar days prior to the record date, which is the last business day of each month. The company’s distributions declined steadily between 2014 and 2020, a reflection of weak commodity prices, but recovered in 2021 and 2022 thanks to a strong recovery of the prices of oil and gas.
In 2018, Cross Timber paid cumulative dividends of approximately $1.43 per share. However, 2019 saw distributions fall to $0.88 per share, followed by a further decline to $0.78 per share in 2020.
Fortunately, distributions partly recovered in 2021, as oil and gas prices rallied considerably off the pandemic lows. As a result, CRT offered total distributions of $1.10 per unit in 2021 for an average annual distribution yield of 10.0% in that year.
Moreover, the trust offered 8-year high distributions per unit of $1.96 in 2022 thanks to the multi-year high prices of oil and gas that prevailed throughout last year.
There is no doubt that Cross Timbers is a high dividend stock. But it has a variable payout that can swing wildly, depending almost entirely on the direction of oil and gas prices. Based on its distributions in the last 12 months, the stock is currently offering an 8.8% distribution yield.
However, we note that the trust is entirely dependent upon commodity prices it has no control over. The trust continues to distribute essentially all of its income, as it has since its inception. Dividend coverage is never going to be strong given that Cross Timbers is required to distribute basically all of its income.
Future distribution growth is reliant upon higher distributable income. As a result, the trust’s distribution growth potential is essentially a bet on oil and gas prices. If commodity prices remain elevated, the trust will keep offering excessive distributions. However, we note the high cyclicality of the prices of oil and gas and their excessive downside risk off their current levels in the long run, especially given the secular shift from fossil fuels to renewable energy sources.
The bottom line for Cross Timbers’ distribution is that it is very unpredictable and while the headline yield is enticing, keep in mind there is significant variability in any particular month’s payout, depending on commodity prices and production levels. Investors should keep in mind the risk and volatility associated with oil and gas royalty trusts before buying Cross Timbers.
Final Thoughts
Cross Timbers gives investors a unique way to play potentially higher oil and gas prices in the future, all while realizing monthly income along the way. At the same time, there are risks and unique characteristics that investors should take into account before buying shares of a royalty trust.
Cross Timbers is a micro-cap, meaning it is more volatile and thinly-traded than larger companies. It is also a royalty trust, which carries its own risks.
Finally, Cross Timbers is not a long-term ‘sleep well at night’ dividend growth stock. Future results are dependent upon oil and gas prices and the true amount of reserves in the properties it has interests in.
As a result, Cross Timbers is only a recommended stock for investors who accept the risks of royalty trusts and micro-caps.
If you are interested in finding more high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:
Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
Thanks for reading this article. Please send any feedback, corrections, or questions to [email protected].
