Updated on September 8th, 2024 by Felix Martinez
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 $54 million. Its market capitalization is minuscule, but its dividend is quite large. Cross Timbers stock has a high dividend yield of 7.3%.
Plus, Cross Timbers pays a monthly dividend. Sure Dividend has compiled a database of 78 monthly dividend stocks (along with important financial metrics such as dividend yields and payout ratios) which you can access below:
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 interest 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 and then make distribution payments to unitholders based upon that income. Net income the trust receives 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 $12.5 million in 2022 and $12.3 million in 2023.
In mid-Auguest, CRT reported (8/13/24) financial results for the second quarter of fiscal 2024. For the quarter ending June 30, 2024, net profit income dropped 51% to $1.56 million from $3.16 million in the second quarter of 2023. This decline is largely due to lower gas prices ($1.9 million), higher development costs ($0.2 million), and net excess costs activity ($0.2 million), which were only partially offset by increased gas and oil production ($0.3 million), decreased taxes and transportation costs ($0.2 million), higher oil prices ($0.1 million), and lower production expenses ($0.1 million).
After factoring in $15,173 in interest income and $234,286 in administrative expenses, distributable income for Q2 2024 was $1.35 million, or $0.224 per unit, compared to $3.04 million, or $0.507 per unit, in the same period in 2023. The increase in administrative expenses by $94,832 is mainly due to the timing of Trust expenses and professional service costs. Interest income fluctuations are tied to changes in net profits, expense reserves, and interest rates.
Calculation of Net Profits Income
The following is a summary of the calculation of net profits income received by the Trust:
Source: Investor Presentation
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.
The trust has generated an average distributable and distributed cash flow of $1.41/unit annually for the past 10 years, though with a noticeabledecrease in the past eight years, until 2022. The distribution trend essentially parallels the trend in oil and gas prices.
Moreover, CRT estimates that the rate of natural production decline of its oil and gas properties is 6%-8% per year. This is a significant headwind for future returns. We also expect the price of oil to deflate in the upcoming years due to the record number of renewable energy projects that are under development right now, as most countries are doing theirbest to diversify away from fossil fuels. Nevertheless, as we expect gas prices to bounce from the depressed levels prevailing right now, we expect 4% average annual growth of distributable cash flow until 2029.
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 $1.92 per unit in 2023 for an average annual distribution yield of 10.9% 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 7.3% 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.
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