This is not, as you might expect, a "new" business. The North European Oil Royalty Trust (NYSE:NRT ) was organized before Germany re-emerged as a country, and was formed as early as 1975. In this article, we're going to see whether this very small investment has anything to offer conservative dividend investors. This situation has certainly brought out the risk aversion in many, but also risk tolerance in some, given where the energy markets are currently at. I cannot fault this, and because of it, I'm willing to take a look at the business.

Let's talk specifics first. NRT is what would be called a micro or nano-cap, with a total market capitalization of no larger than $138M. From being mostly overlooked due to the regulatory status of natgas in Germany, the company has seen renewed interest as the war in Ukraine has heated up, and the energy situation in Europe has grown worse and worse.

NRT is the successor of the North European Oil Corporation and Oil Company, and the units have been listed on the NYSE since 1981 - a long time. This is a small trust, administered by only five trustees. The purpose of the Trust is to collect, hold and verify royalties paid into the Trust by the operating companies, German subsidiaries of the Exxon Mobil Corporation (XOM) and the Royal Dutch/Shell Group of Companies (SHEL).

The trust then pays out the royalties in whole cents on a quarterly basis, after making allowances for administrative expenses. This is the structure of most typical trusts.

NRT does not have any debt, nor plans to take on debt. In fact, the trust is not permitted by law to take on any debt, and would have to adjust its Trust agreement prior to be able to take on debt.

The aforementioned royalties come in from the sale of fossil resources - natgas, oil, sulfur, condensate - extracted by operating companies from the trust's overriding royalty areas. These areas are found in Northwestern Germany. These are held through certain concessions or leases - and only in Germany.

Additionally, the Trustees and Managing Director are responsible for complying with all the legal and financial requirements imposed upon a publicly traded business. The trust and Trustees do not conduct any active business activities or operations - all they do is monitor, verify, collect, hold, invest and distribute royalty payments.

Trust "assets", are as follows.

The primary property is the so-called Oldenburg Concession, which covers 1,386M acres in Lower Saxony, where the resources are extracted. This is currently 100% of all the royalties received. The Oldenburg concession is held by Mobil Erdgas-Erdol GmbH, a German operating subsidiary of ExxonMobil, and by Oldenburgische Erdolgesellschaft. As a result of direct and indirect ownership, ExxonMobil owns two-thirds of OEG and the Royal Dutch/Shell Group of Companies owns one-third of OEG.

The specific royalty, in this case, is that rights covering the western part of the Oldenburg Concession, which amounts to slightly less than half the acreage, NRT receives a 4% gross receipt payment from the sale of well gas, crude oil and condensate. Aside from this, the trust is also entitled to a 2% royalty on Sulfur, which is obtained as a by-product from sour-gas operations from this portion of the agreement, with prices set annually depending on inflation.

Here is the 2021 split on these sales, in terms of product...

...and in terms of acreage.

In short, 2 agreements guarantee NRT a continuous cash flow based on certain acreage in the area of lower Saxony. Operations in these areas include a desulfurization plant (because German gas has plenty of hydrogen sulfide, which needs to be removed prior to feeding it to commercial usage), drilling rigs, sour gas wells, and other operations - but the assets on the land only matter insofar as what they generate, since the trust does not operate them.

Despite the Trust's name, most of the company's income, as you can see, is actually gas. There is virtually zero crude exposure, which makes sense because Germany does not have a whole lot of crude (compared to other nations). You can also understand why this company, when comparing it with Russia, didn't exactly endear itself to investors prior to the current geopolitical macro - but why the situation at this particular time is very different indeed.

I belong to the camp that does not believe Russian gas will flow to the EU as before. Because I am of this opinion, I'm in favor or positively inclined towards qualitative methods of EU solving its own problems with regards to energy.

Macro factors are a big thing worth considering before even looking twice at NRT. The Trust is a very suitable investment for a high-inflation/high-energy-price scenario because the entire sector tends to perform well during such periods.

The second consideration is that NRT is perfectly suited to the climate, because Germany is in near-endless need of energy - and the more can be sourced at home, the better it currently is for the company.

Europe unwinding from its Russian dependence won't be a thing overnight. But it's ongoing, and these are operations that have to be part of that solution. There won't be any issue for the companies involved here to sell its natural gas in Germany for the foreseeable future. Again, this is a tailwind, made doubly interesting by inflation.

So, to conclude here - the theoretical upside to this company is massive. The company also pays out most of its revenues to its unitholders, and the future clarity regarding growth or operational CapEx is very transparent - because there is no CapEx, there is no operational growth, and there are no business segments.

That makes this company "easy" to look at. It's 0.5-4% of the sales from a 1.38M area in lower Saxony. C'est tout.

However, let's now dig into some of the risks of the business and investment. Because obviously, these exist.

Let's start with the elephant in the room. The company's royalty incomes are entirely dependent on the viability of the 1.38M acres in Oldenburg. Just how good are these?

The main problem is a lack of exploration in recent times. XOM and SHEL are responsible for Exploration and wells, and neither has been particularly active in Europe, with only recent months seeing massive activity from several parties. Vermilion (VET) is another player, but they haven't done anything here either.

The current asset base is looking quite thin. 2021 reserves saw net gas well reserves down at ~5,430 mmcf, and this is the company's main royalty generator. This means that to current assets, there are far less than 10 years of viable production left. Barring more exploration, the company doesn't seem that convincing. However, more drilling and exploration now seem far more likely. Higher prices can also change the company's viewing of what are classified as "uneconomic reserves", to actually producing reserves.

With current energy prices, it's also highly likely that we'll see even higher income, and consequently, higher payouts. The company's payouts are entirely variable and dependant on sales - which means that there is very little, or almost no safety to these.

The company's valuation metrics also look somewhat questionable to say the least, with extremely high P/B ratios due to how the company handles liabilities and equity. However, there are bookkeeping explanations for these extremities, with this particular one relating to liabilities including pending cash payouts.

The biggest risk is, as I see it, the "momentary" appeal of this company in the current environment. Any shift in inflation or gas prices or the energy markets will have a significant impact on the business. This certainly wasn't always a high yielder - it typically lies closer to 3-5%, not over 10% as it currently is.

Valuation for the business is tricky from some perspectives. P/B multiples are extremely skewed - and we have somewhat skewed P/E multiples as well. Sales multiples are also very elevated - frankly, every multiple we can look at is somewhat skewed to the sector average here - both historically, and now as well, with P/B multiples of close to 440x and sales multiples of 12x, which is approaching growth company territory.

No S&P global or FactSet analyst follows the company, which means we have no forecasts and no real comps to put the company in context to. This is an incredibly specific and focused royalty company, even if there were other companies in the same space like it, we'd still have to argue comparativeness due to the fact that so much hinges on the specific geography the company is active in. The trust also doesn't hold any sort of earnings calls.

In the end, a company is only as good as the safety I can ascertain when looking it over. Even if many things with NRT are appealing, there are a lot of fundamental uncertainties that cap the upside we're able to consider valid for the business.

This does not make the company entirely uninvestable, but it does make it tricky.

As long as energy prices keep spiking, the company's yield can approach as much as 12-30% per year. But this is, I believe, a temporary situation. Once the situation normalizes a bit, which I believe will happen in less than 24 months, you'll see a different reaction to NRT, and then it won't matter that much if you've managed to eke out double-digit returns through dividends unless you have the foresight to "get out" in time.

This is the sort of thesis or play I'm not that interested in. It might be a good exposure to natgas prices - EU ones - but there are many ways that are far safer, where you can invest in European energy at a lower risk.

It's not that I'm uninitiated when it comes to investing in trusts. I've previously invested in Boston Pizza (OTC:BPZZF) as well as a number of other Canadian Royalty trust structures and seen good returns with them. Ultimately, I decided that I want different sort of investments rather than royalty trusts - and this is especially true when the underlying income generation comes from volatile fossil fuels/inputs, and from one very limited geographical area.

Despite being an interesting play, I would consider this company a "HOLD" here, and say that there are better plays even for income investors.

If the company reached below 5x sales, I might be interested in going in with a speculative sort of position here, provided we get some clarity in terms of reserves. But until then, I say "No" and "HOLD".

My PT for NRT would be around $7/share - and we'd need to revisit the energy market prior to buying.

My thesis for NRT is as follows:

Remember, I'm all about: Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.Invesco is currently in a position where #1 is possible in my process, through #3 and #4.

Here are my 5 criteria and how the company fulfills them (italicized)

The company discussed in this article is only one potential investment in the sector. Members of iREIT on Alpha get access to investment ideas with upsides that I view as significantly higher/better than this one. Consider subscribing and learning more here.

This article was written by

36 year old DGI investor/senior analyst in private portfolio management for a select number of clients in Sweden. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.

I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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