High-Yield Canadian Royalty Trusts vs. Dividend Growth Stocks

Dividend growth stocks typically leave themselves some wiggle room in order to lessen the probability of a dividend cut due to earnings volatility. That’s why normal recessions don’t stop them from increasing distributions. They do pay out lower yields, but the dividend payments are stable, growing and you know that the cash, which the company generates, is also reinvested into the business. The balanced approach of rewarding shareholders while also growing the business is very appealing to income investors who are looking for an inflation proof form of dividend income. Investors who selectively purchase from the dividend aristocrats, dividend champions or dividend achievers lists are true visionaries who do not chase high current yield but look for stable, wide moat businesses which could generate enough earnings in order to support long term earnings and dividend growth in addition to expansion of the business. Nobody ever bought Wal-Mart (WMT) for its yield – yet it has been one of the best performing dividend growth stocks over the past 3 decades.

High Yield Canadian Royalty Trusts on the other hand pay all of their cashflows out as dividends. They grow by selling more units and diluting your stake. There is also some uncertainty about the tax structure of the income trusts after 2011. Currently there are imposed limits on the amount of units Canroys could sell in order to maintain their current status by 2011.

Many investors believe that CanRoys are the only solution that generates enough income for them to supplement Social Security. Actually you shouldn’t spend more than 4% of your portfolio every year. If you do, you are risking spending it all before you die, which is not a good solution for most retirees.

It’s great to receive a 12% yield on cost, but you have to ask yourself how sustainable is that payment? What if the dividend is cut by 50%? Then you are only making a 6% yield on cost. If you are a retiree who is living off their portfolio, spending up to 4% of your portfolio would leave some unused balances to be reinvested and provide some buffer in bad years. If you need an income trust yielding 20% in order to retire, then you don’t have enough money to stop working.

Dividend Growth investors tend to purchase the aristocrats and the achievers primarily for their smoothly growing dividend payments. Stock prices are volatile enough to stomach, thus a dependable and a growing stream of dividends is providing a safety cushion even during the worst bear markets over the past 70 years. If you also have volatility in dividends, then retirees can’t safely live off their investments.

An income investor should not concentrate only in the sectors, which are traditionally the best yielding ones. For example dividend investors have traditionally bought utilities and financials for their stable yields. The 2007-2009 financial crisis has pretty much left financials out of the income investor’s radar screen.

Canadian Income Trusts were very popular among income investors up until 2006 when Canada decided to gradually phase out the Income trust structure by 2011. Since then trusts have cut dividends across the board as their stock prices have collapsed.

Pengrowth Energy Trust (PGH), which engages in the acquisition, ownership, and operation of working interests and royalty interests in oil and natural gas properties in Canada, currently yields 15.80%. The current monthly distribution of $0.081/share is 63% lower than last year’s payment.

Penn West Energy Trust (PWE), which engages in acquiring, developing, exploiting, and holding interests in petroleum and natural gas properties and assets, yields 21% at the moment. The most recent monthly distribution of $0.187/share is 44% lower than last year’s payment.

Advantage Energy Trust (AAV), which operates as an oil and natural gas exploration and development company, has discontinued distributions according to its most recent March 20 press release.

Harvest Energy Trust (HTE), which engages in the exploitation and development of petroleum and natural gas properties in western Canada, has reduced its monthly distributions by 87% over the past year to $0.039/unit. The trust currently yields 11.50%.

The lesson to learn is not to put all your investments in one basket, such as one sector for example.

Remember the story of the tortoise and the hare – the slow and steady wins over time, not the hit or miss approach.

There are many dividend aristocrats whose dividends are safe and would be growing over the next several years. A sample list of dividend aristocrats, which have been growing payments for over 25 years include:

McDonald’s (MCD), which franchises and operates McDonald’s restaurants in the food service industry worldwide, has been a consistent dividend grower for 32 consecutive years, currently yielding 3.50%. (analysis)

Pepsi Co (PEP), which manufactures and sells various snacks, carbonated and non-carbonated beverages, and foods worldwide, has rewarded shareholders with dividend increases for 36 consecutive years. The stock currently yields 3.30% ( analysis)

Johnson & Johnson (JNJ), which engages in the research and development, manufacture, and sale of various products in the health care field, has increased dividends for 46 consecutive years. The stock currently yields 3.60%. (analysis)

Disclosure: Author is long JNJ, PEP, MCD and WMT

Comments

[BrunoT:]

For god's sake someone edit this columns to elminate the ones by those who know little more than the guys around the coffee machine at work.

Even after severe drops in dividends after oil prices crashed late last year (not because unit/stock prices dropped, that is not a factor in dividends) a 10-20% dividend is still light years ahead of anything else. And when oil rises back (it's already way up from the lows earlier this year) the dividends will rise again.

Do you seriously think that during a major depression that may last years your stocks will have real inflation adjusted gains equal to that? Insanity.

You also failed to mention that when the dollar drops in value soon and the canadian dollar doesn't, those dividends will get a multiplier effect from the currency exchange that could add significantly. Or that when US oil stocks get hammered with "excess profit" taxes by a democrat congress as oil prices rise, Canadian ones may not.

And finally, the unit price of these canroys is 1/3 what it was less than a year ago, and dividends have already been adjusted to the lower price of oil. Even if oil halved again they could STILL pay out more than the stocks you listed above. But what if oil returns to even $120/bbl? They double in unit price AND dividends are raised.

I have some PWE purchased that yields me almost 30%. And the unit price is up over 50% since I bought it a few months ago. So stick that in your pipe and smoke it, "expert".



How hard is that simple concept to understand?

Apr 29 10:10 AM

[wobatus:]

Bruno T., chill, he just says don't put all of your eggs in that basket. I have some ERF and have taken a hell of a beating, but i also own mcd, mmm, pg, pfe (which unfortunately cut), hnz, bmy, dvy, wmt, intc, msft, gs, gfig, nm, plus some other income producing sources, mtp, hio, ncz, avk, bny...along with some non-dividend stocks.

Balance. i don't plan on selling my erf, and may add some other canadian trusts, although i'd like to see what the new corporate forms will be, how the law plays out, etc.

You may a good buy of pwe at a trough. Good for you. I think the author is talking more about someone looking for retirment income long term.

Apr 29 10:20 AM

[mplaut:]

Too many people think that the Canadian Royalty Trusts are just a generic type of company and are interchangeable. They are not. There are well-run ones and poorly run CRTs. Look at Crescent Point Energy (CPG-UN.TO or CPGCF.PK). It has not cut its dividend and shows no signs of doing so. It is growing despite the headwinds. Its yield is correspondingly lower than the other CRTs but at over 10% it is still much higher than 3-4%.

There are also similar American companies, known as MLPs. The best ones are fully or nearly fully hedged (LINE, EVEP). They have not cut their distributions nor are they likely to in the near future (3+ years based on their hedges).

Apr 29 11:03 AM

[GMiki1:]

What Bruno T said. Great time to buy energy and definitely to buy the Canroys. The Canadian dollar will certainly rise against the U.S. dollar. As for retirement income--good question. Water utilities perhaps. And yes, hopefully the U.S. Congress won't ruin U.S. energy and mining enterprises.

Apr 29 11:07 AM

[huangjin:]

The other thing to consider is taxes. Some royalty trusts sent out a K-1. Some investors recapture Canadian witholding of taxes on their dividends, while others forego the recapture and avoid the tax headaches by holding the stock in an IRA.

Apr 29 11:20 AM

[Alok Swain:]

To hold Canroys in the IRA is a bad idea, hold in an ordinary taxable account and get tax credits on those 15% foreign witholding taxes.


On Apr 29 11:20 AM huangjin wrote:

> The other thing to consider is taxes. Some royalty trusts sent out
> a K-1. Some investors recapture Canadian witholding of taxes on their
> dividends, while others forego the recapture and avoid the tax headaches
> by holding the stock in an IRA.
>

Apr 29 09:41 PM

[Alok Swain:]

1) Although I agree in general with the main theses of this article
a) Diversify your dividend income sources.
b) Look for sustainable dividend yields not just large dividend payouts.

2) But I have to agree with BrunoT here, Canroys today at the prices they are trading for, are a steal. We are going to kick ourselves in a couple of years for not buying those at current prices. Higher oil prices in the future are virtually a certainity. The longer the oil remains flat at this level, the bigger would be the explosive move upwards in the future. And I think today Canroys are the best way to make that bet on Oil and get paid monthly at double digit taxable yields (almost 9-10% or so after you deduct 15 % foreign witholding tax) while you are waiting for that to happen.

3) As I look at the Canroys today at the current prices, say around ($4.80 for HTE) or ($4.50 for PVX), I would say they have the best feature of (convertible bonds + warrant on OIL prices) without the negative of each.

4) And to see those Canroy dividends being credited in my account every month (which I always look forward to) I feel like crying out loud like Jim Cramer... Kaching Kaching... :-))

Disclosure: Long (HTE & PVX)


On Apr 29 10:10 AM BrunoT wrote:

> For god's sake someone edit this columns to elminate the ones by
> those who know little more than the guys around the coffee machine
> at work.
>
> Even after severe drops in dividends after oil prices crashed late
> last year (not because unit/stock prices dropped, that is not a factor
> in dividends) a 10-20% dividend is still light years ahead of anything
> else. And when oil rises back (it's already way up from the lows
> earlier this year) the dividends will rise again.
>
> Do you seriously think that during a major depression that may last
> years your stocks will have real inflation adjusted gains equal to
> that? Insanity.
>
> You also failed to mention that when the dollar drops in value soon
> and the canadian dollar doesn't, those dividends will get a multiplier
> effect from the currency exchange that could add significantly. Or
> that when US oil stocks get hammered with "excess profit" taxes by
> a democrat congress as oil prices rise, Canadian ones may not. <br/>
>
> And finally, the unit price of these canroys is 1/3 what it was less
> than a year ago, and dividends have already been adjusted to the
> lower price of oil. Even if oil halved again they could STILL pay
> out more than the stocks you listed above. But what if oil returns
> to even $120/bbl? They double in unit price AND dividends are raised.
>
>
> I have some PWE purchased that yields me almost 30%. And the unit
> price is up over 50% since I bought it a few months ago. So stick
> that in your pipe and smoke it, "expert".
>
>
>
> How hard is that simple concept to understand?

Apr 29 10:03 PM

[Dividend Gr...:]

Thanks everyone for commenting on this post. While I am not a big fan of canroys I do agree that some allocation to them could be beneficial. What really concerns me are two things:

1) Dividends fluctuate greatly with cash flow and earnings

2) The 2011 Tax changes.

While manay Canroys such as PWE claim to have substantial tax pools going till 2013, US investors could see their taxable income from Canroys fall substantially assuming distributions remain unchanged.

A quote from Penn West's (PWE) 07 Annual Report goes as follows:

"If structural or other similar changes are not made … For U.S. investors, the distribution yield net of the SIFT and withholding taxes would fall by an estimated 25.1 percent in 2011 and 23.8 percent in 2012 and beyond."

The new Albertan Provincial Royalty Tax will hit the Trusts on their conventional production in 2009 with at least a 10 percent increase,

Currently, there is only a 15 percent Canadian withholding for US investors, but you could get tax credits in the US to offset that.

What truly worries me is that Canroy investors ignore these facts, which are pretty certain to occur nad instead keep HOPING that the US dollar and oil and nat gas prices would increase.

Apr 30 03:09 AM

[Canadian Guy:]

All non-real estate Royalty Trusts will be forced to change their structures to corporations after 2011. For some, like Penwest or Pengrowth it wil mean changing monthly distributions to quarterly dividends. If the payout amounts do drop a bit it may not be that much since the world economy will have recovered (at least partially) by then and oil prices should have increased enough to improve the trusts profitability.

As for real estate trusts, while the U.S. market continues to get crushed, the Canadian market looks to be more like a cyclical down cycle. RIOCAN is a multi-billion dollar real estate trust paying out approximately 10% with a record of NEVER having cut its distributions. It is well run and has a highly diversified porfolio of shopping malls and office towers, with an average occupancy of 97% and the vast majority still being 100% occupied. In their retail malls they have anchor tenants like the big 5 Canadian banks, Wal-mart, or large grocery stores, so their malls always have traffic.

While the 2011 change will mean that RIOCAN can no longer use mezzanine financing to raise cash it does not mean it will be forced to change its structure to a corporation and it will continue to be profitable and pay out its distributions.

Sorry to sound like an advertisement, but I researched alot of them and have made RIOCAN one of my core Canroy holdings.

Apr 30 08:56 AM

[Ames Tiedeman:]

As Oil moves up one would suspect that the dividends from the Canadian Royalty trusts will increase over time. The deep cuts have offered a great entry point for a future capital gain and future, higher dividends. As Oil moves back to $70.00 you will see higher dividends and unit appreciation.

Apr 30 09:08 AM

[grbn:]

so avoid the CanRoys at 15% and stick with McDonald's at 3.5%?? Seem like a long way around just to say "diversify".

Apr 30 10:32 AM

[Prescient:]

I appreciate the insight given by all.

The ALPHA writer is correct in recommending that retires not spend more than 4% of their portfolio or to assume CANROYS will always payout at present or historical rates. However when it comes to evaluating them as "investments", he seems to drive with a rear view mirror -- he says that Canroys are hares and MCD, PEP, JNJ are tortoises and therefore better investments because they have not been beaten down. What's there to to prevent them from get beaten down in the FUTURE? Is he recommending a Buy high Sell low philosophy? Many Corporations doctor their books to smooth out their profit/dividend growth and to hide their fundamental performance from investors. IBM did it for years in the 90s b4 it crashed. Overpaid and overrated Wall Street stiffs thought it had to do with a year or two of bad management. Not!

Dividend Growth Investor mentions how the tax law changes will affect payouts -- very useful information indeed. But even with those changes, the dividend is still very, very good. As a matter of fact, the low stock prices ALREADY reflect the tax law impact. What makes the CANROYS good or bad investments , is the projection of whether oil prices will stay where it is, or whether it will go up. I do not have a crystal ball on oil prices, but if oil goes up, stock prices will certainly go up in tandem. So will dividends. Whether the CANROYS become corporations or not has no bearing on whether they make good investments. If they convert, they would just plow more of their profits back and grow their business. Their payout will be less, but their stock prices will increase, as their NAV increase.

Apr 30 12:51 PM

[mbkelly75:]

I have both CANROYs and Dividend Elites in my portfolios and benefit from both. Yes - the CANROYS are down off their highs but the ones I am in are off their lows too. The high yield makes them worth concideration for being in any portfolio and re-investing the dividends as you get them on a monthly basis is paying off well for me. I believe that Oil and NatGas prices will go up and I also see the returns being paid in the Canadian Dollar to be an advantage over the long term as a defense against US Dollar inflation. Even if you buy the CANROYs for your Speculation Portfolio instead of your Core Portfolio - they are worth having.

Apr 30 01:05 PM

[henarl:]

Everybody's circumstances are different. It depends on your age and your time frame. Canroys, MLPs, tanker stocks, etc. pay double digit yields today but are subject to high volatility, both in yield and share price. They are better short term income investments.
Dividend achievers, such as those listed by the author, pay a much lower current yield but have a long history of dividend increases and share price growth. They are better long term income investments.
I am long XOM, which has experienced an excellent share price growth over the years I have had it but has a very small current dividend yield. I am also long HTE, FRO, and several MLPs, all of which have high current yields but are down in share price since I purchased them.
For someone in their thirties, forties, or fifties, dividend achievers are a good way to go. I am 78 years old and no longer have the time to wait for the slow dividend and price growth of these positions now and so the high dividend holdings make more sense for someone my age.

Apr 30 02:15 PM

[football frank:]

American investors will benefit from the US dollar falling long term,
especially with all the debt congress, and the government is
adding. The Canadian dollar will rise, following the price of oil
long term also.
I think a mix of trusts, stocks, and ETF's would be a
great balance of holdings, especially with dividends, pay outs,
and distrabutions re-invested back into more shares / units.
Depending on your income level, tax rates will rise for trusts.
As for oil trusts, ETF's, and stocks It's a great time to buy
for long term investors

Apr 30 02:39 PM

[WKMA:]

as I read this, I would like to add the following:
nly - hts - nymt -hfs....al 4 payind 15%+ dividends.
ex: hts at 24 '17%' vs nly at 14 '14%'.
consider 10000 shares of each and compute the dividend of each.
WKA

Apr 30 06:31 PM

[einstein p ...:]

I have been buying PWE under 10, along with PBT under 9 --- both for my IRA, with the dividends reinvested. There is no reason not to have these in a retirement account. I'd check with your accountant. While your at it take a look at PRGN for diversification at 3.50. With a 5% yield, it's another great stock to hold for an IRA.

May 01 07:05 AM

[wobatus:]

I don't think you read through. :)

The question is sustainability of the yield. The factors include:

1) energy prices
2) the reserves of the canroys (some replenish more or deplete faster than others)
30 currency
4) corporate structure and canadian tax law (did you pay attention to the mention about the change in tax law).

You cannot look at, say, JNJ's yield, which has increased every year for 46 years, and compare it to a canroys that may (will) fluctuate.

Not to say the canroys or particular ones are not good deals. Depends on the price.


On Apr 30 10:32 AM grbn wrote:

> so avoid the CanRoys at 15% and stick with McDonald's at 3.5%?? Seem
> like a long way around just to say "diversify".

May 01 11:24 AM

[Andy1234:]

I read most of the comments.


Remember that when oil prices increase (or the dollar decreases)....most of the price of oil is from the decline of the dollar....but I do think soon the fundamental price from peak oil may increase in real terms because of scarcity.

If the dollar decreases and the canadian loony increases....that just means the operating costs of the conroy's increase.....so I think the conversion argument it moot.

I like NG and oil stocks period.....they sell products that don't go out of style....and its simple to understand supply and demand. While prices might be depressed now.....the cost to produce oil is above the cost of oil right now....so new projects are not going to come online......this leads us to believe that oil will have to increase in the future....especially if inflation comes along raising the cost of production even further.

RIGHT NOW.....and the coming months are the time to pick up oil and NG producers......limited downside and great upside potential.

You buy when things look the worst for each sector......and you start buying conservative stocks like the author mentioned when the price of oil is much higher than the production costs of new oil coming online...and when inflation is running rampent...and a huge speculative bubble can be seen in housing;)

May 04 09:02 AM

[konchan:]

Interesting reading. I have a question. IS there a way to recoup the Canadian taxes on the CANROY dividends if I am an American taxpayer? Thanks!!

May 07 03:10 PM

[SteveB/Colo...:]

I agree: interesting reading, especially the emphasis on portfolio diversity. I'm not sure, however, that the author is fully up to date on the CanRoys. Following is from the May issue of Leeb's Income Performance Letter (note: Dr. Leeb is historically bullish on energy stocks in general and generally bearish on the CanRoys).

His associate writes, in a review of HTE, "Under a 2006 proposal, Canadian trusts would be taxed like other corporations (at the 31.5 percent rate) beginning in 2011. Trust shares tumbled when the news hit because this would eliminate their major advantage. But other plans have since surfaced including bringing the tax back to 10 percent and not allowing any more trusts to be created."

It would appear that the plan for the big change at beginning of 2011 is not a done deal. Or to put it differently, cooler & smarter minds may yet prevail in Ottawa.

For Konchan, you can recoup some of the Canadian taxes you pay when you file your US tax return by completing form 1116.

May 10 08:08 PM

[K. Argenta:]

I still hold a lot of "Canroys",+ they still pay better than U.S. stocks. I just recently bought WMI, because they pay an attractive dividend and they have waste burning generator stations and they recycle a lot of their other by-products. Beats the crap out of coal burning generators, or gas fired generating stations which really rack up a home-owners bill. Another good stock is FPL which I bought on the low.

May 12 06:48 PM

[anarchist:]

That might cut your dividend a couple %, no big deal. If your brokerage firm has tax information available to you then most of this stuff is calculated for you-or at least it is at Interactive Brokers.


On Apr 29 09:41 PM Alok Swain wrote:

> To hold Canroys in the IRA is a bad idea, hold in an ordinary taxable
> account and get tax credits on those 15% foreign witholding taxes.
>

May 15 03:17 PM

[square to t...:]

BrunoT,
I agree with the other comments that you are taking the point of the article out of context a bit. Congrats for buying at or near a low. Even the best money managers in the business acknowledge how difficult that is to do with consistency.

However, I'll challenge you blanket statement that the CanRoys are a way to play the dollar, which is sure to fall. First, just because you and I have a strong feeling that the dollar will fall, doesnt mean its going to happen. Warren Buffet looked pretty bad with his $2 billion unrealized loss in 2006 when he bet against the dollar. (That, obviously, changed.)

Second, many of these CanRoys are definately not a good way to play a weakening US dollar. The reason is quite simple. Many of the trusts like PWE and ERF recieve much of their revenue in US dollars. I'd suggest you doing a little more research to understand the extent in which your investments have various currency exposure.

Jun 16 09:20 AM

[suncat:]

Bruno;
U R RIGHT ON ! The more I read, the more agitated I got. This piece of nonsense should be seeking more than 'Alpha'; it should find the round file. And as far as someone telling u to chill out...if they think this drivel is worth their time to read, I hope they graduate oo kindergarten. It's simple...u c a piece attributed to - "Seeking Alpha"; don't waste your time, IMHO.
suncat

On Apr 29 10:10 AM BrunoT wrote:

> For god's sake someone edit this columns to elminate the ones by
> those who know little more than the guys around the coffee machine
> at work.
>
> Even after severe drops in dividends after oil prices crashed late
> last year (not because unit/stock prices dropped, that is not a factor
> in dividends) a 10-20% dividend is still light years ahead of anything
> else. And when oil rises back (it's already way up from the lows
> earlier this year) the dividends will rise again.
>
> Do you seriously think that during a major depression that may last
> years your stocks will have real inflation adjusted gains equal to
> that? Insanity.
>
> You also failed to mention that when the dollar drops in value soon
> and the canadian dollar doesn't, those dividends will get a multiplier
> effect from the currency exchange that could add significantly. Or
> that when US oil stocks get hammered with "excess profit" taxes by
> a democrat congress as oil prices rise, Canadian ones may not. <br/>
>
> And finally, the unit price of these canroys is 1/3 what it was less
> than a year ago, and dividends have already been adjusted to the
> lower price of oil. Even if oil halved again they could STILL pay
> out more than the stocks you listed above. But what if oil returns
> to even $120/bbl? They double in unit price AND dividends are raised.
>
>
> I have some PWE purchased that yields me almost 30%. And the unit
> price is up over 50% since I bought it a few months ago. So stick
> that in your pipe and smoke it, "expert".
>
>
>
> How hard is that simple concept to understand?

Jun 16 10:48 PM

[jfr1107:]

HTE's stock is not going to go back up until management makes good on raising the dividend once they have paid down $200MM in debt. Note: the increase in the dividend doesn't have to go back up until the dividend goes back up.
When I read all of the hogwash about HTE paying 10-11% in dividends, the percentage is based on a per share price somewhere in the 5's. I want to see the people who invested in HTE when it was selling for $25 to $30 a share. If the dividend goes back up, then the stock might (and there is a pretty good chance) that HTE will reach $13+ a share. They are making money. It is only the accountants and their shell games that make HTE look like it is a losing company.
Management needs to get its act together and do the right thing for their shareholders and quit looking 2 to 3 years down the road for potential buyers. Make money now with what you've got.

Aug 18 01:02 PM