Can This Trust Survive Another Recession?
Even with the Dow hovering neatly above the 13,000 level the threat of a recession is still palpable, so it would do investors well to consider the impact an extended downturn might have on our portfolios. It might be tempting to move to an all-cash position, but before you make such a hasty move, take the time to look at stocks that have the ability to hold up in tough times.
I used the Motley Fool CAPS supercomputer to look for companies that have proven to be less volatile than the market, but have reported strong revenue and earnings growth over the past few years. With a beta of one or less, these companies ought to react less violently to any market swoon.
By adding in a measure of cheapness -- these stocks also carry a P/E ratio that's less than average -- we build in a margin of safety. However, with the CAPS community according them high ratings, we're getting companies that are expected to outperform.
One that floated to the surface was top-rated royalty trust MV Oil Trust (NYSE: MVO) . Even though revenues and earnings have grown at a near 40% clip over the last three years, its volatility is two-thirds that of the market itself and it carries a 9.4 market multiple. While that suggests it should do well in another extended downturn, let's take a closer look to see if that theory holds.
MV Oil Trust snapshot
|Market Cap||$411 million|
|Revenues (TTM)||$45 million|
|1-Year Stock Return||5.8%|
|Estimated 5-Year EPS Growth||7.0%|
|Return on Investment||132.7%|
|Dividend and Yield||$3.73/10.4%|
Source: Motley Fool CAPS screener
A new frame of reference
Royalty trusts like MV Oil had a big reset in valuation in August after a Wall Street Journal story highlighted the depleting nature of the assets underlying the trusts. Despite that, BP Prudhoe Bay Trust (NYSE: BPT) and Whiting USA Trust I (NYSE: WHX) highlighted in their SEC filings that time-stamped on their contract is a virtually unchangeable expiration date. Investors chasing yield had bid up their stock prices apparently in the belief it was easy money.
Yet a series of dividend cuts enacted by Hugoton Royalty Trust (NYSE: HGT) , San Juan Basin Royalty Trust (NYSE: SJT) , and Dominion Resources Black Warrior Trust underscored how the payouts are tied to their production capabilities, and as the assets are depleted the dividends will fall over time.
There's gold in those drawers!
It may seem incongruous to look at MV Oil's distribution history and see that, despite its assets being depleted just like all the other trusts (its charter ends in 2026, or whenever it hits 14.4 million barrels of oil equivalent -- whichever comes later), its distributions have been rising at 34% annually over the last few years. Has it found some magical elixir unavailable to the other trusts? No, not really, and investors will see the distribution turn down again soon, just like all the others.
As the Fool's Aimee Duffy notes, the trust's payout had hedged the price of oil at $65 a barrel until 2010. Once that collar was removed, MV Oil was able to increase the payout, but it cannot escape the depletion of its assets. Sooner or later -- more likely sooner -- it will need to cut its distribution, too.
As the Journal pointed out, investors had bid up valuations well beyond what the trusts themselves calculated the current value of their future cash available for distributions. It seems MV Oil's valuation is also much higher than what it says it should be worth, in fact, 47% more. According to its last annual filing, the trust's discounted future net cash flow was less than $280 million, yet the market is valuing the trust at $411 million.
After falling like all the other trusts did (though not nearly as steeply as some), MV Oil is again on the move higher, having gained 7% over the past month. Investors, it seems, are still lured by the 10% yield the trust is still paying.
Because there is a finite nature to the trust and that its optimal valuations are likely behind it, I can't recommend taking a stake in MV Oil at this time. But, let me know in the comments box below if there's a reason you think it still makes sense to invest here even as the clock is running out.
Take a recess
REITs, like royalty trusts are highly prized because of their yields, but they don't have an expiration date on them. Of course, they have a whole other set of risks associated with them, but the Motley Fool has zeroed in on Annaly Capital Management as a key REIT to keep an eye on. In a new, premium report the Fool breaks down the situation at Annaly, including the three areas that you must watch. Click here to find out more about this report.