The 10.1%-Yielder You've Never Heard of

Saturday, January 21, 2012

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The 10.1%-Yielder You've Never Heard of

-- By Nathan Slaughter

This unique security offers investors the rare chance to capture high yields and explosive growth. Yet, despite its solid fundamentals, most investors don't even know it exists. (Full Story Below)

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The 10.1%-Yielder You've Never Heard of

Ten-year Treasuries yield 2%, the average yield on the S&P 500 is just 2.1%, and a savings account earns next to nothing.

But if you think that means high-yield opportunities are in short supply, think again.

There are dozens, if not hundreds, of high-yield plays hiding in the market that most investors simply don't know about. You just have to know where to look.

 

Take the energy sector, for example.

When most people think of dividend-paying energy stocks, integrated oil and gas behemoths like Chevron (NYSE: CVX) usually come to mind.

But while Chevron's 3% yield is nothing to laugh at, don't think for a second that's the best you can do. In some industries, 3% might be the ceiling, but it's often just the floor in certain subsectors of the energy space.

The recent shale boom in the U.S., expanding economic output in the emerging markets, and fears over oil security in the Middle East have all stoked demand and prices for everything from fracking fluids to tankers.

Consequently, energy companies across the board are raking in record amounts of cash... and paying it back to investors in the form of dividends.

But look closely, and you'll notice it's not major players like Chevron and Exxon (NYSE: XOM) offering investors the highest distributions. Rather, the highest yields are coming from non-traditional energy investments like master limited partnerships (MLPs) and royalty trusts.

I've found yields of 6%... 9%... even as high as 17% from these types of securities.

I won't talk much here about MLPs. I've already covered them extensively in past issues. Instead, I'd like to introduce you to another class of high-yielding securities the energy sector has to offer -- royalty trusts.

Royalty trusts boast some of the highest yields on the market -- typically 6% to 8%, but payouts north of 10% aren't uncommon. And aside from writing generous paychecks every quarter, many of these securities have also delivered triple-digit share price appreciation. I've found several with returns in excess of 300% over the past 10 years.

Yet despite their double-digit yields and solid industry fundamentals, many retail investors are unaware these securities even exist. Most can't name even two royalty trusts -- let alone know enough about them to consider buying into one.

In the simplest of explanations, they work like this. When an energy company wants to raise money, it can sell a "stake" or interest in certain properties in the form of a trust. Most commonly, these properties are oil and gas wells, but sometimes they're built around other resources like coal or iron ore.

The trust's parent company takes care of the drilling, production, marketing, and selling of the oil and gas produced from those wells.

The royalty trust is passive in the relationship. It doesn't have to do a thing. In return for the initial investment when it went public, its investors get a cut of all the oil and natural gas sold from the wells.

Now, you might be wondering why any energy company would voluntarily give up a percentage of the income from its wells. The answer here is simple.

Developing wells requires a lot of capital. Increasingly, the financial whizzes at these firms are finding that selling royalty interests is a much better way to raise cash than borrowing from a bank, issuing bonds or printing new shares.

This financing arrangement is a win-win. From an investor's perspective, these trusts exist for just one purpose: to collect ongoing royalty payments and distribute them to unitholders. (Shares of trusts are called "units" instead of shares.)

One such trust is Chesapeake Granite Wash Trust (NYSE: CHKR), an offspring of energy giant Chesapeake Energy (NYSE: CHK).

CHKR is a brand-new trust with royalty rights to 69 of Chesapeake's existing wells in the Granite Wash -- an oil-producing region that spreads from the Texas panhandle all the way to western Oklahoma.

But it doesn't stop there. Unitholders will also be entitled to 50% of the proceeds from another 118 development wells that will be drilled over the next few years.

The development wells, which will be located on 45,000 acres in the Anadarko Basin of western Oklahoma, will more than double today's production as they come online.

I think the added output makes CHKR an attractive investment. Though it's a new trust, it's backed by Chesapeake, a veteran oil and gas producer. And the initial distribution bodes well. Thanks to higher-than-expected sales volume, CHKR was able to pay investors a quarterly distribution of $0.58 a unit, versus a target of $0.54.

Projecting that amount forward, the shares yield 10.2% at current prices.

But as production increases, those distributions should grow larger. Right now, CHKR is targeting a $3.13 per unit dividend for all of 2012. But it expects that number to grow to $3.48 by 2013 as more wells come online.

If you're an income investor starved for higher yields, I think CHKR could be a good buy. Its 10% yield is one of the highest you'll see in this low interest rate environment.

Let me warn you though. Like any natural resource investment, royalty trusts carry commodity risk. They often move along with energy prices.

But, that said, the long term fundamentals look bullish for energy investments. Dwindling reserves and rising global demand will inexorably lead to higher oil prices. And judging by the last 10 years of stock market data, one thing seems certain -- the energy space looks like one of the best hunting grounds for income investors looking for higher returns.

[Note: We have a pet name for royalty trusts -- "Pickens" investments. That's thanks to T. Boone Pickens, who popularized royalty trusts about 30 years ago. We've found one "Pickens" trust yielding up to 17.1%... and another that has returned 2,515% over the past 10 years. For more information -- including names and ticker symbols -- visit this link.]

Good investing!

Nathan Slaughter
Chief Investment Strategist, Energy & Income


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Disclosure: Nathan Slaughter own shares of CHK. StreetAuthority owns shares of CHKR and CHK as part of the company's various real-money portfolios. In accordance with company policies, StreetAuthority always provides readers with at least 48 hours advance notice before buying or selling any securities in any "real money" model portfolio.


Income Notes

Winmark (Nasdaq: WINA) recently announced a special $5.00 per share dividend. That payment amounts to 8% of the current share price.

The dividend will be paid March 1 to shareholders of record on February 8.

-- Research Staff


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