Hey Bow Tie Nation, Joseph Hogue here with the Let’s Talk Money channel and a video for all you dividend investors out there!
Now all you out there in the Nation know, I love me some dividends. Dividends have accounted for nearly half the total return on stocks over time, 42% of the stock market return since 1930, and reinvesting those for compound returns is about the best investing you can do.
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Better Dividend Stocks in Royal Trusts
But there’s actually a better type of dividend stock out there, beyond what you normally see in dividend videos. Royalty Trusts are special types of companies set up to hold an income producing asset and then pass all that income on to investors.
Not only do these offer dividend yields more than twice the market average but there are a lot of other benefits that make these an investment you need to check out!
These companies usually buy assets like an oil field or a gold or copper mine. The exploration company gets a one-time payment for a percentage share of the production. The company continues to manage the asset, so drilling for oil on the fields or mining the gold reserves. Royalty trusts have no employees, it’s just a financial account that receives the percentage share from the exploration company and passes it on to investors.
And because the structure is so simple here, there’s really no financial statements to analyze. There aren’t any of the accounting tricks other companies use to make revenue look bigger or expenses smaller, it’s just one income producing asset and the distributions.
We could be starting on a commodity super-cycle with prices for oil and other commodities up double-digits already this year, making now a great time to talk about royalty trusts as an investment!
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5 Royalty Trusts to Buy for Massive Cash Flow
In this video, I’ll explain royalty trusts as well as detail the pros and cons of these income investments. I’ll show you the hidden tax benefits and then reveal five royalty trusts to buy for massive cash flow!
First in our royalty trust list is Gold Royalty Corp, ticker GROY, a $236 million royalty company out of Canada.
The company acquires royalty and stream rights and other interests in mines at different stages of the mining cycle for a balanced portfolio. You’ll notice through the list that I’ve tried to include royalty trusts from different commodities, so not just the traditional oil and gas trusts. This way, you get a more diversified income stream tied to gold, oil, steel and even uranium.
The current portfolio includes 18 royalties between 0.5% to 2% ownership on 12 projects across the Americas and additional rights to acquire nine more royalties. On just the current portfolio, that’s more than 14.7 million ounces of gold on a measured and indicated basis and over 17 million inferred ounces.
And while I’m not as bullish on gold as I am some of the other commodities, gold miners can still do really well because the cost of bullion is so much higher than production costs. You can see here that even on fairly modest increases in bullion, shares of Gold Royalty have jumped 8.8% over the last month, about double the increase in the price of gold.
So even if interest rates keep the price of gold range-bound, miners will see cash flow continue to increase and royalty companies will send that cash straight on to investors. The company has a strong balance sheet with over $87 million in cash and equivalents against no debt so lots of financial flexibility to acquire more of those rights from companies and benefit on this trend.
I’ll leave a link to the company’s investor presentation in the video description if you want to check that out.
One of the most interesting royalty trusts I’ve seen, Uranium Royalty Corporation, ticker UROY, is a play on the demand for uranium in nuclear energy.
Uranium Royalty is the first to apply the royalty model to uranium assets, so it has a partnership interest in uranium projects, receives the cash flows and passes that through to investors through a dividend distribution.
The company has a diversified portfolio across North America and in every stage of development from permitted projects, production and exploration. It’s partners include some of the largest uranium miners in the market like Cameco, RioTinto and UEC. And you can see how this is set up. For example, the company has a 9% interest and 1% gross overriding royalty in the McArthur River project run by Cameco in Canada. The project is licensed to produce 25 million pounds a year with proven and probable reserves of almost 392 million pounds.
And like Gold Royalty, this one is still in the acquisition stage of its life so it’s a new royalty trust that can pay dividends for decades which is going to be important on the pros and cons of royalty trusts we’ll look at next.
So let’s look at the pros and cons of royalty trusts and whether these are good investments.
The big upside to trusts is the higher dividend yield compared to other income stocks. For example the Schwab Dividend ETF, ticker SCHD, is one of the stronger dividend funds but only pays a 2.7% yield. Even the Vanguard Real Estate Fund, ticker VNQ, which owns those income-producing REITs only pays a 2.1% yield.
With royalty trusts, you not only get a higher dividend, usually around 5% and higher but most of that isn’t taxable. We’ll talk more about taxes on royalty trusts later but these have a great hidden tax break where you only pay taxes on the investment after you sell it instead of yearly on those dividend payments.
Another upside here is that, because these trusts are a special type of company, they don’t pay corporate taxes on income…it’s just a much more efficient way to hold these assets compared to other companies like an Exxon or Chevron. Royalty Trusts are able to distribute nearly all their income instead of having to pay for operational costs and taxes.
But now there are some downsides to royalty trusts that you need to know about if you’re going to decide whether these are right for your portfolio.
First, these are limited life investments and may have declining dividend payments in the latter years of the asset. Remember, royalty trusts are set up buying rights to an oil field or a mining deposit. After that initial setup, they don’t buy any other assets so once the production runs out…so do the payments.
Of course, for most of these mining and oil assets, that’s two or three decades of production so it’s not something most investors have to worry about. Also because of advancements in technology, a lot of times the production life of these gets extended because they can pull every last ounce out of the field. When the production does get down to a point though, the operator either buys back the shares or the trust manager liquidates the assets and sends a check out to all the shareholders.
Another drawback of royalty trusts is that the payouts can be extremely volatile. You’re getting a cut of the sales here so everything depends on the commodity price and how much the asset is producing. With commodity prices surging this year, that’s a good thing because a lot of these trusts have been able to increase payouts by forty- and fifty-percent over the last year but that can work the other way as well when prices are falling.
Next is one of the most popular royalty trusts, Sabine Royalty, ticker SBR, an energy trust established in 1982 on landowner’s royalties in six states.
The company has an oil and gas portfolio that covers over two million acres in Florida, Louisiana, Mississippi, New Mexico, Oklahoma and Texas. Reserves on the assets are estimated to produce for at least another eight to ten years but the reserve life has been extended several times in the past on new drilling techniques and discoveries in the fields.
And that’s a big upside for these trusts. They do have that limited shelf life because of the depleting assets but improvements in extracting these commodities will extend that life and can drive big swings in the stock price.
Sabine has more than doubled the dividend so far this year to $0.29 a share. That’s an 8.7% dividend yield and could go even higher if oil prices continue to run. The OPEC group of countries ended their most recent meeting without an agreement to increase production and there are a lot of analysts calling for $100 oil by the end of the year.
For more of that diversification, I wanted to include the Mesabi Trust, ticker MSB, as well.
Mesabi is a steel royalty trust with an investment in mines operated by Northshore Mining, a subsidiary of Cleveland Cliffs. Northshore mines the ore, process it into pellets and sends it off to Cleveland Cliffs and then pays Mesabi royalties based on the selling price. So Mesabi has no operational duties or costs here, it’s just a trust that receives the royalties.
That means the return here is going to be a function of iron ore prices which are at a multi-year high but still below the peak in 2008. Goldman Sachs believes we could be heading into a new commodity super-cycle and if we get even part of that proposed trillion-dollar infrastructure bill, my guess is prices are going much higher and this stock will climb further.
This is also one of the longer-life trusts in the list with estimated reserves of nearly 800 million tons and over 15 years left of production. The trust pays quarterly dividends instead of monthly but has increased the payout 78% over the last year to April and is paying a 4.9% dividend yield.
We’ve still got one more royalty trust to highlight but taxes are a big topic in these and you need to understand how a little bit of pain can actually be one of your biggest points of gain.
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So we’ve already talked about how these are special types of companies that don’t pay corporate taxes as long as they pass almost all their income to investors as a distribution. That means it’s a great way to manage assets, much more efficiently than a regular corporate structure, and it means you get a strong dividend yield.
But it also means you’re going to get a different tax form each year. Your brokerage account where you hold the shares is going to send you a 1099 form for each royalty trust that’s going to show the distributions and how you report them on your taxes.
And yes, it can be a pain figuring these out that first year but it’s actually pretty easy and there is a huge benefit hidden here in the way these are taxed. Like MLPs, nearly all of your dividend from a royalty trust comes to you as a return OF capital…it’s a return of the money you invested in the shares…not technically a dividend or a return ON your money.
That means, you don’t pay taxes on the money you receive. The dividends you collect from these will go to lowering the price you paid on the shares. So say you paid $5 for each share and over five years, you collect $2 in dividends. That means when you eventually go to sell the shares, you take the adjusted cost basis of $3, that $5 original price minus the $2 in dividends collected, when you’re figuring the capital gains tax.
It means higher taxes on the capital gains when you sell but all that money tax-free while you’re holding the shares.
The Permian Basin Royalty Trust, ticker PBT, is another popular one with one of the best upsides on the dividend in the list.
The trust includes 34 sites in Texas around the Permian Basin, which is a giant 75,000 square mile area in West Texas and home of the largest shale production fields in the country.
The operator here is a subsidiary of ConocoPhillips, Burlington, an excellent explorer and committed to extending the life of the assets. The trust was established in 1980 and has an estimated eight to 10 years left of reserves but that’s probably conservative considering the operator is spending $3 million in drilling improvements and redeveloping the fields.
PBT has increased its dividend by 63% this year to the June payment for a 4.1% annualized yield and I think that could increase faster on a lower yield compared to some of the other trusts.
These royalty trusts have strong balance sheets and I personally believe in them. Which stock are you picking?