Canadian Energy Infrastructure Income Trusts: The Big Picture

by: Cliff Wachtel

Comparison to U.S. Energy Infrastructure Master Limited Partnerships (MLPs) – Similarities and Differences

These are similar in a number of ways to their U.S. version, the Energy Infrastructure Master Limited Partnerships. Those U.S. MLPs that we’ve recommended offer yields around 9% that are very reliable. Because they operate almost exclusively in the U.S., they don’t offer a USD hedge. However, their monopoly supplier status for vital oil and gas in their areas of operation gives them pricing power (tempered by regulators) to pass along cost increases, thus providing a considerable degree of inflation protection. Significantly, they don’t have the uncertainty of the Canadian 2011 tax changes. They will continue to be tax free at the entity level, passing along both income and expenses to share holders.

We will deal with these U.S. MLPs in depth in future articles. However, for now, here’s a list of our favorites:

· Buckeye Partners (NYSE:BPL)

· El Paso Pipeline Partners (NYSE:EPB)

· Enterprise Products Partners (NYSE:EPD)

· Energy Transfer Partners (NYSE:ETP)

· Kinder Morgan Energy Partners (NYSE:KMP)

· Magellan Midstream Partners (NYSE:MMP)

· Nustar Energy (NYSE:NS) – also has an asphalt production arm that will benefit from both a shrinking number of suppliers and the Obama administration’s push for infrastructure projects like roads.

· ONEOK Partners (NYSE:OKS)

· Sunoco Logistics Partners (NYSE:SXL)

· TEPPCO Partners (TPP)

· Tortoise Energy Infrastructure Partners (NYSE:TYG) – actually a fund that serves as a basket of these kinds of businesses

1. Similarities

Like the U.S. MLPs, these Canadian midstream (pipelines and storage) firms:

· Must distribute most of their available cash (90% for the U.S. MLPs in most cases) after that needed for maintenance and of current projects and new ones needed to maintain or grow revenues.

· Don’t pay tax at the entity level. Until Canadian tax law changes in 2011, those that don’t elect early conversion to corporations are not taxed at the entity level, allowing higher yields. While there is some uncertainty about how 2011 driven conversions to corporations will affect these trusts, the bottom line is that our selections’ distributions should not be significantly impaired due to various factors discussed below.

· Their revenues are generally based on capacity sold in advance to energy producers regardless of whether that oil or gas is actually moved through their pipelines or not.

2. Advantages

Thus like their U.S. counterparts, they offer reliable, high yields. However, they offer some intriguing advantages.

· Higher Yields: Their yields are generally a bit higher than the approximately 9% average of the U.S. MLPs.

· USD hedge: They all pay distributions in CAD (usually converted to USD by brokers in the U.S.), thus offering a USD hedge.

· Monthly distributions: Most pay each month, not quarterly like their U.S. counterparts.

3. Risks

· 2011 Canadian tax changes may adversely affect yield: Yes, the 2011 driven conversion to corporations with an additional layer of tax at entity level raises questions about how well each firm will be able to maintain its yield. As a group, energy infrastructure companies have relatively high depreciation expenses that can offset taxes.

For example, those who own U.S. MLPs will often notice that they receive returns of capital in addition to income. This means that some of the distributable cash exceeds net income because these firms have high non cash expenses like depreciation of expensive pipelines, ships, storage tanks, and other related high capex facilities.

Also, our specific picks are growing their businesses and can be expected to ultimately increase funds from operations and thus distributions to make up for funds lost to taxes. Note that most Canadian companies do not pay full theoretical taxes due to careful tax planning.

· Currency Risk: Distributions and share prices in CAD can be a dual edged sword. There will be periodic declines in the value of the CAD against the USD.

See Part 9A for full details on why we believe the CAD will appreciate over the coming years against the USD. In short, a more conservative, healthier banking and housing sector that did not indulge in subprime lending has meant that the CAD supply is not expanding on anything close to the scale of the USD. While that isn’t the only factor to consider, it’s a big one.

· Market Risk. Like virtually all shares, they will move with the overall market. Note that all of these are relatively thinly traded, and thus volatile, since little selling or buying can really move their share prices.

Given the market and currency risk that remains, it’s very possible these will yet again power dive with the market. Pray that they do. That’s the best time to add as long as these businesses continue to perform.

Remember: energy transport and storage is one of the most recession resistant industries. Thus these are great defensive plays that pay you very well while you wait for recovery.




A. AltaGas Income Trust (OTCPK:ATGFF)

In addition to the usual combination of oil and gas extraction, gathering, transmission, and processing, this firm also has a green power generation division focused on wind and geothermal facilities, thus diversifying into another reliable and growing revenue source.

1. Advice

Buy under 12.15, Strong Buy under 1015. Yield over 17%.


In addition to the usual combination of oil and gas extraction, gathering, transmission, and processing, this firm also has a green power generation division focused on wind and geothermal facilities, thus diversifying into another reliable and growing revenue source.

2. Why: Q4 Highlights include

· 15.4% increase in funds from operations [FFO]

· Continued expansion of wind and geothermal generation assets in power hungry Western Canada

· Successful renegotiated credit agreement supports our view that the firm has no credit access problems in a generally restrictive market, and puts the company in a position to make further strategic acquisitions at bargain prices

· Payout ratio remains a conservative 72%, adding security to the distribution

3. Concerns

Impact of 2011 tax increases

Both the high yield and low payout ratio provide significant cushion against higher taxes. Cut this by a third and you’re STILL getting around 12%.

Like all energy infrastructure firms, high depreciation expenses will protect a substantial portion of distributions from classification as taxable income to tax free return of capital.

12 month growth in outstanding shares is about 23%

We’d like this below 10%, and consider anything over 20% to be too dilutive. We’ll accept this for now, based on the solid overall results and understandable reluctance to increase debt.

4. Conclusion

With their excellent performance in a tough market and timely emphasis on gas and other high demand “green” energy sources, insiders have been buyers on the price dips. Me too.

B. Pembina Pipeline Income Fund (OTC:PMBIF)

Owns and operates pipelines in the Alberta Tar Sands. While current energy prices have made tar sands oil unprofitable, that hasn’t slowed Pembina a bit. They get paid on a fixed rate of return basis, eliminating exposure to energy prices and even throughput declines.

1. Action

Buy under 12, Strong Buy under 10. Yield over 13%.


2. Why

To get a quick feel for how healthy Pembina is, consider just the following two facts:

· The contracts are obviously long term, and the firm has affirmed that it will be able to at least sustain its current distribution through 2015, despite its plans to convert to a dividend paying corporation (thus taxed at entity level) sometime in 2010.

· They continue to expand capacity, adding Horizon Pipeline system in July 2008, and are investing CAD 165 million in the new Nipisi pipeline and CAD 260 million in the Mitsue pipeline.

· Debt has grown but remains quite manageable when compared to revenues and cash from operations shown in the below mentioned MD&A. Click on the link to see for yourself. Outstanding share growth over the past 12 months is around 1%. They have the cash they need.

· A quick review of the Management Analysis and Discussion (MD&A – see$File/2008MD&A.pdf ) essentially shows increases in everything you want to see grow: Net earnings, cash from operations, distributable and distributed cash, etc. Debt levels are quite manageable. Enterprise value declined, but that is based on share price and thus much more a reflection on the overall market than the firm itself.

3. Concerns

Payout ratio is about 95%. We would prefer this to be below 90%, but given the very steady fixed fee revenue stream, this is acceptable.

4. Conclusion

Pembina is another classic case of a great investment getting unjustly slammed over confusion about its revenue health. While current energy prices may make the tar sands oil unprofitable, that has no effect on Pembina’s financial health or distributions until at least 2015. Ditto its conversion to a corporation in 2010.

C. Inter Pipeline Fund (OTCPK:IPPLF)

Created in 1997, Inter Pipeline Fund is a major petroleum transportation, storage and natural gas liquids extraction business based in Calgary, Alberta, Canada. Inter Pipeline is a publicly traded limited partnership (not a trust subject to 2011 tax changes) that owns and operates a diversified combination of energy infrastructure assets in western Canada, the United Kingdom, Germany and Ireland. This asset portfolio generates long-term and predictable cash flows, thereby providing unit holders with a growing and stable source of monthly cash distributions.

Note: As a Limited Partnership under the laws of Alberta, only Canadian residents can own units. Bummer for the rest of us, and thus vastly limited demand for shares that will limit price appreciation for Canadian residents.

1. Action

Buy under CAD 7.5, Strong Buy under 6.5. Yield about 13%.


Since this is only for Canadian investors, I’ll limit coverage to this brief mention and refer Canadians to the website for more info. Like the others above – steady revenues, great yield, plus exposure to the Euro as well as the CAD.

D. Keyera Facilities Income Fund (OTC:KEYUF)

Keyera operates one of the largest natural gas midstream businesses in Canada. Its three business lines consist of:

· Natural gas gathering and processing

· Processing, transportation, and storage of natural gas liquids (NGLs) and crude oil

· Marketing of Natural Gas Liquids (NGLs) and sulphur. This gives them both added risk because this segment is exposed to prices for these commodities, and added reward when these prices are strong or their hedging strategies work well.

Keyera's gas processing plants and associated facilities are strategically located in the west central and foothills natural gas production areas of the Western Canadian Sedimentary Basin. Keyera’s NGL infrastructure includes pipelines, terminals and processing and storage facilities in Edmonton and Fort Saskatchewan, Alberta, a major North American NGL hub. Keyera also markets propane, butane and condensate to customers across North America.

1. Action

Buy under 12.50, Strong Buy under 12. Yield over 14%.


2. Why

In short, great results.

Record earnings and distributions, declining debt levels: For details, see highlights from the annual report: ($File/2008%20Q4%20final.pdf

Continued ability to obtain affordable financing: On April 14th 2009, the firm announced a long term senior unsecured debt private placement for CAD 97 million at 8.06% and will mature May 1, 2016. The funds will be used to repay CAD 90 million of existing long term debt when it matures on October 1 2009. In the words of CFO and VP Dean Setoguchi:

“Our ability to complete this transaction at favourable rates, given the current economic situation, is a testament to the strength of Keyera’s business model and conservative approach to our financial management”.

Continued expansion: Not surprisingly, Keyera’s ability to prosper and obtain funding in this environment has allowed them to acquire strategic growth assets at favorable prices. In December 2008 the firm acquired additional interests in three gas gathering and processing facilities in West Central Alberta.

Reliable distributions: Payout ratio is a very conservative 55%, share growth a conservative 10%. Except for the NLG by products sales, revenues are protected by capacity based contracts unaffected by oil prices or throughput. That is, customers contract on a long term basis to pay fixed fees to reserve a given volume of product to move through Keyera’s pipelines and storage facilities.

3. Concerns

Revenues can be adversely affected by declines in the NLG by products sales.

4. Conclusion

Even with risks from some exposure to the NLG by products prices, the high yield and ultra conservative payout ratio provide a large margin of safety. As energy prices recover, the NLG business will be a bonus.

Conclusion, Disclosure & More Info

In sum, they provide among the best risk/reward available for high dividend investors. They are similar in many ways to U.S. Energy Infrastructure MLPs, with the added advantage of generally higher yields and a valuable USD hedge. While the 2011 tax changes will cause these to convert to corporations, impact on the dividends of these specific recommendations should be minimal to none for at least the next number of years.

Disclosure: I have positions in most of the above mentioned investments.