Permianville Royalty Trust (NYSE:PVL) recently reduced its monthly distribution by 66% due to the recent collapse of the price of natural gas. Despite the drastic distribution cut, the stock is still offering a forward distribution yield of 9.1%, and thus it is likely to attract many income-oriented investors, particularly given that the recent decline of the stock has resulted in a reasonable valuation. Nevertheless, even though Permianville Royalty Trust has become reasonably valued, investors should be aware of the risks of the stock.

Business Overview

Permianville Royalty Trust was formed in 2011 and is based in Houston, Texas. It is an oil and gas trust that receives 80% of the net profits from the sale of oil and natural gas production from properties located in Texas, Louisiana, and New Mexico. In the last quarter, the production of the trust was 42% oil and 58% gas.

Just like all the oil and gas trusts, Permianville Royalty Trust has greatly benefited from the sanctions of the US and Europe on Russia for its invasion of Ukraine. Before the sanctions, Russia was producing approximately 10% of global oil output and one-third of natural gas consumed in Europe.

Due to the sanctions, the global oil and gas markets became extremely tight last year, and thus the prices of oil and gas rallied to 13-year highs. As a result, Permianville Royalty Trust offered an 8-year high annual distribution per unit of $0.44 in 2022. That distribution was nearly quadruple the distribution of $0.12 in 2021 and corresponds to a yield of 17.8% at the current stock price.

The war in Ukraine, which began more than a year ago, has no end in sight. This is positive for Permianville Royalty Trust, as the sanctions are likely to continue to provide support to the price of oil in the near term. On the other hand, the price of natural gas has plunged 75% off its peak last summer, primarily due to an abnormally warm winter in the US and Europe, which has rendered the market well-balanced this year. In fact, Europe has taken advantage of the favorable weather, and thus it has filled its natural gas tanks to about 67%. In this way, it is likely to be well supplied during the next winter as well, in the absence of extremely adverse weather. To cut a long story short, the global natural gas market is not likely to face the supply problems it faced last year anytime soon, and hence Permianville Royalty Trust will probably be negatively affected by low gas prices for the foreseeable future.

Fortunately for Permianville Royalty Trust, the price of oil has not followed the path of the price of natural gas so far. On the one hand, the price of oil has plunged 40% off its peak about a year ago, and thus it has fallen below its level just before the onset of the war in Ukraine. This is a bearish signal, as it essentially means that the oil market has absorbed the impact of the war in Ukraine on global oil supply. On the other hand, thanks to the aforementioned sanctions, the price of oil has found strong support around $70 whenever it has approached this level. This support is likely to hold firm in the short run, in the absence of a global recession. Therefore, Permianville Royalty Trust is likely to continue to benefit from above-average oil prices in the near term.

However, it is important to note that US oil inventories have increased at an exceptionally fast pace this year, for a total 7% increase since the beginning of the year. The increased inventories have not affected the price of oil so far, but they are likely to affect it if they remain in an uptrend.

Moreover, the rally of the prices of oil and gas to 13-year highs last year made the energy bills extremely difficult to afford for numerous households. They thus caused a global energy crisis. Due to this energy crisis, almost all the countries are now doing their best to accelerate their shift from fossil fuels to renewable energy sources. As a result, there is a record number of clean energy projects that are being developed right now. When all these projects begin to bear fruit, in about 2-4 years, they will probably take their toll on the prices of oil and gas.

Permianville Royalty Trust has proven extremely sensitive to the prices of oil and gas. To be sure, the trust suspended its distributions for 13 consecutive months, between mid-2020 and mid-2021, due to the collapse of the prices of oil and gas caused by the pandemic. That performance was much worse than that of other oil and gas trusts, such as Sabine Royalty Trust (SBR) and Cross Timbers Royalty Trust (CRT), which did not suspend their distributions throughout the pandemic.

It is also important to note that the stock of Permianville Royalty Trust is extremely sensitive during the downturns of the energy sector. To provide a perspective, the stock slumped 67% during the first month of the coronavirus crisis. Most investors claim that they do not pay attention to the gyrations of stock prices, but this is much easier said than done. Only those investors who can really ignore the high volatility of stock prices may consider purchasing Permianville Royalty Trust.

Another risk factor of Permianville Royalty Trust is the secular decline of its production, which results from the natural decay of the producing wells. During the last eight years, the total output of Permianville Royalty Trust has declined by 6% per year on average. It is thus evident that the natural decline of the producing wells provides a strong headwind for future distributions. In other words, long-term investors should expect lower distributions from the trust at a given level of oil and gas prices.

Distribution – Valuation

Most stocks are valued based on their price-to-earnings ratios, but things are easier in oil and gas trusts. As these trusts distribute all their earnings to their unitholders, these stocks can be valued via the comparison between their current distribution yield and their historical average distribution yield.

As mentioned above, Permianville Royalty Trust recently reduced its monthly distribution by 66%. Nevertheless, despite the drastic cut, the stock is still offering a forward distribution yield of 9.1%. On the one hand, this yield may seem too high to most investors, but these investors should be aware that all the oil and gas trusts offer above-average yields due to the excessive risk that comes from their declining production and their high sensitivity to the prices of oil and gas.

On the other hand, the 9.1% yield of Permianville Royalty Trust is lower than the 10-year average distribution yield of 11.1% that the stock has offered over the last decade.

It is thus evident that the market has already priced part of its expectations for lower distributions (due to lower commodity prices) in the future. Overall, the trust seems reasonably valued right now for investors who are comfortable with the inherent risks of oil and gas trusts.

Final Thoughts

Permianville Royalty Trust recently slashed its distribution by 66%, but it is still offering a forward distribution yield of 9.1%. The trust proved more vulnerable than most other oil and gas trusts during the coronavirus crisis. This is a significant risk factor to consider, as the stock will probably have a significant downside risk whenever the next downturn of the energy sector shows up. Nevertheless, in the current environment of oil and gas prices, the trust is reasonably valued. It is thus suitable for investors who have strong conviction in higher prices of oil and gas in the future and are comfortable with the inherent risk of oil and gas trusts that results from their declining production.

Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.