Author: Taj McCree
Covestor model: Value and Growth 2
Disclosure: Long CRT, PCL, HGT
Over the last 30 days the stock market has seen a decline as the situation in Europe continues to develop, and the US issued a less than stellar jobs report. The Value & Growth model has also seen a decline, some of it based upon these factors, but there are industry specific factors at play as well.
Our model is heavily invested in trusts – both REIT and energy sectors. Cross Timbers Royalty Trust (CRT) is currently down $10 per share from our initial purchase price. Plum Creek Timber (PCL) has lost roughly $4.00 per share. These positions may improve as the housing sector rebounds and demand for timber increases from builders.
To hedge against current losses, our model has taken a long position in the Hugoton Royalty Trust (HGT), which has declined from a 52-week high of $23.84 per share to just over $6.56 per share (as of June 4, 2012).
HGT’s decline can be attributed to two major factors (1) the declining price of natural gas, and (2) that the trust has recently settled a class action lawsuit requiring them to pay a substantial portion of their income to the class recipients.
Based upon this information some experts estimated the value of HGT units at $8.25 per share. At the time this article was written HGT was trading around $15.00 per unit. Others see HGT declining even further below its current trading price. At the current price, HGT looks cheap and I believe the uncertainty has been priced in by the market.
I anticipate HGT will cease paying a dividend over the next 18-24 months as they use their available cash to pay the settlement. Even so, the long term prospects for this trust still look appealing to me as there appears to be ample natural gas reserves to mine over the next decade. I am willing to accept a decline in the dividend in anticipation of an increase in the price over the next few years as HGT becomes attractive to dividend investors again.
So, this strategy begs the question – why buy now vs. waiting until HGT begins paying dividends again? Won’t the unit share price decline even further as investors sell off and shorters take advantage? Answer – it’s possible. It is hard to predict whether HGT’s share price has seen its bottom or whether it will decline more. It’s quite possible the price could be pressured down to junk status, or, it could hover around its current price for the next 18-24 months.
Our model entered this position at a price point we believe represents value based upon the totality of the circumstances. We are willing to adopt a wait and see approach over the short term in hopes of reaping long term gains.
