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Summary Cushing Royalty & Income Fund and Cushing MLP Total Return Fund have both gone through a reverse stock split. The press release suggests it was done for shareholders. That’s sort of true, but you shouldn’t thank the CEFs for it. On September 14th, the Cushing Royalty & Income Fund (NYSE: SRF ) (now known as the Cushing Energy Income Fund ) and the Cushing MLP Total Return Fund (NYSE: SRV ) effected 1 for 5 reverse splits. That changes very little for shareholders except the price of the closed-end funds, or CEFs. That said, a higher price is better in some ways, but you still shouldn’t be thanking the funds for this move. What changes? The first thing to keep in mind with any stock split is that it does nothing to a shareholder’s ownership in a company. Your proportional ownership remains unchanged. So, in many ways, a stock split is mostly about theatrics. But that can be important. For example, some companies split their stocks two for one when the stock gets to around $100 a share. The idea being that people are more likely to buy shares in a company with shares selling at $50 than one with shares trading hands at twice that level. Maybe, maybe not… but clearly it’s about the show since the split would just turn a $100 share into two $50 shares. Reverse splits like the ones SRF and SRV just did are a bit trickier. Sometimes a company’s shares are trading at such low levels that they risk being delisted by their exchange. In that case, the split has a very real purpose, but that’s normally only an issue that impacts true penny stocks. In other cases, the move is just a show. Investors often avoid low-priced companies because of a concern over the risk of owning a company with a low share price. Institutional accounts, for example, often have minimum share price limitations. That’s not an unfounded fear, but it isn’t always realistic either. So companies with relatively low share prices will sometimes do a reverse split to prop up the price to attract more investors. Reversing the above example, a company that did a one for two reverse split would simply take two $50 shares and turn them into one $100 share. An Investor’s stake in the company isn’t altered, just the share price and the number of shares he or she owns. What about SRF and SRV? So a split doesn’t really change anything, even though there may be good reasons to do them. Are there bad reasons? The answer is yes. The reverse split at SRF and SRV has been billed as: The intent of the reverse share split is to potentially increase the Fund’s market price per common share and trading volume, thereby reducing the per share transaction costs associated with buying or selling the Fund’s common shares in the secondary market. Sure, with a higher share price, it may be easier to trade SRF and SRV. But that’s not likely the reason for the split. Although neither was at the point where you’d worry about a delisting, both were at the point where investors could reasonably be scared off by the low price. So the reverse split makes both SRF and SRV appear a bit more respectable. The problem is that both have made material use of return of capital in recent years. In fact, SRF has supported its distribution with nothing but return of capital since its initial public offering in early 2011. The net asset value, or NAV, fell from roughly $23 a share at the IPO to $5.60 at the end of May. By the time of the split, the NAV had fallen even further, falling into the $3.80 a share range. That’s brutal, particularly for a fund that’s only provided return of capital to its shareholders. The fund’s goal , by the way, is to seek a high total return with an emphasis on current income. I’m hard pressed to see how it’s lived up to that objective. SRV has done a little better, with its NAV falling to the $3.75 a share range before the reverse split from around $5.75 or so in late 2009. However, the high in the period was an NAV of around $8. So for many investors the NAV drop has been pretty harsh. And return of capital has been a big part of the distribution, representing roughly 60% of the disbursement between December of 2009 and May of 2015. That’s not a good number, but, to be fair, not nearly as bad SRF’s 100%. No dividend cuts, yet… At this point, neither fund has enacted a distribution cut. But with SRF offering a yield of over 15% and so much return of capital, I wouldn’t expect the payment to hold up. And if it does, then the split was cosmetic in that it helps to hide the fact that the fund has basically been self-liquidating since the day it came public. Based on the numbers, I just find it really hard to buy into the “ease of trading” logic the fund is using to justify the reverse stock split. SRV’s reverse split doesn’t look quite as bad, since the CEF yields around half as much as SRF. That could actually be sustainable, but only if the oil and gas sector on which the fund focuses turns around. If that doesn’t happen soon, the note in the split announcement highlighting that the September distribution was expected to be all return of capital is a not-so-subtle problem. And it could just get worse if low oil and gas prices force more dividend and distribution cuts in the oil and gas sector from which SRV generates its income. So SRV will be “easier to trade” too. But bumping up the share price via a reverse stock split still looks more like an attempt to paper over the trouble brewing with the distribution and NAV. Not where you want to be SRF and SRV are focused on a rough area of the market. If you are a contrarian that might interest you. But the high levels of return of capital for funds that have seen their NAVs fall dramatically should be a big concern. And the reverse stock split does nothing to change that dynamic – unless potentially large distribution cuts are made. The reverse split will probably make it easier to trade SRF and SRV, as the CEFs suggest. However, the splits look more like an attempt to cover deeper problems to me. I would avoid this pair. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) 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. Scalper1 News
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