VOC Energy: Dividend Hike On Lower Price, The Upside Potential (NYSE:VOC)

A “Hold” Rating for VOC Energy Trust

This analysis downgrades VOC Energy Trust (NYSE:VOC) stock from the previous “Buy” rating when shareholders were seen as well positioned ahead of an expected rise in crude oil prices, to a “Hold” rating currently. This is not because the outlook for VOC shareholders in 2024 is considered less promising than 2023, but because an attractive low in the share could occur in the run-up to the looming economic recession, increasing the likelihood of benefiting from a positive year for oil after all.

Wall Street Expects a Somewhat Volatile 2024 for Crude Oil

Given OPEC+’s unwillingness to supply the global market with larger volumes of barrels and tensions in the Red Sea due to the Gaza conflict, crude oil was expected to see a more sustained upward trend, as such geopolitical factors usually provide strong upward pressure. But shareholders still had good days at VOC thanks to the positive correlation between the market value of their holdings and changes in the price per barrel of crude oil. This relationship is highlighted at the bottom of the below graph by a dark area that is almost always above zero. A positive correlation means that when Crude Oil is bullish, VOC is bullish, and when VOC is bearish, Crude Oil is also influenced by bearish sentiment.

The positive correlation was a key driver of the VOC share price, as crude oil had its upsides on the following trig:

1. The hopes of the end of the Fed’s tightening cycle amid the US regional banking crisis in March 2023.
2. The supply shortage threatened by the world’s largest producers, border tensions between Guyana and Venezuela, and the Hamas attack on Israel in early October 2023 led to an optimistic market mood for crude oil from summer to autumn 2023.

Analysts at Goldman Sachs Group, Inc. (GS) see volatility in the crude oil market this year as well, with profits fluctuating over the quarters, but because they say there is “enough spare capacity to handle tightening shocks”, the upside will be less pronounced in 2024 than in previous years.

The VOC share price should also have less upside as it is positively correlated with oil. To mitigate this risk, retail investors may consider waiting for a significant share price decline, which is possible this year due to the looming recession.

VOC Energy Trust As of Q3-2023

VOC Energy Trust is a trust, a corporation based in Houston, Texas, entitled to a certain percentage of 80% of the net proceeds from the sale of crude oil in mining areas in Kansas and Texas.

The Trust incurs general administrative costs in managing these financial interests on behalf of its shareholders, who therefore receive regular net income in the form of dividends paid quarterly.

The net profits interest entitlement is not permanent but terminates either on December 31-2030, or as soon as sales volume reaches 10.6 million barrels of oil equivalent (MMBoe) – which corresponds to 8.5 MMBoe concerning the net profits interest (80% of 10.6 MMBoe) – produced from underlying properties in Kansas and Texas.

Since the inception of the Trust and on a cumulative basis through September 30, 2023, the Trust has received total payments from the sale of 8.5 MMBoe from production on the underlying properties (or 6.8 MMBoe concerning the 80% term net profits interest).

As such, the mineral right continues to apply to the remaining 2.1 MMBoe of production, so that VOC shareholders (“Trust unitholders”) will continue to receive payments from the sale of a remaining volume of 1.68 MMBoe or until December 31, 2023, if the latter term comes first than production cap.

Based on past trends, this analysis assumes that VOC Trust unitholders will continue to receive quarterly dividends from sales volume of 0.1 MMBoe per quarter and subject to the price of crude oil per barrel.

Thus, both income and stock price will be roughly affected by the volatility of crude oil prices over the next 21 quarters, or approximately 5.3 years (from now to the end of the Trust), which is long enough to benefit from the opportunities arising from the fluctuations of the stock price, but also the dividend.

Dividend Chapter: A Hike Is Possible

For 2024, Wall Street expects oil prices to move within a certain range: As a benchmark, The Goldman Sachs Group, Inc. predicts $70 to $90 per barrel, an average of $81, let’s say 4.4% above the average price of $77.61/bbl in 2023.

VOC reported a net profit of $17.6 million (or $1.04/share; down 6.3% year-on-year but 2022 was the year the barrel soared amid the energy crisis) for the 12 months through the third quarter of 2023. Based on that bottom line, shareholders received the payment of a quarterly dividend as follows: $0.19/share on Feb. 14, 2024 (lower 17.4% YoY, reflecting lower crude price), $0.225/share on Nov. 14, 2023 (lower 38.4% YoY, reflecting lower crude price), $0.21/share on Aug. 14, 2023 (lower 44.7% YoY, reflecting lower crude price), and $0.23/share on May 12, 2023 (lower 17.9% YoY, reflecting lower crude price).

WTI crude oil futures settled at around $77.5 a barrel on Friday, Feb. 16, 2024, up 9.4% year-to-date. However, supported by geopolitical uncertainties in the Middle East and OPEC+’s efforts to curb oil supplies, analysts at Trading Economics forecast a higher oil price of $81.34 in 12 months, in line with Goldman Sachs’ estimates.

These crude oil price expectations mean that VOC Energy Trust could potentially increase its quarterly dividend this year, leading to a positive impact on the share price.

The current share price of $7.18 for a market cap of $120.87 million leads to a yield (TTM) of 12.03%, which supports the argument of investors looking to hold shares in the portfolio as the reward compares favorably to the 10-year US government bonds yield of 4.297% and the S&P 500 dividend yield of 1.40%.

The stock price is closer to the bottom than the top of the 52-week range of $6.45 to $10.65 and is also below the 50-day, 100-day, and 200-day simple moving lines. The 14-day relative strength indicator at 53.84 is currently showing an uptrend pattern but is unlikely to gain strength as the International Energy Agency warns of the possible impact of a cooling Chinese demand on global oil demand.

Rather, the 14-day RSI suggests that there is enough room below this value for the stock price to reach lower levels. The trigger could be an economic recession.

The negative cycle is signaled by the following 2 indicators:

1. The inverted yield curve for the current spread between a 10-year yield of 4.295% and a 1-year yield of 4.997%. Since this relationship should reverse under normal conditions, the spread currently warns of difficult times for the economy, as shorter maturities now earn higher yields than longer maturities. The indicator has correctly predicted the last seven recessions since 1965.

2. The decline in the number of hours worked signals an impending recession: Lakshman Achuthan, co-founder of the Economic Cycle Research Institute, says the ratio has deteriorated in a manner typical of a recession.

The headwinds of the economic slowdown will put downward pressure on US-listed equities, including VOC, paving the way for a lower share price. Retail investors should just wait and see how dip shares can fall and then try to increase the position, but bearing in mind that this stock is struggling with a low volume of shares trading on the market: 78,326 was the average volume in the last three months out of 17 million shares outstanding.

Conclusion

The VOC Energy Trust offers its holders the opportunity to benefit from possible stock price increases and a higher dividend in the face of rising crude oil prices. While waiting for the stock price to form the low in the cycle amid the headwinds of the recession, the “Hold” rating offers the opportunity for a dividend that doesn’t fade at all compared to fixed-income investments. The latter is currently smiling thanks to the Federal Reserve’s aggressive anti-inflationary policy.